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Break for a Scam Victim

October 01, 2011 | Written by: John Rumbold, EA
Scammer holding a laptop
One of my recent cases was very challenging. I worked with a member who had experienced a significant business theft and then, as bad luck would have it, she was audited by the IRS. I was able to help our member, but it took more of a fight than usual to get the result she deserved.

The case began in April of 2010. The member had paid $25,000 for a dealership to sell business cards and other materials, but she eventually determined that the dealership was a fraud. She found out that the Federal Trade Commission had filed a complaint against the company for deceptive business practices, obtaining a temporary restraining order and eventually winning a judgment in Federal Court which resulted in the closure of the business.

Unfortunately, the member was not able to get a refund of her $25,000, and her dealership was useless. She deducted the $25,000 payment as a business expense on her Schedule C with no other expenses and no income, and the IRS opened an exam for the Schedule C “Other” expense.

After speaking with the member, I did some online research into the matter and downloaded all of the available court documents and press releases from the Federal Trade Commission. It occurred to me that the matter might be actual theft due to FTC’s allegations of deception, and not just a simple capital loss. I also contacted an attorney with the FTC to attempt to find out if compensation had ever been made available to people who had bought the scam dealerships.

I sent a response to the IRS substantiating the expense, showing the theft nature of the matter, and requesting the $25,000 be allowed as a business casualty loss. But the IRS denied the expense, arguing that the taxpayer should have filed a complaint against the company and also should have made a claim against the credit card company through which she had paid the $25,000.

We disagreed with the findings of the IRS for several reasons. With regard to the assertion that the taxpayer needed to file a complaint against the same company, a complaint had already been filed on behalf of the consumer by the Federal Trade Commission. There did not appear to be anything in the Code or Regulations requiring a consumer to file a separate claim. Secondly, regarding the assertion that the taxpayer should file a fraud complaint with the credit card company, several months has passed since the taxpayer had discovered the theft and it was beyond the allowed period for claims with the credit card company. Furthermore, credit card companies do not provide refunds to consumers from merchants that have ceased doing business, as was caused by the injunction against company by the court.

We submitted a new response and received a phone call in June 2011, over one year from the beginning of the audit, from an IRS examiner stating they were allowing the expense on Schedule C. One month later, we received a notice showing that the full amount had been allowed and the taxpayer did not owe any additional tax. The member was and is ecstatic!

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