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“Good News from the IRS on Taxability of Identity”

Safe and Sound By Patricia A. Hintz

Businesses and governmental entities increasingly store sensitive nonpublic personal information electronically. It should be no surprise, then, that identity theft is a major problem in the United States. Identity theft is generally considered to occur when a person wrongfully obtains and uses another person’s personal information (for example, name, social security number, or banking or credit card account numbers) in a way that involves fraud or deception, typically for financial gain. Organizations have ramped up their efforts to keep personal information secure using ever-increasingly complex and costly security measures. When these efforts fail, entities often respond by offering affected customers or employees complimentary identity protection services including credit reporting and monitoring services, identity theft insurance policies, identity restoration services or other similar services (“Identity Protection Services”). These services are not free and cost money to provide. Does this make the value of these services taxable when they are received by an employee or customer? Existing federal tax law does not specifically address this question.

In a bit of welcome news, the IRS recently stated (in IRS Announcement 2015-22) that it will not consider these services taxable when provided to a customer or employee after a data or security breach. The IRS also noted that the value of Identity Protection Services does not need to be included on a tax form, such as a W-2 or 1099. Although Announcement 2015-22 is not clear about its effective date, presumably it applies for the entire current tax year (and, hopefully, prior tax years).

There are some limits to the IRS leniency. For example, the Announcement does not provide relief if affected individuals are paid in cash instead of services. Also, Identity Protection Services which are unrelated to a breach—such as Identity Protection Services received as part of an employee’s compensation or benefit package—are likely taxable. The Announcement also does not apply to proceeds received under and identity theft insurance policy. Further guidance may be forthcoming from the IRS as it has requested comments on these matters.