There seem to be more victims of online cryptocurrency-related scams. They are also known as “pig-butchering” scams due to the scammers’ activities being analogous to fattening the pig before slaughtering it. Most of these scammers operate in Southeast Asia. They are known to kidnap people and force them to participate in the scam.
The scammers follow a plan. They connect with a victim online. They find a hook to grab the victim’s attention, such as romantic affection, promises of a considerable investment return, or both. After establishing trust, the scammers convince their victims to convert their money into cryptocurrency and transfer it into a fake investment app. The phony app would show the victims’ funds rising dramatically, and the scammers would entice their victims to put in more money. When the victims try to withdraw, the scammers force them to pay a nonexistent government exit tax or additional fees (further attempts to collect money from the victim). At this point, the victims discover they have been scammed.
It has gotten so bad that the criminal investigation unit of the IRS recently issued a warning about pig-butchering scams to taxpayers. So far, the highest identified loss is $2 million. I know of people who claimed a loss much higher than that and have spoken with others who have lost more than $10 million.
The IRS isn’t the only government agency to warn people about this scam. The Financial Crimes Enforcement Network (FinCEN) issued a similar warning in September. Also, various state attorney general offices have issued alerts to the public.
The problem is that most people do not follow the activities of the IRS, FinCEN, and state law enforcement agencies because they are generally law-abiding. So they will see these warnings when it is too late.
The victims may be eligible to deduct the amount they lost from their taxable income as a consolation. According to IRS guidance, cryptocurrency-related losses are taken as a capital loss. But in some instances, victims can claim a nonpersonal theft loss, which can reduce or zero out their income taxes in the year they discovered the theft. In addition, if their losses exceed their income for that year, they can carry forward the loss to offset 80% of their income in future years. Individuals cannot carry back their losses to prior years to obtain refunds.
Generally, to be eligible to claim a nonpersonal theft loss, several requirements must be met. First, the theft must be connected to a trade or business or as part of a transaction with an expectation of a profit. Second, the theft must be illegal in the jurisdiction where the victim lives, although a theft conviction is not required. Third, the stolen funds must go directly to the scammer and not to an unconnected third party (the people who lost money on Enron stock learned this the hard way). Lastly, there must not be a reasonable prospect of recovery.
The hypothetical fact pattern in the IRS warning suggests that pig-butchering scam victims could be eligible for a nonpersonal theft loss deduction. It says that a potential red flag is where an anonymous or fake online account guarantees profits or significant returns if you invest with them. The Criminal Investigation Chief Jim Lee states, “Cryptocurrency scammers have become more sophisticated with their schemes. It’s a shame to watch people hopelessly invest their savings in crypto and earn returns on their deposits — never to see the money again.”
The Chinese government, with the help of several Southeast Asian countries, has taken action to arrest its nationals suspected of running these scams. In the U.S., the Department of Justice has arrested and seized stolen funds, including one in April 2023, where $112 million of stolen funds were seized. And recently, another arrest was where $9 million worth of crypto was charged. Despite the progress in capturing the scammers, most victims are unlikely to get their stolen money back. It will be difficult and time-consuming for people to connect their loss to the scammers’ activities.
Not every pig-butchering scam victim can claim a nonpersonal theft loss. For example, if the money was given for a reason other than an expectation of a profit, then it will be considered a personal theft loss. Personal theft losses have numerous restrictions, most notably that the loss must have occurred in a disaster area, and any losses exceeding income cannot be carried forward for future years.
The IRS Criminal Investigation unit could be going after online crypto scammers by issuing a warning. It advises victims to contact local law enforcement or one of their 20 field offices. In the meantime, they may be able to claim a capital or theft loss to help ease their tax burden. As the theft loss rules are complex, they should consult a tax professional to determine their eligibility.