IRS Criminal Investigation Department Issues A Warning To Taxpayers About Online Cryptocurrency Scams

// There seems 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 an unusually large investment return, or both. After establishing trust, the scammers convince their victims to convert their money into cryptocurrency and then transfer the cryptocurrency into a fake investment app. The fake 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 either force them to pay a nonexistent government exit tax or additional fees (further attempts to con money from the victim). At this point, the victims discover they have been scammed.

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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. Personally, I know of people who claimed a loss much higher than that and have spoken with others who have lost more than $10 million.

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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 not see these warnings until it is too late.

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As a consolation, the victims may be eligible to deduct the amount that they lost from their taxable income. According to IRS guidance, cryptocurrency-related losses are taken as a capital loss. But in certain cases, 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 made 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.

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The hypothetical fact pattern provided in the IRS warning seems to suggest that victims of pig-butchering scams could be eligible to take a nonpersonal theft loss deduction. It says that a potential red flag is where an anonymous or fake online account guarantees profits or big 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 — to never 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 made some arrests and seizures of stolen funds, including one in April 2023 where $112 million of stolen funds were seized. And just recently, there was another arrest where $9 million worth of crypto was seized. Despite the progress in capturing the scammers, most victims are unlikely to get their stolen money back as it will be difficult and time consuming for people to connect their loss to the scammer’s activities.

Not every pig-butchering scam victim will not be eligible to 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.

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By issuing a warning, it appears that the IRS Criminal Investigation unit could be going after online crypto scammers. 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 see if they qualify.

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Steven Chung is a tax attorney in Los Angeles, California. He helps people with basic tax planning and resolve tax disputes. He is also sympathetic to people with large student loans. He can be reached via email at [email protected]. Or you can connect with him on Twitter (@stevenchung) and connect with him on LinkedIn.

Topics

cryptocurrency, FinCEN, Government, IRS, Scams, Steven Chung, Tax Law