Is it permissible to deduct the amount stolen by one of the orphans from the Zakat funds paid to them annually, knowing that they are unable to repay the amount?

Zakat given to poor nephews is better than giving it to others, as it is both charity (sadaqah) and maintaining kinship ties (silat ar-rahim). It is not permissible to deduct from the zakat amount an equivalent to a previous debt owed by your nephews, because zakat is a right of Allah and it is not permissible to use it for the benefit of the zakat payer.

If your nephew is in financial hardship, you have one of two options: either you wait until his financial situation improves, which is a religious obligation, as Allah Almighty says: "And if there is one in adversity, then [let there be] a postponement until [a time of] ease"; or you can give him the indebted amount as charity, which is better and more virtuous, along with advising and guiding him. His brothers are not to be held accountable for his actions.