Sunday, August 10, 2014

Inherited IRAs Are Not Exempt in Bankruptcy

The Supreme Court has unanimously ruled that IRAs inherited by non-spouses do not qualify for a federal bankruptcy exemption; that is, they are not protected from creditors in bankruptcy.  Clark v. Rameker[JS1] , No. 13-299 (June 12, 2014).

Background:  The Clark case centered on the question of whether a husband and wife filing for Chapter 7 bankruptcy could exempt from their bankruptcy estate an IRA account that the wife had inherited from her mother.  At the time the bankruptcy petition was filed, the value of the inherited IRA was approximately $300,000.  In seeking to exempt the inherited IRA funds, the couple relied on Bankruptcy Code §522(b)(3)(C) (11 USC 522(b)(3)(C)), which permits a debtor to exempt amounts that are both (a) “retirement funds,” and (2) exempt from income tax under one of several enumerated Internal Revenue Code provisions, including Code Sec. 408, which provides a tax exemption for IRAs.  
            The bankruptcy trustee and the unsecured creditors of the taxpayers objected to the claimed exemption on the ground that the funds in the inherited IRA were not “retirement funds” within the meaning of the Bankruptcy Code.  The bankruptcy court agreed and disallowed the exemption.  The District Court then reversed, explaining that the Bankruptcy Code exemption covers any account containing funds that were originally accumulated for retirement purposes.  Upon further appeal, the Seventh Circuit reversed the District Court’s ruling concluding that the inherited IRA funds could not be exempt because “inherited IRAs represent an opportunity for current consumption, not a fund of retirement savings.”
            The Seventh Circuit’s conclusion was directly opposite that reached by the Fifth Circuit when faced with the same question just one year earlier (In re Chilton). To resolve the conflict between these two Circuit Court rulings, the Supreme Court agreed to hear the case.