A troubling scam pattern has left many taxpayers not only robbed of their savings, but facing an unexpected tax bill on top of it. In this scheme, a fraudster contacts a victim claiming their bank account has been hacked or compromised, often invoking the FBI or another law enforcement agency to add urgency and legitimacy. The victim is told their money isn't safe where it is or will soon be inaccessible while law enforcement investigates the issue. The victim must "protect" his or her access to the funds, or the funds themselves, by transferring them into a new account the scammer controls.
In many of these cases, the funds the scammer pressures the victim into moving come straight out of retirement accounts—a 401(k) or an IRA—because those often hold the largest, most accessible balances. Because the victim is the one who initiated the withdrawal, even though it was done entirely under manipulation and false pretenses, the IRS generally treats it as a taxable distribution. That can mean ordinary income tax on the full amount, plus a 10% early withdrawal penalty if the victim is under 59½ years old—a devastating result for someone who has already lost their savings to fraud.
Why the Withdrawal Creates a Tax Problem
Retirement account withdrawals are taxable events regardless of what happens to the money afterward. The IRS generally does not automatically distinguish between a withdrawal made voluntarily for personal use and one made because a taxpayer was deceived into believing their assets were at risk. As far as the retirement plan and IRS are concerned, a distribution occurred and, absent an applicable exception or deduction, it's treated as income in the year it was taken. This is often the part victims don't expect: the theft compounds the harm because the same funds that were stolen also generate a tax liability.
The "For-Profit Motive" Theft Loss Deduction
The most significant relief avenue available to many scam victims is the theft loss deduction under the tax code—specifically the version tied to a transaction "entered into for profit."
Historically, taxpayers could deduct theft losses as itemized deductions. The Tax Cuts and Jobs Act (TCJA) suspended most personal casualty and theft loss deductions for tax years through 2025, generally limiting them to losses connected to federally declared disasters. This suspension, however, generally does not apply to theft losses connected to a transaction entered into for profit. That distinction matters enormously for scam victims, because it can mean the difference between a deduction being available at all.
The "for-profit motive" test generally looks at how the scam was presented to the victim and why the victim engaged with it. The IRS has previously applied this reasoning in the context of Ponzi scheme losses, treating victims' losses as connected to a for-profit transaction rather than a personal one — even though, in hindsight, the "investment" was fraudulent from the start. Similar reasoning may extend to scams where the victim was induced to move retirement funds
under the belief they were protecting, securing, or growing their assets, rather than simply making a personal purchase or gift.
Several factors generally matter in this analysis:
- How the scammer characterized the transaction (e.g., as an investment, an account-protection measure, or a way to preserve assets)
- Whether the victim believed they retained an economic interest in the funds after the transfer
- Whether the scheme resembled other frauds the IRS has already addressed in this context, such as Ponzi-type arrangements
- The specific facts and documentation available to support the claim
Because this determination is fact-intensive and the guidance in this area continues to develop, it's generally advisable to have a tax professional evaluate the specific circumstances of the scam before claiming this deduction on a return, or before amending a return that already reported the withdrawal as ordinary taxable income.
Other Considerations for Scam Victims
Beyond the theft loss deduction itself, taxpayers in this situation should also keep the following in mind:
- The 10% early withdrawal penalty is a separate issue from the income tax on the distribution and may need to be addressed on its own.
- A theft loss deduction, if available, may require amending a previously filed return.
- State tax treatment of theft losses and retirement distributions doesn't always mirror federal rules.
- Documentation is critical. Reports to the FBI, FTC, or Internet Crime Complaint Center (IC3), along with scam communications and account records, can support a later claim.
- Timing matters. There are limits on how long a taxpayer generally has to claim a loss or amend a return, so acting sooner rather than later helps preserve options.
Concerned You May Owe Tax on a Scam-Related Withdrawal?
Being deceived into withdrawing your own retirement savings is devastating enough without an unexpected tax bill attached to it. Bryson Law Firm helps individuals evaluate whether the for-profit theft loss deduction, penalty relief, or another tax resolution strategy may apply to their situation. Contact us today to discuss what happened and explore your options for addressing the tax consequences of this type of fraud.
