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Seventh Restores Ruling That Inherited IRA Cannot Be Exempted in Bankruptcy -Rameker v. Clark

April 29, 2013

Vincent Howard and our San Bernardino individual bankruptcy lawyers have written before about IRAs in bankruptcy. Congress has exempted IRAs and many other retirement vehicles from bankruptcies, which is uncontroversial when the IRA belongs to the bankruptcy debtor or was inherited from a deceased spouse. But there's a split among the federal appeals courts about whether an IRA inherited from another source is exempted from creditors' claims during bankruptcy, and a recent Seventh U.S. Circuit Court of Appeals ruling widened that split. In Rameker v. Clark, bankruptcy trustee William Rameker wanted to tap into an IRA left to Heidi Heffron-Clark by her mother, Ruth Heffron. The bankruptcy court permitted it, but the district court reversed that. The Seventh Circuit reversed again, permitting the trustee access to the money.

Bankruptcy law exempts retirement funds from bankruptcy to the extent that they are exempt from taxation under certain sections of the tax code. An IRA inherited by a spouse meets this requirement. However, Heffron-Clark inherited her IRA from her mother, which subjects it to different rules: no new contributions can be made; the balance cannot be rolled over or combined with other accounts; and it must start paying discharges within a year of the original owner's death. However, the money is still tax-exempt until withdrawn. The bankruptcy judge handling the bankruptcy of Heffron-Clark and her husband ruled that the IRA is not "retirement funds" because Heffron-Clark may not save it for her own retirement. The Clarks appealed to the district court, which reversed. Its ruling said funds that were retirement funds in a deceased person's hands must be retirement funds in the subsequent owner's. In so ruling, the district court sided with the Eighth U.S. Circuit Court of Appeals BAP; the Fifth Circuit later agreed.

The Seventh Circuit, however, disagreed in this case. It looked at how the funds would be used in Heffron-Clark's hands, not at their legal designation. For example, the court said, if Heffron-Clark were a trustee for someone else's funds, her creditors could not reach those funds even though she would be the legal owner. The Seventh then concluded that this IRA could not be used as retirement funds because of the requirement that the money be distributed before Heffron-Clark's retirement. In disagreeing with the other courts, the Seventh said the word "retirement" alone should not be given too much weight. Drawing an analogy, it said Heffron-Clark could not claim a homestead exemption for a house that was her mother's homestead, but that she had inherited and rented out. The exemption in both cases depends on how Heffron-Clark is using the property, the Seventh said, and this IRA is not reserved for use after she stops working. Thus, it reversed the case.

The Seventh Circuit panel noted that because it was creating a split with the Fifth Circuit, it asked all of its active judges if they would like an en banc rehearing (another case before a larger panel of judges). Apparently, a rehearing was not requested--but Vincent Howard and our Irvine personal bankruptcy attorneys suspect the issue will arise again. A split between the circuits often means the issue is controversial or the question is close, so the issue may be watched among bankruptcy attorneys. Our own home circuit is the Ninth Circuit, where this issue was addressed in the Bankruptcy Appellate Panel, which agreed with the Fifth that the accounts should be protected. At Howard Law, P.C., our Corona consumer bankruptcy lawyers prefer this interpretation, which gives our clients the maximum chance at a fresh financial start.

If you are considering bankruptcy as a way to deal with debts you can't handle anymore, don't hesitate to contact Vincent Howard and the team at Howard Law. You can send us a message online or call 1-800-872-5925 toll-free.

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