Rare is the court decision where a taxpayer is permitted to deduct a theft loss without someone at least being accused of a crime. Today, in Herrington v. Commissioner, T.C. Memo 2011-73, the court allowed just such a deduction in a decision likely to change some views around the tax community as to what constitutes a “theft.”
In Herrington, the taxpayer was in an extremely abusive relationship, often facing violence and intimidation at the hands of her boyfriend. She was coerced by her boyfriend into opening two sandwich shops which were home to video poker machines.
The boyfriend took charge of the finances of the business, cutting checks to himself without alerting the taxpayer as to the amount and reason. While she knew he was withdrawing money from the business at his every whim, the taxpayer never knew when it was coming. In the two years at issue, the boyfriend took $114,000 and $96,000, respectively, out of the business for his own benefit.
The Tax Court was left to determine whether the amounts could be deducted as theft losses.
As a reminder, an individual may deduct theft losses incurred in a trade or business under Section 165. Generally, whether a theft loss has occurred depends upon the law of the state where the loss was sustained. In Herrington, however, the boyfriend was never accused, let alone charged, with theft.
The court, citing previous case law, maintained that the deduction for theft losses does not depend upon “whether the perpetrator is convicted or prosecuted or even whether the taxpayer chooses to move against the perpetrator.” (emphasis added) Instead, the taxpayer need only to provde that a theft occurred under the relevant state law, which it did in this case under Louisiana law.
The IRS argued that the boyfriend’s withdraws could not be thefts since the taxpayer never objected to the transfers, and Louisiana law provides that a theft cannot occur if the victim actively consents to the theft. The Tax Court, however, concluded that the taxpayer gave only ”passive consent,” which was induced by force and threats of violence. For these reasons, the court placed little significance on the fact that the taxpayer never reported the thefts to the authorities, and allowed the theft losses in full.