Chilton v. Moser, (DC TX 3/16/2011) 107 AFTR 2d ¶2011-594
A district court, reversing a bankruptcy court, has determined that a debtor's inherited IRA met the requirements for bankruptcy exemption under 11 USC 522(d)(12).
Background on Bankruptcy Code exemption for IRAs. The Bankruptcy Code provides for two basic exemption regimes: (1) the statutory federal exemptions under 11 USC 522(d)(12); and (2) exemptions under state or local law (or federal nonbankruptcy law). A state can choose to “opt out” of the federal exemption scheme by prohibiting its citizens from selecting the exemptions set out in 11 USC 522(d)(12).
Under 11 USC 522(d)(12), a federal bankruptcy exemption applies for certain tax-qualified retirement funds and accounts, including the following:
... Code Sec. 401 (qualified defined benefit and defined contribution plans, including 401(k) plans);
... Code Sec. 403 (qualified annuity plans and tax-sheltered 403(b) annuities);
... Code Sec. 408 (traditional IRAs, SEP-IRAs, and SIMPLE IRAs);
... Code Sec. 408A (Roth IRAs);
... Code Sec. 414 (qualified governmental plans);
... Code Sec. 457 (deferred compensation plans of state or local governments or tax-exempt organizations); or
... Code Sec. 501(a) (tax-exempt organizations). (11 USC 522(d)(12))
Under 11 USC 522(b)(4)(C), a direct transfer of retirement funds from one fund or account that is exempt from taxation under Code Sec. 408 does not cease to qualify for exemption under 11 USC 522(d)(12) by reason of that direct transfer.
Background on inherited IRAs. If an IRA owner designates his spouse as beneficiary of his IRA and dies before the account is exhausted, the surviving spouse may roll over the decedent's IRA into the spouse's own IRA, or elect to treat the decedent's IRA as the spouse's own IRA. (Code Sec. 408(d)(3)(C), Reg. §1.408-8 Q&A 5(a))
A designated nonspouse beneficiary can't treat an inherited IRA as his own, but can make trustee-to-trustee transfers of the inherited amount to another IRA if the ownership of the new IRA is set up in the same way as the ownership of the old IRA, that is, in the name of the decedent for the benefit of the IRA beneficiary.
Facts. Janice Chilton's mother, Shirley Heil, established an IRA account and named Janice as beneficiary. On Nov. 28, 2007, Shirley died. As a designated nonspouse beneficiary, Janice couldn't treat her mother's IRA as her own, but she was allowed to make a trustee-to-trustee transfer of the inherited amount to another IRA (an “inherited IRA”) if the ownership of the new IRA was set up in the same way as the ownership of the old IRA (i.e., in the name of the decedent for the benefit of the IRA beneficiary). Thus, on Jan. 21, 2008, Janice established an IRA account, titled “Janice Chilton, Beneficiary, Shirley Heil, Decedent,” to receive the funds from her mother's IRA. The assets in her mother's IRA were transferred directly to the trustee for the account that Janice had set up. Janice made no contributions to the funds or assets in the account.
Janice filed for relief under Chapter 7 of the Bankruptcy Code on December 18, 2008 (although the proceeding was later converted to a Chapter 13 case), and listed the inherited IRA on her bankruptcy schedule. She claimed that the inherited IRA was property exempt from creditors under 11 USC 522(d)(12). The bankruptcy trustee objected to the exemption claim.
The bankruptcy court, noting that it had found no published case that addressed the exemption of inherited IRAs under 11 USC 522(d)(12), concluded as a matter of first impression that an inherited IRA is not equivalent to an ordinary IRA for purposes of determining whether the account contains “retirement funds” that may be exempted under 11 USC 522(d)(12). The bankruptcy court further determined that, even if the inherited IRA did contain “retirement funds,” the account that Janice set up to receive the funds from the IRA account was not a traditional IRA exempt from taxation under Code Sec. 408(e)(1). On that basis, the bankruptcy court denied the bankruptcy exemption for the inherited IRA.
Bankruptcy court reversed. The district court reversed the bankruptcy court and held that Janice's inherited IRA could be exempted from her bankruptcy estate. Since the bankruptcy court's March 5, 2010 decision, five other courts have found that inherited IRAs do meet the requirements for a Bankruptcy Code exemption. (See, eg., In re Nessa, (Bktcy Appellate Panel CA 8, 4/9/2010) 105 AFTR 2d 2010-1825) In that case, the 8th Circuit BAP relied on the broad language in Code Sec. 408(e) providing that “[a]ny individual retirement account is exempt from taxation,” and noted that under 11 USC 522(b)(4)(C), retirement funds that are directly transferred from a Code Sec. 408(a) tax-exempt account to another such account continue to qualify for exemption under 11 USC 522(d)(12).
Agreeing with the reasoning of Nessa and the other cases, the district court concluded that the funds in a debtor's inherited IRA do not have to be the “retirement funds” of the debtor to satisfy the bankruptcy exemption requirements. The court emphasized that 11 USC 522(b)(4)(C), which had not been discussed by the bankruptcy court, provides that a direct transfer of funds from one account that is tax-exempt under Code Sec. 408 to another such account (like the type of transfer that created Janice's inherited IRA) does not make the funds ineligible for a bankruptcy exemption.
The district court also concluded that inherited IRAs are among the IRAs that are exempt from taxation under Code Sec. 408(e)(1), which provides that any IRA is exempt from taxation. Thus, because an inherited IRA meets this requirement, any differences between a traditional IRA and an inherited IRA are irrelevant for purposes of the bankruptcy exemption.
References: For Federal bankruptcy exemption for IRAs, see FTC 2d/FIN ¶H-12207.1; TG ¶8063.