This New Bill Could Give Fraud Victims Their Tax Money Back

Losing money to a scam can be financially devastating, especially if you have to dip into your retirement savings because of the loss. An unexpected withdrawal can disrupt your retirement plan, and under current tax rules, some victims could then face another hit from taxes and early-withdrawal penalties.

A bipartisan bill that overwhelmingly passed the House would change that. The Tax Relief for Fraud Victims Act would restore tax deductions for certain fraud losses and create special rules for retirement withdrawals connected to scams, potentially allowing some victims to amend old tax returns and recover money they previously paid to the IRS.

The House passed the Tax Relief for Fraud Victims Act

The House approved the Tax Relief for Fraud Victims Act on September 15 by a vote of 408-17, with support from both Republicans and Democrats. The bill, introduced by Reps. Max Miller, R-Ohio, and Tom Suozzi, D-N.Y., would provide new tax relief for victims of qualifying fraud losses.

Current law generally restricts deductions for personal casualty and theft losses unless the loss is connected to a federally or, in some cases, state-declared disaster. That can leave victims of romance scams, imposter scams, and other fraud unable to deduct significant losses.

Suozzi said during debate that people who lose money to scams can still face taxes or retirement penalties on money stolen from them. "The Federal Government should not tax stolen money," he said.

The House-passed bill would remove that restriction for qualifying losses and introduce additional relief for victims who turned to their retirement savings.

Fraud-related retirement withdrawals could get tax relief

The bill could be particularly valuable for victims who withdrew money from a retirement account because of a scam. Taking money from a traditional IRA or 401(k) before age 59 1/2 can generally trigger a 10% additional tax unless an exception applies. On top of that, you may owe ordinary income tax on the taxable portion of the withdrawal.

The Tax Relief for Fraud Victims Act would create an exception to the 10% additional tax for qualifying retirement distributions related to theft involving fraud, deceit, or misrepresentation.

Importantly, the provision would apply to qualifying distributions made after December 31, 2020. That means the legislation isn't only aimed at future scam victims. Some Americans who have already paid the additional tax on qualifying retirement withdrawals could potentially seek a refund if the bill becomes law.

You could potentially put the money back into retirement

The proposal goes further than eliminating the additional 10% tax. It would also allow victims to repay qualifying distributions into an eligible retirement account.

The House-passed bill would generally give victims a one-year period, beginning the day after discovering the qualifying loss, to repay the distribution.

If you withdrew $30,000 from your retirement savings after becoming the victim of fraud, for example, you would lose both that money from the account and the potential investment growth it could have generated. Being allowed to repay a qualifying distribution could help restore some of that retirement balance.

Some victims could amend old tax returns

The bill could also help people who discover a scam years after losing their money. Taxpayers generally face deadlines for filing amended returns and claiming refunds. Under the proposal, the deadline for certain fraud-related refund claims generally couldn't expire earlier than one year after the taxpayer discovers the qualifying theft loss.

The bill goes further by providing special retroactive relief. Qualifying fraud-related personal casualty losses sustained after December 31, 2020, and before January 1, 2026, could become deductible under the new rules.

For victims who discovered a qualifying loss before the legislation becomes law, the bill would generally provide a new one-year window beginning on the date of enactment for certain refund claims.

Exactly how much someone could recover would depend on their individual loss, retirement distributions, previous taxes paid, and other circumstances.

The bill would also restore deductions for theft losses

Beyond the retirement-account provisions, the bill would also expand deductions for qualifying personal theft losses.

It would also allow victims of theft involving fraud, deceit, or misrepresentation to elect to treat the loss as occurring in the year the money was actually stolen rather than the year they discovered the theft.

That could matter when someone doesn't realize they've been scammed until years later and needs to amend an earlier return.

What should scam victims do now?

The Tax Relief for Fraud Victims Act hasn't become law, so none of the proposed tax breaks are available yet. If you've experienced a significant fraud loss since 2021, however, it could be worth keeping records of the loss and any retirement withdrawals connected to it.

That includes previous tax returns, retirement account statements, withdrawal records, and documents establishing when you discovered the fraud. Those records could become important if the bill becomes law and you qualify to seek a refund or amend an earlier return.

Bottom line

The Tax Relief for Fraud Victims Act could prevent some scam victims from taking a second financial hit from the tax system, especially if losing retirement savings has made it harder to make the right moves in retirement.

The House-passed bill would make qualifying fraud losses deductible, waive the 10% additional tax on certain retirement withdrawals, allow victims to repay qualifying distributions, and give some taxpayers more time to seek refunds.

However, the legislation is currently with the Senate Finance Committee and isn't law yet. Until that changes, affected taxpayers should keep their records rather than count on receiving a refund.

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