In a departure from the majority of courts, the Seventh Circuit has found that debtors cannot exempt inherited IRAs. In re Clark, No. 12-1241 & 12-1255 (April 23, 2013). Section 522(b)(3)(C) (and section 522(d)(12) if using the federal exemptions) permits debtors to exempt“[r]etirement 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 of 1986.” In Clark, the debtor’s mother had an IRA which, upon her death, was transferred to the debtor into one of the tax exempt accounts specified by the Code. As the Fifth Circuit, the BAPs for the Eighth and Ninth Circuits, and many lower courts have found, such accounts may be exempted in bankruptcy. See, e.g., Chilton v. Moser, 674 F.3d 486 (5th Cir. 2012); Mullen v. Hamlin, 465 B.R 863 (B.A.P. 9th Cir. 2012); Doeling v. Nessa, 426 B.R. 312 (B.A.P. 8th Cir. 2010).
The Seventh Circuit, however, found otherwise. The court’s decision turned on its interpretation of “retirement funds” which it found were no longer “retirement” once they transferred to the debtor’s account. In so holding, the court noted that the debtor did not contribute the funds in contemplation of retirement and that inherited IRAs receive different treatment under the Tax Code. The court expressed its distaste for the outcome that would have resulted from permitting the exemption, saying: “To treat this account as exempt under § 522(b)(3)(C) would be to shelter from creditors a pot of money that can be freely used for current consumption.”
But, as pointed out correctly by the Fifth Circuit, the plain language of the Code sets forth only two requirements for the exemption to apply: 1) that the funds in the account represent retirement funds when contributed, and 2) that upon the death of the owner the funds be transferred to a tax exempt account specified in the exemption statute. Chilton, 674 F.3d at 488. With respect to the first requirement, “the defining characteristic of ‘retirement funds’ is the purpose they are ‘set apart’ for, not what happens after they are ‘set apart.’” Therefore, where the debtor’s mother contributed the funds toward retirement, they do not lose that status upon transfer to the debtor. This interpretation is further supported by section 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 . . . 408 . . . of the Internal Revenue Code of 1986, . . . shall not cease to qualify for exemption under paragraph (3)(C) . . . by reason of such direct transfer.” The Seventh Circuit’s imposition of a requirement that the funds be contributed by the debtor is simply not a statutory condition.
With respect to the second requirement, the funds are either in one of the specified accounts or they are not. There is no need for judicial interpretation. Therefore, the Seventh Circuit’s analysis of the use to which a debtor can or must put the inherited funds is irrelevant. If they were earmarked as “retirement funds” when contributed to the account, and they are transferred to one of the accounts specified by Congress as retaining their exempt status, a court goes beyond its purview by adding a requirement that Congress has not included. The Seventh Circuit has ignored the plain language of the statute to reach an outcome in line with its opinion as to what Congress should have done.
NACBA has been active in supporting debtor’s position on this issue. This decision, which creates a split in the Circuits, is far more superficial in its reasoning that those decisions reaching the opposite conclusion.
Tags: Inherited IRAs
