Theft of IRA Assets & Settlement

[Danny CPA]

I believe I know the answer here, but I am just looking for something definitive that supports my position.

A client had approximately $60K worth of Bitcoin in their Roth IRA that was stolen through a hack on one of the crypto exchanges. They believe they are going to receive a settlement check (unsure of the amount) from a lawsuit. Client wants 100% of the proceeds to go back into their Roth IRA. 

I believe this would be permissible and would not be considered a contribution for the year. I can't find anything definitive to support/oppose that position though. 

Thoughts? Agree/Disagree?

[Bird]

Any settlement check should be paid to the original owner (the plan) and it is simply different money, still owned by the plan. It is not a contribution. Getting the investment company to recognize that may be the hard part.

[Luke Bailey]

Bird is totally correct, Danny CPA, but make sure the paperwork and/or deposit to the account reflects that.

[Peter Gulia]

What sets up a restorative payment is that a fiduciary pays it to restore losses to a plan (or IRA) if there was a reasonable risk of liability for the fiduciary’s breach, and other facts and circumstances show the payment is not a disguised contribution.

For a § 401(a)-qualified plan (or another plan that has § 415 limits), a Treasury department rule distinguishes between an annual addition and a restorative payment, which does not count as an annual addition.

26 C.F.R. § 1.415(c)-1(b)(2)(ii)(C) https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR686e4ad80b3ad70/section-1.415(c)-1#p-1.415(c)-1(b)(2)(ii)(C); Limitations on Benefits and Contributions Under Qualified Plans, 72 Federal Register 16878, 16887 [middle column] (Apr. 5, 2007), https://www.govinfo.gov/content/pkg/FR-2007-04-05/pdf/E7-5750.pdf.

That rule follows a general principle described in Revenue Ruling 2002-45, 2002-2 C.B. 116.

The Internal Revenue Service has issued letter rulings applying the principle regarding IRAs.

IRS Letter Rulings 2009-21-039 (Feb. 25, 2009), 2008-52-034 (Sept. 30, 2008), 2008-50-054 (Sept. 18, 2008), 2007-38-025 (June 26, 2007), 2007-24-040 (Mar. 20, 2007), 2007-19-017 (Feb. 12, 2007), 2007-14-030 (Jan. 11, 2007), 2007-05-031 (Nov. 9, 2006). [In the numbering of letter rulings, the two digits after the year show the week in which the ruling was released under the Freedom of Information Act.]

Although a letter ruling is no precedent [I.R.C. § 6110(k)(3)], one might use the reasoning of the three layers of sources described above—and that the IRS has consistently applied the principle since at least 2002—to support a substantial-authority tax-return position. 26 C.F.R. § 1.6662‐4(d)(2)-(3) https://www.ecfr.gov/current/title-26/chapter-I/subchapter-A/part-1/subject-group-ECFR1d0453abf9d86e0/section-1.6662-4#p-1.6662-4(d)(3).

The position will be stronger if the IRA holder had and keeps evidence, preferably independent evidence, that shows the settlement was truly made to end a fiduciary’s (or alleged fiduciary’s) risk exposure.