Vincent Howard and our Claremont consumer bankruptcy lawyers wrote recently about a Ninth Circuit BAP case that established a fairly new right for bankruptcy filers -- exemptions for individual retirement accounts that the filers inherited from another person. The right to exempt the filer's own IRA is clear and the right to inherit from a spouse had been established, but the right to exempt an IRA inherited from a non-spouse was new to the Ninth's BAP, and also to the Fifth. In Chilton v. Moser, Robert and Janice Chilton of Texas sought to exempt an IRA inherited from Chilton's mother from their Chapter 7 bankruptcy. Trustee Christopher Moser objected that this IRA was not exempt, and while the bankruptcy court agreed, the district court and the Fifth U.S. Circuit Court of Appeals did not.
Shirley Jean Heil died in 2007 and left an IRA worth $170,000 to Janice Chilton. Chilton established her own inherited IRA to receive the proceeds of Heil's. The Chiltons filed for Chapter 7 bankruptcy in 2008 and sought to exempt the inherited IRA. Moser, their trustee, objected, saying funds in the account were not retirement funds within the meaning of sec. 522(d)(12) of the bankruptcy code. In response, they converted to Chapter 13, but Moser raised the same objection to their exemption claim. After a hearing that was not detailed, the bankruptcy court again sided with the trustee and denied the exemption. The Chiltons appealed to the district court, however, which reversed, citing several cases that had been decided in the interim and came to the opposite conclusion. Moser appealed to the Fifth Circuit.
That court affirmed the district court, finding the Chiltons could exempt their inherited IRA. Under sec. 522, debtors may exempt retirement funds, and those funds must be in a tax-exempt account included in a list given by the law. Deciding whether this applies to inherited IRAs is an issue of first impression for all the federal appeals courts, the Fifth said. On the first prong of the test, whether the IRA contains "retirement funds," the court found that a majority of lower courts had decided it does. Reasoning that retirement funds may include funds someone else set aside for retirement, the Fifth agreed. The defining characteristic of retirement funds is the purpose for which they were set aside, not what happens afterward. On the second prong, the Fifth had to decide which section of federal law gave the inherited IRA its unambiguous tax exemption, and chose 26 USC 408(e). That section says "any individual retirement account is exempt from taxation under this subdivision," roping in all IRAs. Inherited IRAs are defined as IRAs, the court noted, so there's no reason to think they should be treated differently.
Vincent Howard and our Placentia consumer bankruptcy attorneys are pleased to see this decision, which echoes that of the Ninth Circuit's BAP. These two circuits are considered far apart politically, so when they agree, it's a sign that the law is clear. Of course, we also find it clear that inherited IRAs are IRAs, with the same rules, benefits and limitations carried by all IRAs. The bankruptcy trustee's job is to find and secure the maximum amount of money possible for the bankruptcy estate's creditors, so it's not surprising that he would try to secure extra through the IRA --but the rules say otherwise. In our own practice, the Temecula individual bankruptcy lawyers at Howard Law, P.C., try to preserve assets like this whenever possible, knowing that our clients will need them to make a fresh start after bankruptcy.
Led by partner Vincent Howard, Howard Law serves clients across California from main offices in Costa Mesa. If you'd like to talk to us about your financial situation and your legal options, call us today at 1-800-72-5925 or send us a message through our website.