Link to Eighth Circuit Opinion
The Eighth Circuit Bankruptcy Appellate Panel (hereinafter BAP) held that an individual retirement account (hereinafter IRA), which a Chapter 7 bankruptcy debtor inherited from her father before filing for bankruptcy, was exempt from the bankruptcy estate under the Bankruptcy Code’s exemption for retirement funds. This decision is inconsistent with a Texas bankruptcy court, which had recently held that inherited IRAs do not fall within the federal exemption.
I. Facts and Holding
Nancy A. Nessa (hereinafter Debtor), was named as the beneficiary of her father’s IRA.[2] Robert Borrett, the father of the Debtor, had established an IRA in accordance with the standards of the Internal Revenue Code.[3] Upon the death of her father in August 2008, the Debtor made a trustee-to-trustee transfer of her father’s IRA into her own account.[4] “She did not ‘roll over’ [her father’s IRA] account to her own IRA, [and] she did [not] take any distributions from her father’s IRA.”[5] The Debtor also did not contribute any of her own funds to the inherited account.[6] In January 2009, the Debtor filed a voluntary Chapter 7[7] petition for bankruptcy, and claimed the inherited IRA as an exemption under section 522(d)(12) of the Bankruptcy Code.[8] The bankruptcy Trustee objected to this exemption, and this case ensued.[9]
“The bankruptcy court overruled the Trustee’s objection, . . . explain[ing] that the transfer of the contents of the [inherited] account [into the Debtor’s personal] account was a trustee-to-trustee transfer.”[10] The court concluded that when the funds from the father’s account were transferred, they “retained their character as retirement funds.”[11] Therefore, the court held “that the funds in the [Debtor’s] account qualified for an exemption under . . . section 522(d)(12).”[12] The Trustee appealed to the BAP, which affirmed the decision of the bankruptcy court.[13]
II. Legal Background
The BAP began with a discussion of how the bankruptcy estate is defined.[14] The bankruptcy estate, as defined in section 541 of the Bankruptcy Code, includes all of the debtor’s legal and equitable interests in property, along with other specific interest of the debtor.[15] Section 522 lists the types of property that the debtor may exempt from his or her bankruptcy estate.[16] The specific exemption at issue in the present case is found in section 522(d)(12), which states that the debtor may take an exemption for “[r]etirement funds to the extent those funds are in a fund or account that is exempt from taxation under section 401,[17] 403,[18] 408,[19] 408A,[20] 414,[21] 457,[22] or 501(a)[23] of the Internal Revenue Code of 1986.”[24]
The BAP stated that section 522(d)(12) lays out two requirements that must be met for a debtor to claim an exemption under that section.[25] These requirements are: “(1) the amount the debtor seeks to exempt must be retirement funds; and (2) the retirement funds must be in an account that is exempt from taxation under one of the provision of the Internal Revenue Code set forth therein.”[26]
In determining whether the amounts in the inherited account were ‘retirement funds,’ the BAP first noted that the Debtor’s father’s account was an “individual retirement account” as defined in section 408(a) of the Internal Revenue Code.[27] It noted that the account is now classified as an “inherited individual retirement account” as defined in section 408(d)(3)(C) of the Internal Revenue Code because the Debtor inherited the account following the death of her father.[28]
The bankruptcy Trustee argued that, in order for the funds in the Debtor’s inherited account to retain their status as retirement funds, “the contents of the inherited account would have to have been contributed by the Debtor or be part of the Debtor’s retirement plan.”[29]
The BAP rejected the Trustee’s argument, finding that “Section 522(d)(12) requires that the account be comprised of retirement funds, but it does not specify that they must be the debtor’s retirement funds . . . . [E]ven though the contents of the Debtor’s inherited account were the Debtor’s father’s retirement funds, not the Debtor’s own retirement funds, they remain in form and substance, ‘retirement funds.’”[30]
The BAP disagreed with a recent ruling from a Texas bankruptcy court which held that the words “retirement funds” as used in section 522(d)(12) “‘cannot reasonably be understood to authorize an exemption of an inherited IRA.’”[31] The BAP stated that the Texas bankruptcy court “fails to take into account section 522(b)(4)(C) of the Bankruptcy Code . . . and in fact it would make that section totally meaningless.”[32]
The BAP then addressed whether the funds at issue in this case met the second requirement of section 522(d)(12): whether the retirement funds were in an account that is exempt from taxation.[33]
The bankruptcy Trustee argued that “‘the rules are different . . . regarding the use, distribution, and taxation of funds in an IRA versus an inherited IRA.’”[34] The BAP held that the Debtor’s inherited account was exempt from taxation under section 408, reasoning that “[i]t is irrelevant whether a traditional IRA and an inherited IRA have different rules regarding minimum required distributions,” since section 408(e) states that “‘[a]ny individual retirement account is exempt from taxation.’”[35]
Finally, the BAP addressed section 522(b)(4)(C) of the Bankruptcy Code, which states that “[a] direct transfer of retirement funds from 1 fund or account that is exempt from taxation under section . . . 408 . . . of the Internal Revenue Code of 1986, . . . , shall not cease to qualify for exemption under . . . subsection (d)(12) by reason of such a direct transfer.”[36] In other words, section 522(b)(4)(C) provides that direct transfers from an account under section 408(a) are exempt under section 522(d)(12).[37] The BAP reasoned that since it was undisputed that the father’s account was an individual retirement account before his death and it was undisputed that the transfer to the inherited account was a direct trustee-to-trustee transfer, that section 522(b)(4)(C) clearly allowed for the funds to be claimed as an exemption.[38]
The BAP concluded by affirming the decision of the bankruptcy court.[39]
III. Comment
The Eighth Circuit Bankruptcy Appellate Panel is the first appellate panel in the federal circuits to decide the issue of whether a debtor’s inherited IRA is exempt from the bankruptcy estate under section 552(d)(12). It remains to be seen whether the remaining circuits will follow suit with the Eighth Circuit and hold in the affirmative, or if they will instead look to the reasoning used by the Texas Bankruptcy Court, which would create a split in the circuits.
-Adam J. Wallach
[1] No. 10-6009 (B.A.P. 8th Cir. April 9, 2010). The West reporter citation is In Re Nessa, 426 B.R. 312 (B.A.P. 8th Cir. 2010).
[2] Id. at 313.
[3] Id. The Internal Revenue Code is contained within Title 26 of the United States Code. 26 U.S.C §§ 1 to 9384 (2010).
[4] Nessa, 462 B.R. at 313.
[5] Id.
[6] Id.
[7] In a Chapter 7 bankruptcy proceeding, also known as liquidation bankruptcy, the bankruptcy trustee gathers the debtor’s non-exempt assets, sells them, and distributes the proceeds to the debtor’s creditors. The debtor is then discharged from any remaining debt (unless any debt is nondischargeable). See generally 11 U.S.C. § 701 (2010).
[8] Nessa, 426 B.R. at 313-14. The Bankruptcy Code is contained within Title 11 of the United States Code. See 11 U.S.C. §§ 101 to 1532 (2010).
[9] Nessa, 426 B.R. at 314.
[10] Id.
[11] Id.
[12] Id.
[13] Id. at 315.
[14] Id. at 314.
[15] Id. See 11 U.S.C. § 541 (2010).
[16] Nessa, 426 B.R. at 314. See 11 U.S.C. §522 (2010).
[17] 26 U.S.C. § 401 (2010) (qualified pension, profit-sharing, and stock bonus plans).
[18] 26 U.S.C. § 403 (2010) (taxation of employee annuities).
[19] 26 U.S.C. § 408 (2010) (individual retirement accounts).
[20] 26 U.S.C. § 408A (2010) (Roth individual retirement accounts).
[21] 26 U.S.C. § 414 (2010) (definitions and special rules).
[22] 26 U.S.C. § 457 (2010) (deferred compensation plans of State and local governments and tax-exempt organizations).
[23] 26 U.S.C. § 501(a) (2010) (exemption from tax on corporations described in sections (c), (d), or section 401(a)).
[24] In re Nessa, 426 B.R. 312, 314 (B.A.P. 8th Cir. 2010) (citing 11 U.S.C. § 522(d)(12) (2010)).
[25] Id.
[26] Id.
[27] Id. See 26 U.S.C. § 408(a) (2010) (“‘individual retirement account’ means a trust created or organized in the United States for the exclusive benefit of an individual or his beneficiaries, but only if the written governing instrument creating the trust meets” the requirements outlined in this section).
[28] Nessa, 426 B.R. at 314. See 26 U.S.C. § 408(d)(3)(C)(ii) (2010) (“an individual retirement account . . . shall be treated as inherited if the individual whose benefit the account . . . is maintained acquired such account by reason of a death of another individual, and such individual was not the surviving spouse of such other individual”).
[29] Nessa, 426 B.R. at 314.
[30] Id. at 314-15.
[31] Id. at 315 n.3 (quoting In re Chilton, 426 B.R. 612, 618 (Bankr. E.D. Tex. 2010).
[32] Id.
[33] Id.
[34] Id.
[35] Id. (citing 26 U.S.C. § 408(e)(1) (2010)).
[36] Id. (citing 11 U.S.C. § 522(b)(4)(C) (2010)).
[37] Id.
[38] Id.
[39] Id.
