Legal fees from an IRA

[Guest ladycpa]

A client has an IRA that held a high-tech stock that he told the broker to sell. Unfortunately, the broker did not sell and the client incurred a huge loss in value. The client has incurred $12,000 in legal fees to initiate a lawsuit against the securities firm. They have paid $6,000 already from their personal account, and they want to get reimbursed from the IRA. Secondly, they want to know if they can pay the remaining $6,000 in legal fees from the IRA assets. I think I know the answer to the first question since it seems like that would be a prohibited transaction. Where could I confirm that they could pay the other remaining legal fees from the IRA directly?

[mbozek]

You need to read the custodial account agreement to see if it permits the use of IRA assets to pay expenses relating to the investment of assets. Most IRA agreements permit the disbursement of plan assets to pay expenses, e.g, annual fee, with the consent of the custodian. I dont know whether the custodian will allow the reimbursement of the IRA owner for expenses already paid on behalf of the IRA. You need to read the agreement. Also what kind of a lawsuit has been initiated against the broker? I thought that all claims against a broker are subject to arbitration.

Under Rev rul 84-146, the IRA owner can take a deduction for expenses incurred for the IRA as a misc. deduction subject to the 2% AGI limit.

[Guest ladycpa]

Thanks for the cites and I will check the custodial agreement for authorization. I'm not sure what type of lawsuit it is or was but they received a substantial settlement so maybe that was the arbitration. The settlement will become an IRA asset.

You didn't seem concerned about the IRA reimbursing the owner for expenses as long as the custodian allowed for it. What about prohibited transaction considerations?

[John G]

I don't understand why someone would want to reduce the IRA assets by taking out attorney fees? Ussually folks want to take any charges outside of the IRA and maintain the max amount of assets.

If the assets are substantial, then why worry over 12k?

If they won their position, why did they not get compensated for attorney fees?

[Guest ladycpa]

John,

I agree with you that I'm not sure why they want to take the fees from the IRA and not maximize the deferral. They could deduct the fees on their Sch A subject to the 2% floor but they are upper income & that may not be possible. Secondly, I agree that what's $12000 if their settlement was substantial but they want reimbursed. In response to your question about legal fees not being reimbursed, I'm not sure. I don't have the details on the settlement.

Thanks again for your response!

[mbozek]

I think the reimbursing the IRA owner is a close question but shuld not violate the PT rules because it is not a sale or exchange of assets nor is it a transaction for the benefit of the owner since the legal fees were incurred to provide a recovery for the IRA because of the actions of the broker. Since the IRA and not the owner benefits from the recovery the owner should be able to collect legal fees advanced toward the recovery action. However, it is up to the custodian to decide whether such expenses should be reimbursed.