The following article was recently submitted to Leimberg Information Services, a fantastic resource for any estate planning professional. The article was authored by Lauren Detzel and Brian Malec, contributors to this blog.
Executive Summary: Recently, Bob Keebler and Michelle Ward reported on the January 2011 decision of In re Theim out of the U.S. Bankruptcy Court for the District of Arizona, which held that an inherited IRA was exempt from the beneficiary’s bankruptcy estate under the Arizona exemption statute and under § 522(b)(3)(C) of the Bankruptcy Code. As Bob and Michelle noted, many other jurisdictions continue to have unfavorable precedent with respect to the protection afforded to inherited IRAs. However, at least one jurisdiction has changed its view since the Theim decision. Notably, on March 16, 2011, the U.S. District Court for the Eastern District of Texas reversed the 2010 Bankruptcy Court decision of In re Chilton. The District Court was persuaded by five cases issued since the Bankruptcy Court decision, including In re Nessa and In re Theim, that held an inherited IRA to be exempt under § 522(d)(12) or § 522(b)(3)(C). The District Court in Chilton held that that the funds within the inherited IRA were exempt under § 522(d)(12) of the Bankruptcy Code because such funds satisfied each of the following statutory requirements: (i) the funds must be “retirement funds”; and (ii) the retirement funds must be in an account that is exempt from taxation under Section 401, 403, 408, 408A, 414, 457 or 501(a) of the Internal Revenue Code. With respect to the first requirement, the Court specifically held that the retirement funds are not required to be those of the debtor; rather, they can be those of a non-debtor, as in the instant case. Further, the District Court quoted § 522(b)(4)(C), which provides that a “direct transfer of retirement funds from one fund or account that is exempt from taxation under Section 401, 403, 408, 408A, 414, 457 or 501(a) of the Internal Revenue Code . . . shall not cease to qualify for exemption under . . . subsection (d)(12) by reason of such direct transfer.” With respect to the second requirement, the Court found the language of § 408(e) persuasive, which says that “any individual retirement account is exempt from taxation.”
On March 28, 2011, Florida became the latest jurisdiction to follow the reasoning of Nessa in the case of In re Mathusa.
Facts: The debtors, James and Marilynn Mathusa, inherited funds held in an IRA upon the death of Marilyn’s mother. The debtors followed the required formalities to make a trustee-to-trustee transfer of the IRA into an inherited IRA. The debtors claimed an exemption in bankruptcy proceedings under both Florida Statutes § 222.21 and Bankruptcy Code § 522(b)(3)(C). The Chapter 7 bankruptcy trustee argued that an inherited IRA did not qualify for exemption under either statute.
The United States District Court for the Middle District of Florida stated that § 522(b) of the Bankruptcy Code allows states to opt-in or opt-out of the federal exemption scheme. If a state opts-in, section 522(b)(2) operates to apply § 522(d)(12) to determine the exemption available to a debtor with respect to funds held in an IRA. If a state opts-out, then § 522(b)(3) applies. Since Florida is an opt-out state, the Court stated that § 522(b)(3) applied to determine the protection afforded to the debtors’ inherited IRA in a Florida bankruptcy proceeding.
Pursuant to § 522(b)(3)(C), a debtor may claim an exemption for “retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457 or 501(a) of the Internal Revenue Code.” The Mathusa Court noted that the language in § 522(b)(3)(C) is identical to § 522(d)(12), which is intended to afford equal treatment to exemption claims of retirement funds regardless of whether a state opts-in or opts-out of the federal exemption scheme. Accordingly, the Court looked to decisions interpreting § 522(d)(12) to determine the protection afforded under § 522(b)(3)(C).
In its brief opinion, the Mathusa court (like the District Court reversal of the Chilton Bankruptcy Court) focused on the reasoning of the Eighth Circuit in Nessa. In Nessa, the court concluded that the debtor’s inherited IRA was exempt under § 522(d)(12) because the inherited IRA funds (1) qualified as “retirement funds” and (2) were exempt from taxation under § 408 of the Internal Revenue Code. The Nessa court found that § 522(d)(12) does not require the retirement funds to be the debtor’s retirement funds to qualify for exemption. Further, the Eighth Circuit found that § 522(b)(4)(C) supported the position that inherited IRAs are exempt under the Bankruptcy Code. Specifically, section 522(b)(4)(C) provides that a direct transfer of retirement funds from 1 fund or account that is exempt from taxation under particular sections, including § 408, of the Internal Revenue Code shall not cease to qualify for exemption under § 522(b)(3)(C) or § 522(d)(12) by reason of such transfer.
The Mathusa court expressly adopted the reasoning of Nessa and extended it to apply to an inherited IRA under § 522(b)(3)(C). Accordingly, the District Court held that the inherited IRA of the debtors was exempt from the claims of their creditors.
Comment: Mathusa is yet another victory for debtors claiming exemption of inherited IRAs under the Bankruptcy Code and is especially important for debtors residing in an opt-out state. However, the holding does not directly offer protection to Florida debtors claiming exemption of inherited IRAs under the state exemption statute. The Mathusa court did not explore the protection afforded under Florida Statutes § 222.21, and, in fact, noted in the final footnote of its opinion that the debtors “arguably cannot exempt the inherited IRA under Florida Statutes § 222.21(2)” based on the recent decisions of Robertson v. Deeb and In re Ard. In reaching its holding, the Mathusa court did not otherwise analyze Robertson and Ard because the debtors in those cases did not claim an exemption under § 522(b)(3)(C) of the Bankruptcy Code.
As readers are likely aware, the Robertson court held that inherited IRAs were not exempt under Florida state law because the plain language of Florida Statutes § 222.21(2)(a) referenced only the original “fund or account” and the different tax treatment of inherited IRAs rendered them completely separate funds or accounts from the original IRAs. This decision caught many Florida practitioners off guard with respect to the protection afforded to inherited IRAs because such practitioners felt that the legislative intent and plain language of Florida Statutes § 222.21(2)(a) was clearly in favor of protecting inherited IRAs. Senate Bill 978 and House Bill 469 have been introduced in the 2011 Florida legislative session in direct response to Robertson and Ard and are aimed at inserting explicit language into § 222.21(2)(a) to clarify that inherited IRAs are exempt under state law. These bills have unanimously passed several committees of the Florida Senate and House thus far and appear to have the support necessary to potentially become law by the end of the 2011 session. If SB 978/HB 469 does, in fact, become law, then inherited IRAs of Florida debtors should be protected regardless of whether they find themselves in state court or federal bankruptcy court.
Chilton v. Moser, 107 A.F.T.R.2d 1391 (E.D. Tex. March 16, 2011) In re Mathusa, No. 6:10-bk-13336-KSJ (March 28, 2011); Robertson v. Deeb, 16 So. 3d 936 (Fla. 2d DCA 2009); In re Ard 435 B.R. 719 (M.D. Fla. 2010); In re Theim, 107 A.F.T.R.2d 529 (Bkrtcy. Ct. AZ 2011).