Entrust Learning Center > Keyword: IRA > On Appeal, Debtor IRA Held Exempt Property Of Bankruptcy Estate Under Section 522(d)

On Appeal, Debtor IRA Held Exempt Property Of Bankruptcy Estate Under Section 522(d)

Judge Patrick J. Duggan agreed with the bankruptcy court that the IRA is property of the debtor's estate but overruled the lower court's finding that the IRA was not exempt.

9/15/99

A debtor's individual retirement account is property of the bankruptcy estate under Bankruptcy Code Section 541(c)(2) but the IRA is exempt pursuant to Section 522(d)(10)(E), the U.S. District Court for the Eastern District of Michigan ruled Sept. 15 (In re Hermes, E.D. Mich., No. 98-CV-74694-DT, Duggan, J., 9/15/99).

Judge Patrick J. Duggan agreed with the bankruptcy court that the IRA is property of the debtor's estate but overruled the lower court's finding that the IRA was not exempt.

The bankruptcy court cited In re Zott, (Bankr. E.D. Mich. 1998), which provides that under Section 541(a)(1), a debtor's bankruptcy estate generally consists of all of the debtor's legal and equitable interests in property at the time of filing. However, citing Patterson v. Shumate (19 BPR 1015, 6/15/92; 15 EBC 1481), the bankruptcy court found that under Section 541(c)(2), a debtor may exclude from the bankruptcy estate any interest in a trust that contains a transfer restriction enforceable under applicable non-bankruptcy law. Relying on In re Dunn, (Bankr. E.D. Mich. 1997), the bankruptcy court stated that "the application of 541(c)(2) to a trust requires a three-step inquiry. ... First, whether the debtor's interest is a beneficial interest held in a "trust;" second, whether there is a restriction on the transfer of the debtor's beneficial interest; and third, whether that restriction is enforceable under applicable federal or state nonbankruptcy law."

The court said there does not appear to be a serious dispute that the first requirement is met. The second requirement is met because the Shumate court held that plans that are "ERISA qualified" are excluded from the bankruptcy estate because to be ERISA-qualified, the plan must contain an anti alienation provision. the court said.

"Debtor's IRA does not contain an anti alienation provision and the fact that the Michigan statute [MICH. COMP. LAWS 600.6023]places restrictions on a creditor's ability to reach the funds in an IRA, does not, in this Court's opinion, satisfy the requirement that the IRA must contain an anti alienation provision," the court said. "The language in the IRA itself contains no provisions that prohibit debtor from transferring or withdrawing funds," the judge noted. "Accordingly, this Court agrees with the bankruptcy court that the IRA is property of the estate."

Holding That IRA Not Exempt Overruled

"Although an asset may not be excluded from the bankruptcy estate, nevertheless, it may be exempt," the court said.

Section 522(d)(10)(E) makes exempt a debtor's right to receive payment under a stock bonus, pension, profit-sharing, annuity, or "similar plan, "the court noted, adding that an IRA is a plan that is "similar" to those specifically listed. "IRAs have a significant characteristic that is common to pension and profit-sharing programs, i.e., all three programs are intended to provide a substitute for future wages, i.e., they are designed to provide retirement benefits to individuals," the court wrote. Allowing an exemption for an IRA as a "similar plan or contract' is consistent with the treatment afforded to other forms of deferred compensation and retirement benefits," the court decided.

Section 522(d)(10)(E) also provides that a "similar plan or contract" is exempt unless "such plan or contract does not qualify under ...408 of the Internal Revenue Code of 1986," Duggan said. IRAs are governed by Section 408 of the Internal Revenue Code, he noted. "Therefore, if Congress did not intend IRAs to be included in those `similar plans' exempt under 522(d)(10)(E), there would be no need to refer to 408,"the judge reasoned.

The court in In re Hall, (Bankr. W.D. Mich. 1993), wrote that because individual retirement plans are specifically included under 522(d)(10)(E)(iii), it is self contradictory and illogical for the exact type of investment to be excluded from the general provision of 522(d)(10)(E)." "Stated differently," it continued, "if individual retirement plans are excluded from the `similar plan or contract' language of 522(d)(10)(E), why would Congress include a non-qualified individual retirement plan as a possible exception to that same exemption?" Duggan agreed that because the Internal Revenue Code section referring to IRAs is part of the exception, this reference "makes inescapable the conclusion that IRAs were intended to be classified as a `similar plan or contract,' and thus exempt."

Furthermore, the failure to treat IRAs as "similar plans," and thus exempt, would "penalize individuals who are not in a position to participate in a pension plan or profit-sharing plan, e.g., self-employed individuals," Duggan reasoned, citing In re Gralka, (Bankr. W.D. Pa. 1997). Duggan agreed with the Fifth Circuit's 1996 ruling in In re Carmichael, 100 F.3d 375 (1996), that holding that the IRA is not exempt would be "antithetical to Congress' solicitude for retirement benefits for self-employed individuals," such as the debtor.

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