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Fraud: Tax guidance for fraud victims

October 24, 2014 Article 1 min read
Authors:
Michelle D. McHale-Adams

Woman watching the sunset over a cityscape 

Annually, thousands of taxpayers and businesses fall victim to fraudulentactivities. As with many tax issues, the nature of the fraud will determinehow the loss is reported. While determining the deductible loss dependson several factors, it is clear that fraud losses are deductible in the yeardiscovered, so don’t delay reporting them.

If you’re an individual who’s experienced a theft of personal property,the loss is limited to the amount in excess of 10 percent of your adjusted grossincome. The loss is deductible as an itemized deduction.

If you’re a business that’s experienced a theft loss, the loss will generallybe deducted as an ordinary deduction. Losses previously deducted on aprior tax return, possibly as a normal business expense, cannot be deductedagain.

For both personal and business losses, proceeds received from theperpetrator or insurance reduce the loss that can be reported. If the lossis covered by an insurance policy and a claim is not filed, the IRS coulddisallow the deduction for not pursuing all means of reimbursement. Thesame disallowance may also apply if a police report is not filed.

While these items pertain to fraud losses that most taxpayers are familiarwith, how are losses from a Ponzi scheme deducted? In responseto large losses incurred by investors in Madoff’s Ponzi scheme, the IRS issued guidance in March 2009 on the tax treatment of theft losses fromPonzi-type schemes. While the guidance was intended to offer a theft lossdeduction to Madoff’s victims, its provisions apply to victims of all Ponzi-typethefts. The guidance provided clarity regarding when losses can bededucted and how recoveries are treated.

Lastly, technology has allowed the creation of a virtual currency, bitcoins,which has gained popularity and usage. However, even this virtual moneyis vulnerable to fraud and theft through online “robberies” from bitcoinexchanges. Thankfully, the IRS ruled earlier this year that stolen virtualmoney can be deducted as a theft loss. The challenge is valuing theamount of the loss. Since bitcoins are volatile, the loss is valued at thelesser of the price paid for the bitcoins or its current value. As always, thetaxpayer has the burden of proof in determining the basis or the value.

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