Inherited IRA’s are Exempt [UPDATE – JUNE 12, 2014 -THIS CASE WAS OVERRULED]

[THIS CASE WAS OVERRULED BY THE U.S. SUPREME COURT BY CLARK V RAMEKER, DECIDED JUNE 12, 2014]

The Fifth Circuit has ruled that an inherited Individual Retirement Account (“IRA”) is exempt under the federal exemption scheme (§522(d)(12)).  In re: Chilton, 774 F.3d 486 (5th Cir. 2012).  Janice Chilton inherited an IRA worth $170,000.00 from her mother and followed the requirements of the Internal Revenue Code to establish an “inherited IRA.” An IRA inherited by someone other than a spouse in defined as an Inherited IRA. 26 U.S.C. §408(d)(3)(C)(ii).  Special distribution rules apply to inherited IRA’s.

Subsequently, the Chiltons filed a Chapter 7 bankruptcy case and claimed the inherited IRA as exempt pursuant to 11 U.S.C. §522(d), which provides:

[t]he following property may be exempted under subsection (b)(2) of this section:… (12) Retirement funds to the extent that those funds are in an account that is exempt from taxation under 401, 403, 408, 408A, 414, 457, or 510(a) of the Internal Revenue Code of 1986.

The Trustee objected to the claimed exemption on the basis that the funds in an inherited IRA are not “retirement funds” within the meaning of §522(d)(12) and are not held in the type of tax exempt account specified.  In response, the debtors converted their case to a Chapter 13 case and the Trustee objected again. The bankruptcy court ruled for the Trustee, but the District Court reversed the decision.  The Trustee appealed.

In a case of first impression at the Circuit Court level, the 5th Circuit ruled that the term “retirement funds” within the meaning of §522(d)(12) can include funds that others had set aside for retirement and are not limited to funds set aside by the debtors. Relying on language in the Internal Revenue Code, the Court further ruled that an inherited IRA is tax exempt under one of the tax code provisions listed in §522(d)(12).  Inherited IRA’s are exempt under the federal exemption scheme of §522(d).

The Chilton opinion was based upon specific statutory language found in §522(d)(12), which is not available to debtors in opt out states like Mississippi.  Would the same analysis apply to inherited IRA’s under Mississippi’s exemption statute? Probably.  But it is unnecessary to consider the question because 11 U.S.C §522(b)(3)(C) allows debtors in opt out states to claim IRA’s as exempt using language identical to §522(d)(12). See In re: Hamlin, 465 B.R. 863 (BAP 9th Cir. 2012) (Inherited IRA’s are exempt under §522(b)(3)(C)).

Caution: in order to qualify as an inherited IRA under ERISA, a trust-to trust transfer must be made and other distribution rules must be followed.  A debtor risks losing the exemption in an inherited IRA if formalities are ignored.

“100% of FMV” post Schwab

In Schwab v. Reilly, ___U.S.___, 130 S. Ct. 2652 (2010), the debtor claimed certain restaurant equipment as exempt as tools of the trade using federal exemptions.  The exemption was expressed in a dollar amount equal to the fair market value of the equipment as listed on Schedule B.  The trustee did not object to the exemption, and after the 30 day deadline to object had passed, the trustee filed a motion to sell the equipment. The debtor objected to the motion to sell arguing that the equipment was removed from the bankruptcy estate when the trustee did not timely object to the exemption.

The trustee argued that it was the monetary amount that the debtor claimed as exempt, not the asset “in kind.”   The Court ruled that if the asset claimed as exempt was properly claimed (the asset type was allowed to be claimed as exempt) in a certain dollar amount, then the trustee could sell the asset and turn over the exempt proceeds without filing an objection to the claimed exemption.  It was the monetary value that was exempt, not the asset itself.

Recently, In re Orton, 687 F.3d 612 (3rd Cir. 2012), considered facts similar to Schwab and confirmed that statutory exemptions that are expressed in dollar terms must be claimed in dollars. The opinion states:

[T]he quintessential purpose of limiting a debtor to a dollar-amount exemption is to permit the trustee to liquidate assets in the best interest of the creditors by cashing out the debtor, effectively removing him from considerations about how to administer the estate. See 11 U.S.C. § 704(a)(1) (“[The Trustee must] collect and reduce to money the property of the estate for which such trustee serves, and close such estate as expeditiously as is compatible with the best interests of the parties…”).

Id. at 619.

The Court also confirmed that the estate is entitled to any appreciation in asset value over the amount claimed as exempt. Id. (citing In re Reed, 940 F.2d 1317 (9th Cir. 1991); In re Paolella, 85 B.R. 974 (Bankr. E.D. Pa. 1988)). The Court relied on the language of §541(a)(6) which defines bankruptcy estate property to include any ‘“[p]roceeds, products, offspring, rents, or profits of or from property of the estate..’ in other words, appreciation of value…”  Id.

Language in Schwab suggests that if a debtor wants to indicate his intent to exempt the asset “in kind,” then he should use specific language that was not expressed in dollar terms, such as “100% of FMV.”  Most courts interpreting Schwab have not allowed debtors to convert the monetary exemptions to “in kind” exemptions by using language such as “100% of FMV.”

In re Salazar, 449 B.R. 890 (Bankr. N.D. Tex 2011) was a consolidated decision involving objections to exemptions in nine (9) separate Chapter 7 and Chapter 13 cases.  In each case, debtors had claimed property as exempt using the language “100% of FMV.”  The debtors had followed the purported directive of Schwab and put the trustees on notice that they intended to claim the asset as exempt “in kind.”  The Court ruled that an objection by the trustee to the language “100 of FMV” could be sustained without an evidentiary hearing in cases in which an exemption should be expressed in terms of dollars.  The bankruptcy estate is entitled to post petition appreciation in asset values.  Therefore, if an exemption is expressed in terms of dollars, then the exemption must be claimed in dollar amounts.  The use of terms such as “100% of FMV” is an attempt to claim post petition appreciation, and is facially invalid. Id.       The Courts in In re Massey, 465 B.R. 720 (B.A.P. 1st Cir. 2012) and In re Luckham,  464 B.R. 67 (Bankr. D. Mass. 2012) have also held that an evidentiary hearing is not necessary on an objection to exemptions when a debtor claims “100% of FMV” of an asset as exempt on the basis that it a facially invalid attempt to exempt post-petition appreciation in property values.

The Bankruptcy Court for the North District of Texas, Forth Worth Division, holds evidentiary valuation hearings on objections to exemptions claiming “100% of FMV.”  The Court ruled in In re Moore, 442 B.R. 865 (Bankr. N.D. Tex. 2010), that  “[t]he debtor will have the burden of going forward and must show a plausible basis for the claim that “100% of FMV” falls within the statutory limit on the amount that may be exempted.  Once the debtor has satisfied that burden, the party opposing the exemption will have, as provided by Rule 4003(c), the burden of proving that, in fact, the exemption exceeds the statutory limit.” Id. at 866.

To the best of my knowledge, the issue has not been raised in Mississippi.  A few attorneys in Mississippi have started using the  “100% of FMV” language.  I have not objected to any of the exemptions because I did not intend to administer the assets claimed as exempt, but I may do so in the future.

What is “Cash on Hand”?

Under Miss. Code Ann. §85-3-1, debtors may claim as exempt certain tangible personal property not to exceed $10,000.00 in equity value.  “Cash on Hand” is specifically included as a category of property that may be claimed as exempt subject to the $10,000.00 limitation.

CASH ON HAND:

NOT CASH ON HAND:

Bank Accounts are not CASH ON HAND! Cartwright v. Deposit Guaranty Nat. Bank, 675 So. 2d 847 (Miss. 1996).

Does that mean that funds in a bank account can NEVER be exempt? No.  With proper planning, the following may be claimed as exempt if the funds are in a bank account:

-Traceable proceeds from the sale of a homestead.  Miss. Code Ann.§85-3-1(b)(i).

-Traceable proceeds of insurance on exempt property.   Miss. Code Ann.§85-3-1(b)(i).

-Traceable income from an exempt source. (i.e., Social Security Benefits, Workers’ Compensation Benefits, Public Assistance Benefits).

-Wildcard exemption for debtors 70 and older Miss. Code Ann. §85-3-1(h).

DISCLAIMER

Homestead Exemption Issues

Mississippi has opted out of the federal exemption scheme.    Miss. Code Ann. §85-3-2.  Debtors who have been domiciled in Mississippi for 730 days prior to filing bankruptcy may claim as exempt up to $75,000.00 of equity value in real property used as a primary residence (not to exceed 160 acres). Miss. Code Ann. §85-3-21.  However, did you know that the statute also provides that widows or widowers over the age of 60 may claim the exemption even if they do not reside on the property?  Apparently, the authors of this legislation believed that Mississippians who attain the advanced age of 60 would surely move to rest homes or in with family members when their spouses die.  Oh! – this statutory provision was enacted in 1914 when the life expectancy was around 52.  Fast forward to the 21st century – if one is unfortunate enough to have his/her spouse die at such an early age, is it possible to lease out the “old home place” and travel the world without losing the homestead exemption?  Maybe!

A husband and wife share one homestead exemption. Joe T. Dehmer Distributors, Inc. v. Temple, 826 F. 2d 1463 (5th Cir 1987). In a  joint bankruptcy case the shared homestead exemption is not a problem because the husband and wife claim a single $75,000.00 exemption on Schedule C.  However, the “shared” homestead exemption seems to be problematic when only one spouse files bankruptcy.    The issue is whether the exemption amount is applied against the full equity value of the property even though one spouse is not in bankruptcy, or whether the exemption amount is applied against the debtor’s 1/2 interest in the property.  Some debtors’ attorneys still take the position that the debtor can claim the full $75,000.00 exemption against his 1/2 interest in the property.

My position is that the exemption is applied against the full equity value even if only one spouse files bankruptcy.  This seems clear from Dehmer.   Applying the full homestead exemption against a 1/2 interest in the property is equivalent to allowing 2 exemptions in the same property.

Disclaimer.