IRS written determination 201440027

Private letter rulings and published taxpayer determination letters. Native document type is retained separately; a determination letter is not labeled a private letter ruling. These taxpayer-specific releases cannot be used or cited as precedent under 26 USC 6110(k)(3); applicability and current legal force are not independently certified. Keep repeated UILC subjects attached to one actual numbered document.

TAX EXEMPT AND
GOVERNMENT ENTITIES
DIVISION
. DEPARTMENTOFTHETREASURY
INTERNAL REVENUE SERVICE
WASHINGTON, D.C. 20224
JUl 1 0 2014
211440027
UIL Numbers: 162.00-00, 401.04-00, 402.00-00, 415.00-00, and 4972.02-00
Legend:
Trustee A
=
Employer B
=
Plan C
=
Administrator D
=
Individual E
=
Financial Institution F
=
Financial Institution G
=
Financial Institution H
=
Administrator I
=
Amount 1
=
Amount 2
=
Amount 3
=
Amount4
=

2
281440027·
Amount 5
=
Amount 6
=
Amount 7
=
Amount 8
=
Dear
This
is in response to a request dated April 29, 2013, as supplemented by
correspondence dated April23, 2014, and June
18, 2014, submitted by your authorized
representative on your behalf, concerning the characterization and tax consequences
of
certain proposed payments to a defined contribution plan.
The following facts and representations in support
of your request have been submitted
under penalties
of perjury:
Plan C is a profit sharing plan maintained by Employer B for the benefit
of its
employees. Plan C was established effective January 1, 1989, and is intended to be
qualified under section 401 (a) of the Code. The adoption agreement for Plan C
provides that Trustee A is the trustee of Plan
C, and Employer B is the Plan
Administrator for Plan
C. Trustee A is the sole proprietor of Employer B and a
participant
in Plan C.
Prior to July 15, 2009, contributions to Plan C consisted of discretionary employer
contributions. Effective July 15, 2009, Plan C executed an adoption agreement for a
non-standardized prototype
401 (k) profit sharing plan that had received an EGTRRA
opinion letter from the Internal Revenue Service ("Service") dated March 31, 2008.
Effective July 15, 2009, Plan C also provided elective deferrals and matching
contributions. The assets
of Plan C are invested in a pooled investment account.
Participants
in Plan C do not direct any investments.
From
2005 through late 2012, Trustee A experienced knee and back problems, and
chronic pain. Trustee A had six surgeries
in 2005, 2007, 2009, 2011, mid-2012, and
late 2012, and was prescribed painkillers to help relieve the pain. During this time,
Trustee A
gradually became addicted to the painkillers.
In 2001, Employer B hired Administrator D to administer Plan C. Employer 8
represents that Administrator D, through its principal, Individual E, was responsible for

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211440027
allocating Employer 8 contributions to participant accounts, as well as maintaining
records for
all transactions pertaining to Plan
C. In 2009, the Department of Labor
("DOL") contacted Trustee A regarding an investigation into fraudulent activity with
respect to Plan C and Individual
E. The ensuing DOL investigation revealed that
Individual E wrongfully diverted approximately Amount 1 from Plan C during the period
from October 2002 through May 2007 into her personal accounts and for her personal
use.
In addition, the DOL investigation revealed that from October 2003 through April
2007, Individual
E knowingly made false statements and concealed facts
in violation of
Title I of the Employee Retirement Income Security Act of 197 4 ("ERISA").
Upon learning
of the results of the DOL investigation, Trustee A, as trustee and named
fiduciary for
Plan
C, took several steps to protect the interests of Plan C participants and
to recover the misappropriated plan assets. Trustee A filed a civil claim against
Financial Institutions
F, G, and H, alleging that the financial institutions allowed the
fraudulent deposits to Individual E's personal accounts and corresponding debits from
Plan C accounts, despite invalid endorsements. Employer 8 and Financial Institutions
F, G and H entered into a settlement agreement, pursuant to which Trustee A recovered
a total
of Amount 2 for Plan C. Trustee A also filed a claim under Plan C's surety bond
policy and secured a payment
of Amount 3.
Federal criminal charges were brought against Individual E. As part of her plea
agreement to settle the charges of theft or embezzlement from an employee benefit
plan and for false statements and concealments
in ERISA documents, Individual E
agreed to return Amount 4 to Plan
C.
Trustee A represents that Amounts 2, 3 and 4 have been deposited into Plan C's pooled
investment account.
Employer 8 represents that although the DOL could have pursued fiduciary breach
actions against Trustee A or Employer 8, and that it did bring charges against other,
unrelated employee benefit plan trustees from which Individual E had misappropriated
funds, the
DOL has elected not to pursue fiduciary breach charges against Trustee A or
Employer
B. Employer 8 states that the DOL's decision is a result of Employer B's
agreement to restore any and all losses to Plan C participants that could not
be·
recovered from third parties. Employer 8 informed Plan C participants of its intention, in
an effort to
forestall participant lawsuits against Trustee A and Employer 8 for breach of
fiduciary duties to Plan C.
Employer 8 hired Administrator I to administer Plan C and to calculate the total losses
to Plan C as a result of Individual E's actions, net of the restorative payments already
made to Plan C (Amounts
2, 3 and 4). Administrator I determined that there were 12
affected participants,
including Trustee
A. Although Administrator I lacked the

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20144002?
information necessary to determine the losses for years 2002 and 2003, it calculated
that the total principal loss to Plan C from 2004 through 2008 equals Amount
6.
Administrator I calculated the lost earnings on Amount 6, determined through April 4,
2011, as an amount equal to Amount
7. Earnings were calculated based on Plan C's
actual earnings rate beginning with the 2004 year through April
4, 2011, with the total
estimated loss equal to Amount
8. Trustee A represents that the information regarding
the losses incurred by Plan C were conveyed to the United States Probation Office in
regard to Individual
E.
Employer B proposes to make a restorative payment of Amount 5 to Plan C to resolve
any potential claims against Employer B and Trustee
A. Employer B represents that
Amount
5, when added to Amounts 2, 3 and 4, will restore Plan C participant accounts
to where they
would have been had the misappropriations not occurred. Employer B
represents that the restorative payments will be allocated to all affected participants,
including Trustee A's account,
of the affected Plan C participants as determined by
Employer B and as calculated independently by Administrator
I.
Based on the preceding facts and representations, your authorized representative has
requested the following rulings on your behalf:
1. The restorative payments from third parties and Employer B will not constitute
employer contributions
or amounts subject to provisions of sections 404(a)(3), 415(c) or
4972 of the Internal Revenue Code ("Code").
2. The restorative payments from third parties and Employer B will not adversely affect
the qualified status
of the Plan under section 401 (a) of the Code.
3. The restorative payments from third parties and Employer B will not, when made to
Plan
C, result in taxable income to Plan C participants.
4. The restorative payments from Employer B will be deductible in full pursuant to
section 162
of the Code as an ordinary and necessary business expense.
With respect to ruling requests
(1 ), (2), and (3), section 401 (a)(4) of the Code provides
generally that the contributions
or benefits provided under a qualified plan may not
discriminate in favor
of highly compensated employees.
Section
402(a)
of the Code generally provides that any amount actually distributed to
any distributee by an employees' trust described
in section 401 (a) which is exempt from
tax under section
501 (a) shall not be taxable to a participant until actually distributed to
the participant.

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201440027
Section 404(a) of the Code generally provides that contributions paid by an employer to
or under a stock bonus, pension, profit-sharing, or annuity plan, if otherwise deductible,
are deductible under section 404, subject to the
limitations under section 404(a).
Section 415(a) of the Code provides, in part, that a trust which is part of a pension,
profit-sharing
or stock bonus plan shall not constitute a qualified trust under section
401 (a) if, in the case of a defined contribution plan, contributions and other additions
under the plan with respect to any participant for any taxable
year exceed the limitations
of section 415(c).
Section 1.415( c)-1 (b )(2)(i) of the federal Income Tax Regulations ("Regulations")
provides that the term "annual additions" includes employer contributions credited
to the
participant's account for the limitation year.
Section 1.415(c)-1 (b)(2)(ii)(C)
of the Regulations provides that a restorative payment
that is allocated to a participant's account does not give rise to an annual addition for
any limitation year.
It further provides that:
Restorative payments are payments made to restore losses
to a plan
resulting from actions by a fiduciary for which there
is reasonable risk of
liability for breach of a fiduciary duty under Title I of ERISA or under other
applicable federal
or state law, where plan participants who are similarly
situated are treated similarly with respect to the payments. Generally,
payments to a defined contribution plan are restorative payments only if
the payments are made
in order to restore some or all of the plan's losses
due to an action (or a failure to act) that creates a reasonable risk
of
liability for such a breach of fiduciary duty (other than a breach of fiduciary
duty arising from failure to remit contributions to the plan).
Section 4972
of the Code imposes on an employer a ten percent excise tax on the
amount
of the nondeductible contributions made to any "qualified employer plan,"
including a plan qualified under section
401 (a).
Section 4972(c)
of the Code defines "nondeductible contributions" as the excess (if any)
of the amount contributed for the taxable year by the employer to or under such plan
over the amount allowable as a deduction under section 404 for such contributions
(determined without regard to subsection (e) thereof), and the amount determined under
subsection (c) for the preceding year reduced by the sum
of the portion of the amount
so determined returned to the employer during the taxable year and the portion
of the
amount so determined deductible under section 404 for the taxable year (determined
without regard to subsection (e) thereof).

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28144002?
6
Revenue Ruling 2002-45, 2002-2 C.B. 116 ("Rev. Rul. 2002-45"), applies a facts and
circumstances test to determine whether a payment to a plan qualified under section
401 (a)
of the Code is a restorative payment or a contribution to the plan. Under Rev.
Rul. 2002-45, payments made merely to replenish a participant's account
in a defined
contribution plan after investment losses are to be treated as contributions. However,
payments that are made to restore some or
all of the account's losses due to an action
(or failure to act) that creates a reasonable risk
of liability are restorative payments. In
addition,
in order to be a restorative payment, the payment does not need to be the
result
of legal action; it only needs to be made as a result of a reasonable determination
that there is a reasonable risk of liability. Rev. Rul. 2002-45 also provides that the
amount
of a restorative payment cannot exceed the amount lost, including appropriate
adjustments for earnings. A restorative payment is not taken into account under section
410(a)(4), 415(c), or401(k)(3) or (m).
In addition, a restorative payment is not subject
to the provisions
of section 404 or 4972.
Applying the reasoning of Rev. Rut. 2002-45 in this case, Employer B has made a
reasonable determination that there was a reasonable risk
of liability for breach of
fiduciary duty as a result of the losses sustained by Plan C through the fraudulent action
of Administrator D and Individual E. In addition, the payments which Employer B intends
to make to Plan C are designed to ensure that the affected Plan C participants'
accounts are restored. Further, Employer B has indicated that the DOL conditioned its
decision not to pursue fiduciary
liability claims against Employer B or Trustee A on the
making
of the restorative payments and that the DOL had pursued claims against
fiduciaries
of other, unrelated plans with funds misappropriated by Individual E. But for
the promised restorative payments, it is reasonably likely that either the DOL
or Plan C
participants would pursue fiduciary breach actions against Employer B and Trustee
A.
Based on the above, it is reasonable to characterize this payment as a restorative
payment, rather than as a plan contribution or as
an annual addition.
Employer B represents that the restorative payments will be allocated to all affected
participants, including Trustee A's account, according to the value
of the accounts of the
affected Plan C participants as determined by Employer B and as calculated
independently by Administrator I. Employer B proposes that all affected Plan C
participants, including Trustee
A, will be treated similarly, and all Plan C accounts will be
restored.
Based on the foregoing, we conclude that the restorative payments pursuant to the
proposed transaction will not constitute a contribution or other payment subject to the
provisions
of either section 404 or 4972 of the Code; will not adversely affect the
qualified status
of Plan C pursuant to either section 401 (a)(4) or 415 of the Code; and
will not, when made, result
in taxable income to affected Plan C participants or
beneficiaries under section 402(a)(1)
of the Code. However, in no case will amounts

2f)l44002?
7
paid in excess of the amount lost (including appropriate adjustments to reflect lost
earnings) be considered restorative payments.
With respect to
ruling request (4), section 162
of the Code provides that there shall be
allowed as a deduction all the ordinary and necessary expenses paid or incurred during
the taxable year
in carrying on any trade or business.
In general, the Service views payments made
·in settlement of lawsuits or potential
lawsuits as deductible if the acts that gave rise to the litigation or potential litigation were
performed
in the ordinary conduct of the taxpayer's business. See,~-· Rev. Rul. 80-
119, 1980-1; Rev. Rul. 78-210,1978-1 C.B.
39; Rev. Rul. 73-226,1973-1 C.B. 62. This
view is consistent with a series of cases holding that payments to settle litigation or
threatened
litigation (including for claims
of fiduciary breach) are ordinary and
necessary business expenses, and therefore deductible, if the threatened
litigation
arises out of the taxpayer's business, and the corresponding payments are made to
protect a taxpayer's business from the liability of a possible lawsuit, added legal fees
and damages to the taxpayer's business.
See,~ Butler v. Commissioner, 17 T.C.
675 (1951), acg., 1952-1 C.B.
1; Marks v. Commissioner, 27 T.C. 464 (1956), acq.,
1966-2 C.B. 2; Old Town Corp. v. Commissioner, 37 T.C. 845, (1962), acq., 1962-2
C.B.
5.
In this case, Administrator D was hired to perform certain ordinary and necessary
administrative tasks for Plan
C, which is sponsored by Employer B for the benefit of its
employees. Individual
E, acting as principal of Administrator D, misappropriated Plan C
assets during the course of performing these functions, and the losses incurred by Plan
C arose in the ordinary conduct of Employer B's business. Employer B has represented
that the proposed restorative payments will be made to forestall litigation that might
potentially arise as a result
of Individual E's actions. Accordingly, with respect to ruling
request four, we conclude that the proposed restorative payments made by Employer B
would be ordinary and necessary business expenses deductible under section 162
of
the Code.
This ruling
is based on the assumption that Plan C otherwise meets the requirements of
section 401 (a) of the Code and that its related trust is tax-exempt within the meaning of
section 501 (a) of the Code. No opinion is expressed as to the Federal income tax
consequences of the transactions described above under any other provisions
of the
Code.
This ruling is directed only to the taxpayer who requested
it. Section 611 O(k)(3) of the
Code provides that it may not be used or cited as precedent.
Pursuant to a power
of attorney on file with this office, a copy of this letter ruling is being
sent to the taxpayer's authorized representative.

281440017
8
If you wish to inquire about this ruling, please contact
. Please address all correspondence to SE:T:EP:RA:T1.
Enclosures:
Deleted copy
of ruling letter
Notice
of Intention to Disclose
cc:
Sincerely yours,
Carlton
A. Watkins, Manager
Employee Plans Technical Group 1