I have a client that was convicted of a federal crime, not involving taxes. His 401k was seized for restitution...about $180k. They do NOT withhold ANY taxes. Between federal and CA state he should owe about $70k in taxes and penalties...he is not over 59 1/2. Apparently, his lawyer advised him that somehow he wouldn’t have to pay the penalties but didn’t elaborate. I can’t seem to find anything that would exempt him from the penalties. In my eyes, he repaid money he obtained illegally and so why would he be exempt from the penalties. 

Has anyone ever had a case like this and could there possibly be a way around the penalties?