Financial advisors have one indisputable edge when competing against the behemoth fund companies of the world: While the trillion-dollar fund companies just take orders, planners have the opportunity to get to know their clients intimately. Therefore they more easily spot who are susceptible to fraud through forgery and other deceptive acts — especially when the source of those acts is another family member.
Take, for example, the sad and sordid tax case case of
This case concerned an elderly woman, Mary Ellen Cramner Nice, whose IRA was allegedly pillaged by her son, Charles “Chip” Nice III, leaving her with a stunningly large tax bill. The estate of Mrs. Nice, who died in 2019, went to court to recoup over $500,000 in taxes. The estate lost the case and the tax had to be paid.
Mary Ellen and her husband had been married for 61 years. Before he died in 2002, he arranged to leave substantial assets for his wife’s care. Chip was named executor of the husband’s estate and moved in with his mother. In 2007, she was diagnosed with dementia. As Mary Ellen’s condition worsened, Chip allegedly began engaging in certain fraudulent activities. Among them: gaining access to her IRAs, allegedly causing distributions to be made from the IRAs and diverting those funds for his own benefit. A sharp-eyed planner might have noticed what was happening but without such oversight, the alleged activity continued with devastating effects.
In addition, the son allegedly filed federal income tax returns on behalf of his mother after causing her to execute a fraudulent power of attorney. Those tax returns treated the IRA distributions as taxable income to Mary Ellen. In the case of IRA funds, the client not only loses the actual funds when they are gone, but also gets hit with a tax bill. That’s what happened here.
In 2014, Mary Ellen’s daughter, Julianne Nice, applied for and received a temporary injunction against Chip, removing him from Mary Ellen’s home and finances. Chip died in 2015. A court subsequently determined Mary Ellen was incapable of handling her affairs, and Julianne was appointed as guardian. Julianne filed amended tax returns on behalf of her mother, claiming a refund for tax years 2006-07 and 2009-13. The IRS denied the claims for 2006 and 2010-13. It accepted the claim for 2009 and never responded to the claim for 2007. Julianne appealed the denials, but each appeal was also denied.
On behalf of Mary Ellen, who by then had died, Julianne brought a lawsuit against the IRS in Louisiana federal district court, seeking a refund of $519,502 in federal income taxes, plus interest and penalties. The suit contended that because of Chip’s alleged fraudulent acts, Mary Ellen never actually received the IRA distributions on which she was taxed. Therefore, Mary Ellen’s tax returns for 2011-14 overstated her actual income, and her estate is owed a refund for overpayment of federal income taxes.
In her suit, Julianne argued that Mary Ellen never actually possessed the IRA distributions because she was unaware of the funds, could not exercise control over them, was restricted from access to them, and did not benefit from them. Nevertheless, the court concluded that Julianne failed to show that Mary Ellen did not actually receive the IRA withdrawals and denied the refund claim.
Restorative payments
There are lessons to be gleaned from this sad story that can help ensure your clients never find themselves in similar situations.
When a client’s IRA funds are mishandled or misappropriated, the client may be able to rollover to an IRA the amounts received after bringing a lawsuit to recover the losses. In 2004, the IRS issued 11 related private-letter rulings that permitted lawsuit settlements to be rolled over to IRAs. In each of the cases, the taxpayers received settlements and sought PLRs requesting those amounts to be rolled over to their IRAs. The IRS allowed the rollovers and gave the owners 60 days from the date of receipt of the settlement money to complete the rollovers.
In PLR 200512035, an advisor stole the IRA funds of a client in a nursing home after the client withdrew the funds. The client received a settlement and the IRS allowed the settlement to be rolled back to the client’s IRA.
In subsequent PLRs, the IRS began referring to settlement amounts paid back to IRAs as “restorative payments” — that is, replacements for the losses, not as rollover contributions.
For example, in PLR 200705031 a surviving spouse received a settlement for mishandling of investments in her deceased spouse’s IRA. The IRS treated her payment to the IRA as a restorative payment and allowed the spouse to contribute the proceeds to her IRA even though the 60-day deadline had passed.
The IRS has made clear that only compensatory damages for losses awarded following a lawsuit may be paid to an IRA as a restorative payment. Punitive damages and attorneys’ fees cannot be contributed to an IRA. (See PLR 200850054). In addition, interest accrued during the distribution period cannot be part of a restorative payment. (See PLR 200921039).
Besides amounts awarded by a judge or jury in a lawsuit, restorative payments can also be made from an arbitration award or from a settlement of a lawsuit or arbitration case (see PLRs 200724040, 200738025 and 200921039).
Questioning Nice
The court’s decision in Nice is certainly open to criticism. For example, its finding that all of the IRA distributions (apparently paid out over several years) were received by Mary Ellen before Chip misappropriated any of the funds does not seem to square with the factual allegations. In addition, the court distinguished Nice from other cases by finding that Mary Ellen was at all times the sole owner of the checking account into which the IRA distributions were deposited.
While technically true, this finding overlooks evidence that Mary Ellen’s dementia caused her to surrender any real control of the account to her son via the allegedly fraudulent power of attorney. Thus, it is possible that Mary Ellen’s estate could appeal this decision to the federal appeals court.
Language used by the IRS in all restorative payment rulings strongly suggests that payments to IRAs to recover losses cannot be made with personal funds. Therefore, Mary Ellen’s estate would be unable to make restorative payments from any non-IRA savings.
Rather, assuming that the statute of limitations has not expired, the daughter would first have to sue Chip Nice’s estate and then make payment to the IRAs from either compensatory damages or settlement proceeds (after perhaps requesting a private-letter ruling).
The advisor is in
Unfortunately, it’s not in a financial advisor’s power to protect clients from all criminal activity, but there are certainly steps that can be taken by the vigilant professional. Imagine, for example, if Mary Ellen had a financial advisor who was actively monitoring her accounts. Chip’s alleged criminal activity could have been stopped much earlier.
And, while most clients do not want to be involved with every detail about their IRA and other accounts, a basic level of knowledge can be the best protection against fraudulent activity by scheming relatives and other “trusted” individuals. Stress to clients the dangers of handing over the financial and retirement reins to any single person, even if that one person is a spouse or child. As this case shows, that can be a recipe for disaster.
Finally, help clients prevent fraudulent activity by, for example, appointing a financial power of attorney or, for non-IRA assets, placing them in a trust with an attorney or other professional serving as trustee. Make sure these actions are taken before dementia or other illnesses rob clients of their ability to make financial decisions.
In this case, Mary Ellen did not appoint Chip as her power of attorney until after her dementia had progressed. By then, it was too late. But advisors hired even after fraudulent activity occurs can still add substantial value by guiding a family through the steps necessary to recover the losses i.e., bringing legal action and making a restorative payment.
