Honorable Jim D. Pappas, United States Bankruptcy Judge.
Debtors Elvin Warren Smith and Linda Loreen Smith filed a chapter 7
On November 2, 2016, chapter 7 trustee Noah Hillen ("Trustee") filed an objection to Debtors' claim of exemption as to the IRA funds ("the objection"). Trustee's Obj.
Having considered the evidence and the parties' arguments, as well as the applicable law, this Memorandum sets forth the Court's findings, conclusions and reasons for its disposition of the objection. Rules 7052; 9014.
At the hearing, Elvin Smith ("Smith") testified that, sometime prior to 2014, he deposited approximately $419,000 into an IRA ("the Provident IRA") managed by Provident Trust Group ("Provident"). The funds in the Provident IRA were invested in several life insurance policies sold by Life Partners, Inc. ("Life Partners"). Smith testified that, at the end of 2013, he decided to close the Provident IRA because he no longer wanted to pay the annual fees for Provident to manage the account. See also Ex. 101. On November 25, 2013, Smith opened a U.S. Bank IRA account, which did not require an annual fee, so that he could deposit any funds he eventually received from his investments in Life Partners policies. See Ex. 100.
To close the Provident IRA, Smith testified he sent a letter in which he informed Provident that he had established the U.S. Bank IRA, and that he no longer wanted Provident to monitor his account. That letter is not in included in the evidentiary record.
On January 31, 2014, Provident sent a letter to Smith regarding "Change of Ownership, Account # 2512-Elvin W Smith." Ex. 202. The letter recites that "[w]e received your directive to close the above referenced account", and after requesting a $250.00 account closing fee, provides, "[w]e have prepared a Change of Ownership form to re-register your assets from Provident Trust Group to you individually." Id.
In a response letter dated February 8, 2014, Smith informed Provident that he canceled the account because he could no longer pay the yearly maintenance fee, and that he had set up the U.S. Bank IRA. Ex. 101. He closed the letter by stating, "I am at this time not able to pay your closing fee as all you have to do is close the account." The letter makes no reference to the "Change of Ownership" mentioned in the January 31 Provident letter. Apparently, there was no further correspondence between Smith and Provident concerning the closing of his account.
On May 9, 2014, Purchase Escrow Services, LLC, an escrow agent for Life Partners, sent Smith a letter indicating it had been able to resell one of his insurance policies and would be distributing approximately $2,800.
Sometime prior to August 2014, Life Partners filed for bankruptcy. The Life Partners schedules indicated "Elvin Smith" was an unsecured creditor with a
In a letter dated April 16, 2016, Smith wrote to Provident regarding "2014 Form 1099-R." Ex. 103. Apparently, Provident had issued an IRS Form 1099-R in 2014 after closing Smith's account. Ex. 211. However Smith testified he did not see the 1099-R until 2016, when the IRS had contacted him requesting that he file a 2014 federal tax return. See also Ex. 103. Smith testified that neither he nor his wife had been employed or filed income tax returns for the years 2014-2016. In the April 16 letter, Smith explained that he did not receive a distribution in 2014; he requested that Provident correct the 1099-R form. Ex. 103. Apparently, Provident responded to this letter on April 27, 2016, but that letter is not on the record. See Ex. 203 ("as stated in our letter dated April 27, 2016").
In a letter dated July 4, 2016, Smith again wrote Provident asking that it either send him the amount shown in the 1099-R as a distribution, or that it send a corrected form to the IRS. Ex. 104. Provident responded in a letter dated July 15, 2016. Ex. 203. In it, Provident stated that the "1099-R was issued for [the closing of the IRA account] as the asset was distributed in-kind from your IRA to you personally."
During this time, Smith had also been communicating with the IRS. In a letter dated July 4, 2016, Smith explained to the IRS that he was trying to resolve the issue with Provident. Ex. 105. After receiving Provident's July 15 letter to him, Smith sent it to the IRS with a letter dated July 15, 2015, writing "[Provident's reply] shows that there was no money sent to me. Therefore, there was no income to be reported and no taxes to be paid." The IRS responded in a letter dated August 15, 2016, stating "[b]ased on your information we are taking no further action at this time, but may need to contact you again if other tax issues arise." Smith has had no further communications with IRS about the 2014 transactions with Provident.
In a letter to Smith dated June 6, 2016, an entity known as ASM Capital ("ASM") expressed interest in purchasing Smith's claim in the Life Partners bankruptcy case for $60,655.62. Ex. 205. Smith accepted ASM's offer in a letter dated June 6, 2016, and attached a signed copy of a claim purchase agreement that had been included with ASM's original letter to him. Exs. 206, 207. The purchase agreement indicates "Elvin Smith" was the seller of the claim; it was signed by "Elvin Smith." Ex. 207 at 1, 3.
On June 14, 2016, ASM filed a "Transfer of Claim" form in the Life Partners bankruptcy case that listed "Elvin Smith" as the transferor. Ex. 201. On July 5, 2016, the clerk of the bankruptcy court sent a notice to "Elvin Smith" indicating that the claim he originally filed had been transferred. Ex. 208. Sometime prior to June 27, 2016, ASM sent Smith the funds for the purchase of his claim. Smith deposited those funds in his U.S. Bank IRA account on June 27, 2016. Ex. 209.
Two days later, on July 29, 2016, Debtors filed their chapter 7 petition. Dkt. No.
Trustee argues that the funds in Debtors' U.S. Bank IRA are not exempt because at the time they were deposited in 2016, Debtors were not eligible to make an IRA contribution because they had no earned income. Tr.'s Suppl. Mem. at 6-8. In addition, Trustee argues that the funds were not a proper "rollover" IRA contribution for a number of reasons. Tr.'s Reply at 5-6, Dkt. No. 50; Obj. at 6, Dkt. No. 26.
Debtors urge the Court to look to the substance, not the form, of the transactions in this case. They contend that Provident is to blame for any defects in what would otherwise be a proper rollover contribution because Provident changed the Life Partners investments in the Provident IRA to Smith's individual name without his authorization. Resp. to Tr.'s Obj. at 3, Dkt. No. 33; Resp. to Tr.'s Suppl. Mem. at 1-6, Dkt. No. 49. They argue that, to deny their claim of exemption in the U.S. Bank IRA funds would, in this case, be a "manifest injustice" because Debtors had already lost the bulk of their retirement investment through the fraud of Life Partners,
After a brief overview of the relevant bankruptcy exemption laws, the Court will address each of these arguments in turn.
This Court has previously explained:
In re Hall, 464 B.R. 896, 903 (Bankr. D. Idaho 2012).
Exemption statutes are liberally construed in favor of the debtor in Idaho. In re Thomas, 477 B.R. 778, 782 (Bankr. D. Idaho 2012); In re Hall, 464 B.R. at 903. "However, the statutory language may not be `tortured' in the guise of liberal construction." In re Wiley, 352 B.R. 716, 718 (Bankr. D. Idaho 2006) (citing In re Collins, 97.3 IBCR 78, 79 (Bankr. D. Idaho 1997)).
Here, Debtors claim the funds in the U.S. Bank IRA are exempt under Idaho Code § 11-604A.
Idaho Code § 11-604A(3). The Court has explained that, for the purposes of this exemption statute, "employee benefit plan" is defined expansively to include "any plan or arrangement" described in one of six sections of the Internal Revenue Code, including IRC § 408, which governs the establishment and operation of IRAs. In re McClelland, 08.1 IBCR 5, 7, 2008 WL 89901, at *3 (Bankr. D. Idaho Jan. 7, 2008) (citing Idaho Code § 11-604A(4)(b)). Accordingly, in Idaho, a bankruptcy debtor may exempt his or her interest in a qualified IRA as prescribed in IRC § 408.
IRC § 408 provides, in relevant part that:
26 U.S.C. § 408(a)(1). IRC § 219, in turn, fixes the maximum amount of income that an individual may deduct for tax purposes for contributions made during the tax year to an IRA. Any contributions made to an IRA in excess of the amount allowable as a deduction under IRC § 219 are considered "excess contributions." 26 U.S.C. § 4973(b). Generally, excess contributions are taxed with a six-percent excise tax each year until they are removed from the IRA or applied towards the contribution limits of the taxpayer in future years. 26 U.S.C. § 4973(a).
Given these statutory requirements, the issue before the Court is whether, in 2016, the funds Debtors received from ASM were eligible for deposit in their U.S. Bank IRA under the provisions of IRC § 408, such that they are exempt under Idaho Code § 11-604A.
Trustee first argues that Debtors' 2016 deposit of funds into the U.S. Bank IRA did not qualify under IRC § 408 because Debtors were not entitled to make any IRA contribution that year. Tr.'s
The funds in the U.S. Bank IRA were deposited prior to the filing of Debtors' bankruptcy petition. If they were qualified contributions under § 408, they are exempt under § 11-604A. However IRA "contributions will not be accepted for the taxable year . . . in excess of the amount in effect for such taxable year under [IRC] section 219(b)(1)(A)." That statute provides:
Maximum amount of deduction. —
For purposes of paragraph (b)(1)(A), "deductible amount" is generally $5,000. 26 U.S.C. § 219(b)(5)(A). However for those individuals over the age of 50 in 2016, including Debtors,
However, recall, the "maximum amount of deduction" under IRC § 219(b)(1) is the lesser of subparagraphs (A) and (B). While Debtors could have deposited up to $13,000 in an IRA in 2016 under subparagraph (A), under subparagraph (B), the deduction was limited to the amount of their "compensation," a term defined to mean "earned income." 26 U.S.C. 219(f)(1). Since neither of Debtors were employed in 2016, they had no earned income, and in turn, their "compensation" for that year was $0. Because $0 is the lesser amount of subparagraphs (A) and (B), the "amount in effect" for purposes of IRC § 408(a)(1) was also $0.
Simply put, Debtors were not entitled to make qualified IRA contributions in 2016.
Even if Debtors were not eligible to make contributions to an IRA in 2016 because they had no earned income, the amounts they deposited in the U.S. Bank IRA would still receive favorable treatment under IRC § 408, and thus be exempt under § 11-604A, if the deposit was a "rollover contribution." Debtors argue that this is what happened in 2016, despite the many quirks in these facts. Debtors' argument lacks merit.
The contribution limit for IRA deposits does not apply to rollover contributions as described in IRC § 408(d)(3). 26 U.S.C. § 408(a)(1) (establishing deposit limits "except in the case of a rollover contribution"). In particular, § 408(d)(3) provides, in relevant part, that:
26 U.S.C. § 408(d)(3)(A)(i).
Debtors insist that the 2016 deposits made to the newly established U.S. Bank IRA were simply the culmination of what was, in effect, a "rollover" of their original investment in the Provident IRA. But Trustee argues that Debtors' 2016 deposit in the U.S. Bank IRA did not qualify as a rollover contribution for two reasons. First, the source of the funds Debtors used to make the deposit did not result from any rollover of Debtors' original deposits at Provident, but instead, was the sale of their claim in the Life Partners bankruptcy case. Tr.'s Reply at 5-6, Dkt. No. 50. Second, Trustee points out that Debtors did not rollover the "distribution-in-kind" of the Life Partners insurance policies to the U.S. Bank IRA within the sixty days as in IRC § 408(d)(3).
Trustee argues that Debtors' contribution in 2016 to the U.S. Bank IRA was not a a qualified "rollover contribution" because the source of the funds was not another qualified IRA, but came from the payment made by ASM for the purchase of Debtors' claim in Life Partners' bankruptcy case. Tr.'s Reply at 5-6, Dkt. No. 50. Debtors only response is that Trustee waived this argument. Trustee did not waive this argument,
Section 408(d)(3) of the IRC requires that a rollover contribution must be "distributed out of an individual retirement account." Here, Debtors' "distribution" did not come from Provident, nor even from Life Partners. While Debtors argue the funds effectively originated from the money invested in the Provident IRA, the record establishes that the funds actually deposited in the U.S. Bank IRA came from ASM, not from Provident or Life Partners. Because of this, then, the U.S. Bank deposit was not a "rollover" as defined in 26 U.S.C. § 408(d)(3).
Trustee argues that, even if the source of the deposited funds were not a problem
At his request, Provident, the custodian, closed out Smith's IRA account in late 2013 or early 2014. Provident did so by transferring the IRA investments, the interests in the Life Partners policies, into Smith's name. Debtors do not dispute that this occurred, nor can they contest that the subject deposits were not made to the U.S. Bank IRA until 2016. Even so, Smith insists that he did not take steps to move the investments into the U.S. Bank IRA because he was unaware that they were in his name until 2016, when the IRS first requested that he file a tax return to account for the distribution. Resp. to Tr.'s Obj. at 3, Dkt. No. 33; Resp. to Tr.'s Suppl. Mem. at 1-6, Dkt. No. 49. The evidence suggests something different.
In January 2014, Provident notified Smith it intended to transfer his IRA account interests to his name. Smith received and responded to this letter. In August 2014, Smith filed a proof of claim in the Life Partners bankruptcy case indicating, under penalty of perjury, that he, not his IRA, was a creditor. Then, in 2016, he, personally, executed a contract to sell his bankruptcy claim to ASM.
The only document in the record that references the "Elvin Smith IRA" after the assets were distributed by Provident was a May 2014 notice to Smith disclosing that Life Partners resold one of the life insurance policies. But given the proximity in time to the change of ownership of the policies, the reference in this notice was likely to the Provident IRA, not any new IRA, due to a delay in Life Partners updating its records. Indeed, when Life Partners later filed for bankruptcy, it indicated in its schedules that Smith, individually, owned the remaining policies.
Despite this factual record, Debtors argue that the Court should allow their claim of exemption as if Provident had never transferred them to Smith's name. They argue that this case is similar to In re Susan Sutton-Robinson, 472 B.R. 77 (Bankr. D. Ariz. 2012), where a brokerage firm erroneously transferred the debtor's assets from a qualified IRA to a nonexempt account and failed to properly correct the mistake until after the debtor filed a bankruptcy case. Id. at 80-81. Noting that the IRS permits taxpayers to "cure" defects in qualified IRA's,
In re Susan-Sutton Robinson is distinguishable. In this case, Smith was promptly notified about the transfer of the policies to his individual name, a transfer that was not the result of any error by Provident. As noted above, the transfer was made at Smith's request. Thus, the Court
Even assuming Smith's deposits to the U.S. Bank IRA originated with the Provident IRA, rather than ASM, on this record, the Court concludes that Debtors' 2016 deposit was not a rollover contribution because it did not occur within sixty days of distribution of the investments to Smith from Provident made in 2014.
Because the deposit in the U.S. Bank IRA both exceeded the IRC contribution limit for 2016, and did not constitute a proper rollover contribution, Debtors' deposits in the U.S. Bank IRA are not a pension, annuity, or retirement allowance accrued under a plan described in § 408 of the IRC as required for an exemption under Idaho Code § 11-604A.
As a last ditch effort to preserve their exemption claim, Debtors request that they be allowed to seek a determination by the IRS that the U.S. Bank IRA, and the funds in that account, qualify under IRC § 408, and therefore, are exempt. For support, they cite an unpublished decision from the Ninth Circuit Bankruptcy Appellate Panel: D.A.N. Joint Venture III, L.P. v. Richey (In re Richey), 2011 WL 4485900 (9th Cir. BAP 2011).
In Richey, the objecting party argued that funds in the debtors' IRA could not be exempt because they had been rolled over from debtors' unqualified plan. Id. at *10. In response, the debtors offered letters detailing a favorable determination from the IRS, although none of them had been issued as of date the debtors' prior plan was terminated and the funds were rolled into the IRA. Id. at *3-4. The objecting parties' expert witness also pointed to defects in the plan that could have potentially disqualified the plan under the IRC. Id. at *4. Given those circumstances, the bankruptcy court ordered the debtors to participate in the IRS's voluntary compliance program ("VCP"), to obtain a determination of whether the plan from which the funds originated was tax-qualified, and to request that IRS permit debtors to cure any plan defects with retroactive effect. Id. at *4. Via the VCP, the debtors identified the failures in their former plan to the IRS, and proposed various ways to correct the defects. Id. at *5. The IRS eventually issued a compliance statement allowing for a cure of the defects with retroactive effect, indicating that IRS would not pursue sanctions or disqualification of the prior plan. Id. The bankruptcy court, relying on the IRS compliance statement, overruled the objection to the debtors' exemption claim, Id. at *6-7, and on appeal, the BAP affirmed stating:
Id. at *11.
As an unpublished opinion, the BAP's decision in Richey is not binding on this Court. Moreover, by blessing the bankruptcy court's exercise of discretion in Richey, the decision would not require this Court to allow Debtors to participate in the VCP. Here, the Court declines Debtors' suggestion that they should be able to resolve their exemption dilemma via an IRS determination.
The Court empathizes with Debtors' ultimate loss of their entire original retirement investment. But while Smith argues he intended to effect a rollover of his Provident investment to the U.S. Bank IRA, the facts suggest otherwise. As the Court has previously noted, "[u]nfortunately, [a debtor's] intention to make property exempt does not, standing alone, accomplish that goal . . . [;] [a] debtor's election on how to handle his or her assets may unintentionally waive protections otherwise provided by the Code or state law." In re Kane, 99.4 IBCR 175, 177-178, 1999 WL 33490225, at *4-5 (Bankr. D. Idaho Nov. 24, 1999).
Trustee's objection to Debtors' claim of exemption in the U.S. Bank IRA is sustained. Debtors were not eligible to make an IRA contribution in 2016 because they had no earned income. In addition, the U.S. Bank IRA deposit was not a proper rollover from the Provident IRA. As a result, the funds in the U.S. Bank IRA were not part of a pension, annuity, or retirement allowance accrued under an IRA as described in IRC § 408, and thus cannot be exempted under Idaho Code § 11-604A.
A separate order will be entered.
