Is Identity Theft Protection Tax Deductible?

Identity theft is a growing concern, leading many individuals and businesses to invest in protection services. These services monitor credit activity, alert users to suspicious behavior, and assist with fraud recovery. Given the cost, taxpayers may wonder whether these expenses qualify for a tax deduction.

Classifying the Expense

The IRS categorizes expenses based on their purpose, which determines deductibility. Identity theft protection services are generally considered personal expenses, similar to insurance or credit monitoring. Personal expenses are not deductible unless explicitly allowed under tax law, and the IRS has not classified identity theft protection as a deductible personal expense. Individuals cannot claim it as a miscellaneous deduction.

For businesses, deductibility depends on whether the expense is considered “ordinary and necessary” under Section 162 of the Internal Revenue Code. An ordinary expense is common in a particular industry, while a necessary expense is helpful for business operations. If a company provides identity theft protection to employees after a data breach, the IRS ruled in Announcement 2015-22 that this is a non-taxable fringe benefit rather than a deductible business expense. However, if a business purchases identity theft protection as a preventive measure, it may be classified as a general administrative expense.

Criteria for Tax Deduction

For an expense to be deductible, it must meet IRS guidelines, primarily falling under trade or business expenses, investment-related expenses, or explicitly deductible personal expenses. The IRS requires that the expense be both ordinary and necessary, meaning it must be common in the taxpayer’s line of work and directly connected to income generation.

One potential avenue for deductibility is if the expense is incurred in the production of taxable income. Under Section 212 of the Internal Revenue Code, expenses related to managing or protecting income-producing property may be deductible. If identity theft protection is purchased to safeguard financial accounts tied to taxable investments, there could be an argument for its deductibility. However, the Tax Cuts and Jobs Act (TCJA) of 2017 suspended miscellaneous itemized deductions subject to the 2% adjusted gross income (AGI) floor through 2025, making this option unavailable for most taxpayers.

Another possibility is if the expense is required as a condition of employment. Some professions, such as financial advisors or attorneys, handle sensitive client data and may be required by regulatory bodies to maintain security measures, including identity theft protection. If an employer mandates such coverage as a work-related expense and does not reimburse it, the cost might qualify as an unreimbursed employee expense. However, due to TCJA restrictions, these deductions are currently unavailable for most employees unless they qualify under specific exceptions, such as armed forces reservists or certain performing artists.

Business vs. Personal Application

The tax implications of identity theft protection depend on whether the expense is incurred by an individual or a business. For individuals, the IRS does not recognize identity theft protection as a deductible expense, even if the service helps safeguard personal financial accounts. This applies whether the individual has been a victim of identity theft or is taking preventive measures. Unlike medical expenses, which can sometimes be deducted if they exceed a certain percentage of adjusted gross income, identity theft protection does not fall under a recognized category of deductible personal costs.

Businesses, however, may have more flexibility. If a company integrates identity theft protection into its cybersecurity policies, it could be considered part of a broader risk management strategy. Businesses routinely invest in fraud prevention tools, data security software, and employee training programs to mitigate financial and operational risks. Identity theft protection services could be classified similarly, particularly if they are used to monitor company credit, prevent unauthorized transactions, or protect sensitive client data. Under Generally Accepted Accounting Principles (GAAP), such costs are typically recorded as operating expenses, reducing taxable income in the year they are incurred.

Another consideration is how identity theft protection is provided to employees. If a company offers these services as part of an employee benefits package, the tax treatment depends on how the benefit is structured. If employees receive coverage due to a company-related data breach, it is not included in their taxable income. However, if the company pays for identity theft protection as a voluntary perk unrelated to a breach, the IRS may classify it as taxable compensation, requiring employers to include the value of the benefit in employees’ W-2 forms.

How to Report on Tax Returns

When reporting deductible expenses on a tax return, proper classification and documentation are essential. If identity theft protection costs qualify as business expenses, they should be reported on Schedule C (Form 1040) for sole proprietors or on the appropriate business tax return form, such as Form 1120 for corporations or Form 1065 for partnerships. These expenses typically fall under “Other Expenses” unless included within broader cybersecurity or administrative costs. Maintaining clear records, including invoices, payment receipts, and documentation of how the expense relates to business operations, is necessary to support the deduction in the event of an audit.

For businesses providing identity theft protection as an employee benefit, tax treatment depends on whether the expense is considered a taxable fringe benefit. If the service is offered due to a company-related data breach, it is not included in employees’ taxable income and does not require additional reporting. However, if the company provides protection services as a general perk unrelated to a breach, the value of the benefit must be included on employees’ W-2 forms under “Other Compensation.” Employers must account for payroll taxes on this amount and report it on quarterly employment tax filings (Form 941).