Annually, thousands of taxpayers and businesses fall victim to fraudulent activities. As with many tax issues, the nature of the fraud will determine how the loss is reported. While determining the deductible loss depends on several factors, it is clear that fraud losses are deductible in the year discovered, 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 gross income. The loss is deductible as an itemized deduction.
If you’re a business that’s experienced a theft loss, the loss will generally be deducted as an ordinary deduction. Losses previously deducted on a prior tax return, possibly as a normal business expense, cannot be deducted again.
For both personal and business losses, proceeds received from the perpetrator or insurance reduce the loss that can be reported. If the loss is covered by an insurance policy and a claim is not filed, the IRS could disallow the deduction for not pursuing all means of reimbursement. The same disallowance may also apply if a police report is not filed.
While these items pertain to fraud losses that most taxpayers are familiar with, how are losses from a Ponzi scheme deducted? In response to large losses incurred by investors in Madoff’s Ponzi scheme, the IRS issued guidance in March 2009 on the tax treatment of theft losses from Ponzi-type schemes. While the guidance was intended to offer a theft loss deduction to Madoff’s victims, its provisions apply to victims of all Ponzi-type thefts. The guidance provided clarity regarding when losses can be deducted 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 money is vulnerable to fraud and theft through online “robberies” from bitcoin exchanges. Thankfully, the IRS ruled earlier this year that stolen virtual money can be deducted as a theft loss. The challenge is valuing the amount of the loss. Since bitcoins are volatile, the loss is valued at the lesser of the price paid for the bitcoins or its current value. As always, the taxpayer has the burden of proof in determining the basis or the value.