Possible Trouble from a Clients IRA Distribution

[Dougsbpc]

We just terminated a 1 participant DB and received a favorable Determination Letter. Initially, the client approached us about a DB because she received a $2 million referral award from a law firm. She was age 63 and a sole proprietor. We set up the DB to have NRA of 65 and 3 years of participation. We also suggested she incorporate as an S-corp so she could carry back the losses created from the large pension contribution to the year she received the high income. This probably saved her $200,000 in income taxes.

Two years ago she needed some money to remodel her home and tapped $50K from her IRA. Of course, this had the effect of reducing the loss carried back to the high income year by $50K.

Now, after all is done, she wants to sue us for the $24K in income tax she paid in relation to the IRA distribution. Nobody in our office recalls talking to her about any IRA distribution. She claims we did not properly counsel her regarding the taxation of her IRA distribution.

Anyone have any experience with such a matter?

Thanks

[Guest b2kates]

file this under no good deed goes unpunished.

you do not say what you continuing relationship with the "attorney" is.

Are you here ongoing financial advisor.

Is the claim malpractice. Generally the fact that a person incurs a legitimate tax liability is not malpractice/negligence.

observation. Is her claimed damage 24,000- I would be happy to go in front of a jury and have the high earning attorney demonstrate how she was hurt. Hog factor.

[Dougsbpc]

b2Kates-

Thanks for the reply.

We are a third party plan administrator who sells no investments and usually directs clients to consult with their CPA regarding tax matters. Seems like we often come up with advantageous plan designs that lead to great savings for small employers, but we never give tax advise. For one thing, we're only one peice of the puzzle and dont have nearly enough information about a client to advise them in tax matters, nor would we want to.

Hog factor - that's funny.

Now, I could see, if a plan became disqualified or a client had to pay high penalties for non-filing, or a participant sued an employer over a mistake we made. But it seems like she is stretching it - indeed the hog factor.

Thanks again.

[mbozek]

The question of liability will be determined by scope of the advisor's duties with the client. The mere fact that you are a TPA/ recordkeeper does not mean that you are also responsbile for giving tax advice. Some advisors explicitly exclude tax or legal advice in their correspondence with clients because of this problem. You must review the documents that define the realtionship with the client. Second you need to retain counsel to figure out what are your options under state law since the usual claim is malpractice or breach of contract/ failure to provide due care, depending on the state law. Third what was your responsibility to advise her on her personal income tax return? Unless you had assumed the duties of her tax preparer you would not know her personal tax situation. Fourth distributions under an IRA fall under the heading of general tax advice which should be provided by the client's personal tax advisor/perparer.

There was a case a few years go where a plan sponsor violated the plan loan provisons and sued the TPA/ advisor who provided services to the plan and paid out the loan to the sponsor on the theory that the advisor should have prevented the loan. The courts ruled against the sponsor on the ground that the administrator was only performing a ministerial function under the plan and had not been retained to provide tax advice.

Good luck

[Dougsbpc]

Thanks for the info MJB.

We will review our services and fee agreement that was signed by this client.

It is interesting how the main objective of a qualified plan is to provide retirement benefits to employees. This allows a small employer to sponsor a plan like a large employer and reap the benefits of tax-deferred accumulation. Of course the small employer is most often only interested in the tax benefits. For a small employer to argue that a TPA was neglegent in ensuring maximum tax benefits were achieved by the owner, seems to contradict the main purpose of the plan.