Help for an Investment Fraud Victim

Here’s one for the books. I never thought the IRS would go for it, but I had to try…

The member received a notice questioning her IRA rollover of $212,000 from 2008. The notice included a bill for $62,271, plus penalties and interest, which brought the total due to $79,292. Her tax return for that year showed that she had received a distribution from a pension plan of $284,035, which she had treated as a rollover, leaving the taxable amount at $46,219. According to her 1099-R forms, she had received taxable distributions on the death of her spouse in the amounts of $243,992 and $7,481.

When I contacted the member to discuss her situation, she said she had taken the distribution in order to re-invest the funds (called a “conversion”) into a Roth IRA with a private investment firm. I asked her to contact the investment firm to confirm what kind of IRA account the money had been moved into, and explained that a conversion to a Roth IRA would be taxable and that the notice would be correct in that situation. She was not certain if it had been moved into a Roth IRA or a traditional IRA. She confirmed that the pension had been inherited when her husband had died the previous year.

I made several follow up calls in the next two weeks, and each time the member said she had not been able to get in touch with her broker. Then she sent me an email saying that the owner of the investment firm was in the hospital, but that he would send a statement confirming the IRA rollover to her within a couple of days. A few days later she called again, extremely upset. She had just found out that the owner of the investment firm had passed away that morning, and no one seemingly knew anything about any investments he may have made on her behalf. I suggested she contact the office of the her state’s Attorney General or the local securities broker association to find out where her investment advisor held his trust accounts, as those are usually registered. We agreed to talk the following week after she had made the inquiries.

A week later, we spoke again, and it became clear that the money she had received from the pension distribution had been invested with some sort of scam investment company. The member gave me the name of her alleged broker, and I offered to make some calls since she was too upset. She said she had been told by a friend of hers who also knew the broker that he had not died of cancer as she had heard, but had committed suicide.

I checked with several regulatory agencies in the city where the taxpayer lived, including the SEC and the local police department. I also checked FINRA’s “brokercheck” website but could not find the broker listed. The SEC informed me that while the person had applied for a CRD number at least 5 years prior to my call the application had never been completed. The scam artist had been holding himself out as a licensed securities dealer.

Later that same day, the member forwarded account statements that she had received from him, but it was obvious to me that they had been produced using Microsoft Word. I also learned that Form 5498 had ever been filed with the IRS to report the value of the IRA account, for any of the years she had held the account.

I wrote the IRS and explained that even though we believed the IRA distribution had occurred, we also had reason to believe the member had lost all the money in a potential Ponzi scheme. I asked the IRS to relieve the member from the liability this created by allowing her to take the theft loss in the same year as the distribution. I also requested an abatement of penalties, since the member had acted in good faith and only recently had learned that her broker had been a scam artist and that her money had never been reinvested in an IRA account as she had believed all along.

In the meantime, our member continued to pursue her own inquiries, including calls to the FBI, local police department (to file a formal complaint) and the local Department of Consumer Affairs. Because the broker had died, however, all agencies declined to start an investigation to determine where the investors’ money had gone. Our member and other investors with the same broker discussed a civil lawsuit against his estate, but determined there were no assets to pursue.

We sent a follow up response to IRS, clarifying that the distribution had indeed been lost in an investment fraud and requesting relief from a portion of the liability by allowing her to use the Ponzi scheme relief procedures under Revenue Procedure 2009-20. Even though the loss did not meet the strict guidelines, we received a letter about a month later stating that the IRS was considering the matter and would respond within sixty days.

Finally, the IRS issued a new notice showing the distribution was still taxable, but allowing the theft loss as an offsetting itemized deduction in the amount of $204,250. The IRS also agreed to waive the accuracy-related penalty and charged only interest. This reduced the member’s liability from $79,292 to $6,764 (including interest). When I called the member after receiving the notice, she was thrilled that we had reduced her liability by over 91%. While she is still unhappy that she lost her investment, she said that the money she had paid for audit defense that year was the best money she had ever spent and she was so happy that she had purchased it that year.