Fifth Circuit Holds Inherited IRA Exempt in ... - Underwood Law

Posted 03/15/2012 by Roger Cox*

The United States Court of Appeals for the Fifth Circuit has held that an inherited IRA is exempt from a Chapter 7 bankruptcy estate.

1.? In re Chilton

In In re Chilton, ____, Fd.3d _____, 2012 U.S. App. LEXIS 5140 (5^th. Cir. 2012), the Court allowed a Chapter 7 Debtor?s claimed exemption in an Individual Retirement Account (?IRA?) inherited about a year prior to the Debtor?s bankruptcy filing.

This appears to be consistent with prior precedent regarding the treatment of IRAs in bankruptcy; however, the question of whether an inherited IRA would be afforded similar treatment was apparently a matter of first impression before the Fifth Circuit.

?2.? Exemptions Generally

As a general rule, individual bankruptcy debtors may exempt certain property from their bankruptcy estate.? As the court stated:

The Bankruptcy Code permits debtors to exempt certain property from the bankruptcy estate.

As a general matter, upon the filing of a petition for bankruptcy, all legal or equitable interests of the debtor in property become the property of the bankruptcy estate and will be distributed to the debtor?s creditors. To help the debtor obtain a fresh start, the Bankruptcy Code permits? [*4] him to withdraw from the estate certain interests in property, such as his car or home, up to certain values.

Rousey v. Jacoway, 544 U.S. 320, 325, 125 S. Ct. 1561, 161 L. Ed. 2d 563 (2005) (quotation marks and internal citations omitted). A claim of exemptions is presumably valid, and the objecting party has the burden of proving that exemptions are not properly claimed. 11 U.S.C. ? 522(l); Fed. R. Bank. P. 4003(c).

Id.

3.? Retirement Funds Exempt

Generally, IRAs have been considered ?retirement funds? and therefore entitled to exemption under Section 522(d)(12) of the Bankruptcy Code.? See, e.g., In re Tabor, 433 B.R. 469, 476 (Bankr. M.D. Pa. 2010).

4.? Inherited IRS Exempt?

In Chilton, the Fifth Circuit isolated two issues:

1.???????? Whether the inherited IRA contains ?retirement funds? under Section 522(d)(12); and

2.???????? Whether those retirement funds are in an account that is exempt from taxation under a series of enumerated sections of the Internal Revenue Code.

Regarding the first issue, the Court found that the original IRA was literally ?set apart? for retirement, thus satisfying the classic definition of ?retirement funds.?? In other words, the original decedent set aside her funds for retirement while she was alive.? Additionally, a direct transfer of retirement fund from one qualified account to another would not alter their status as retirement funds.? Id.? See also, 11 U.S.C. ? 52(b)(4)(C).? The IRA assets transferred by contract rather than by probate, and the survivor (who later became the debtor) established an inherited IRA, presumably consistent with applicable tax law.

Regarding the second issue, the parties did not dispute that the inherited IRA was tax exempt; however, the question was apparently under which Internal Revenue Code section it was rendered exempt for tax purposes.? Noting that the transfer had occurred pre-petition (before bankruptcy), the Court focused its inquiry on what provision rendered the inherited IRA exempt after the transfer.? Noting that Section 408 of the Internal Revenue Code (effectively the exempting statute for tax purposes) is among the tax code sections listed in Section 522 of the Bankruptcy Code, the Court found the second issue satisfied:

Because section 408 is one of the sections named in 11 U.S.C. ? 522(d)(12), inherited IRAs are contained in an ?account? that is ?exempt from taxation? as that phrase is used in section 522(d)(12).

Id.

This case appears to be consistent with settled law regarding the exempt nature of a properly established, qualified IRA.? What is not entirely clear from the opinion (and what was not a fact in Chilton) is whether this same reasoning would apply to a transfer that occurs post-petition,? say, within the period following the Chapter 7 bankruptcy filing, when certain inherited interests are implicated.

?5.? Lessons Learned

Two lessons going forward: for business owners and persons engagedin high risk professions, maximizing the use of a retirement account or IRA is typically a good strategy for legitimate asset protection (if done under ordinary circumstances and within allowable amounts).? From a lender?s perspective (attention credit analysts!), one should keep in mind that most qualified retirement accounts and IRAs are exempt from general creditors, therefore, they are not typically available to satisfy a judgment or other collection effort should that become necessary.

*Roger Cox, a shareholder with the Underwood Law Firm, is Board Certified in Business Bankruptcy Law (and formerly Board Certified in Commercial/Real Estate Law) by the Texas Board of Legal Specialization.? Mr. Cox regularly represents lending institutions in foreclosures, restructuring, and formal bankruptcy proceedings.?

This column is published for informational purposes only. It should not be construed as legal advice and is not intended to create an attorney client relationship. The views expressed are those of the author and do not necessarily reflect the views of the author?s law firm or its individual partners.

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Source: http://www.uwlaw.com/fifth-circuit-holds-inherited-ira-exempt-in-bankruptcy/

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