Cryptocurrency scams, hacks, and theft have affected millions of taxpayers, and the financial damage often extends far beyond the initial loss of digital assets. While recent IRS guidance has acknowledged the problem, victims are still left navigating uncertainty. An internal IRS memo now allows certain scam victims to claim an ordinary loss deduction, but a memo is not the same as binding law or formal regulation. Without clear statutory or procedural relief, many taxpayers remain exposed to inconsistent outcomes and significant tax bills tied to losses they never truly realized.
The IRS Memo Helps, but It Is Not Enough
The IRS memo represents an important shift. It recognizes that victims of fraud and scams may be entitled to an ordinary loss deduction in some circumstances, rather than being barred under Section 165(c). However, because this guidance exists only in a memorandum, it does not carry the same weight as a regulation, revenue ruling, or statute. It can be interpreted differently by examiners, applied inconsistently, or withdrawn without notice.
For taxpayers, this creates risk. Many victims are hesitant to rely on a memo when the financial stakes are high and the facts are complex. What should be a straightforward claim becomes a judgment call, often requiring professional representation and negotiation with the IRS.
The Loss Is Rarely Just the Stolen Crypto
Another critical issue is that the tax damage from a crypto scam rarely stops at the loss of the assets themselves. Victims often take additional financial steps in response to the scam, triggering other taxable events that compound the harm.
In many cases, victims liquidate investments to raise funds they believe are required to complete a transaction or recover assets. This can generate unexpected capital gains. Others withdraw funds from retirement accounts such as IRAs or 401(k)s to pay scammers, triggering ordinary income tax and early withdrawal penalties. Some take out loans or refinance property, only to lose the proceeds in the scam.
None of these downstream tax consequences are reversed simply because the underlying transaction was fraudulent. Even if the stolen crypto is treated as a deductible loss, the tax on liquidated investments or retirement withdrawals often remains fully taxable.
Phantom Income and Compounded Tax Harm
This creates a particularly cruel outcome. A taxpayer may pay tax on income generated from liquidating assets or withdrawing retirement funds, then lose those funds entirely to fraud, and still owe tax on the transaction. In effect, the taxpayer is taxed on money they no longer have and never benefited from.
In crypto cases, this problem is magnified when assets were previously taxed as income, such as staking rewards, mining rewards, or airdrops. The taxpayer reports income when the crypto is received, loses it to a scam, and then faces additional taxes tied to the steps they took to fund or respond to the scam. The cumulative effect can be devastating.
Why Memo Based Relief Is Not Sufficient
Relying on informal guidance leaves too much uncertainty. Victims need clear rules that define eligibility, documentation standards, and the scope of relief. Without that clarity, similarly situated taxpayers can receive dramatically different treatment depending on the examiner, the jurisdiction, or the quality of representation.
A binding framework would allow victims to assess their options with confidence and encourage accurate reporting rather than avoidance. It would also reduce disputes and administrative burden on the IRS.
What Real Relief Should Include
Meaningful relief should go beyond recognizing the theft itself. It should account for the full economic reality of scams. That includes allowing ordinary loss treatment for stolen assets, addressing phantom income created by prior taxation, and providing pathways to mitigate or offset taxes triggered by liquidation of investments or retirement accounts directly tied to the scam.
Clear procedures could allow taxpayers to demonstrate the connection between the scam and subsequent taxable events, creating a fairer outcome without opening the door to abuse. Documentation standards, time limits, and reporting requirements can protect the system while still offering relief.
Why This Matters for Compliance and Fairness
When victims see that coming forward will likely result in more tax pain, not less, they disengage. That undermines voluntary compliance and erodes trust in the system. A tax code that recognizes real losses and does not punish victims twice encourages honesty and cooperation.
Crypto scams are not isolated incidents. They are a growing feature of the digital economy. Tax policy must evolve to reflect that reality.
The Bottom Line
The IRS memo allowing ordinary loss treatment for scam victims is a step in the right direction, but it is not enough. Without clear statutory or procedural rules, victims remain exposed to inconsistent outcomes and compounded tax harm. Crypto scams often trigger multiple taxable events beyond the initial loss, leaving taxpayers facing phantom income, retirement account taxes, and capital gains on money they no longer have.
At Gordon Law, we work with victims navigating these exact issues. We see firsthand how unclear rules and partial relief fail to address the full scope of the damage. A fair tax system should provide binding, comprehensive relief that reflects economic reality and protects victims from being taxed on losses they never truly realized.
