Randal S. Mashburn, U.S. Bankruptcy Judge.
The Chapter 13 Trustee objects to the Debtor's exemption in an Individual Retirement Account ("IRA") because of certain pre-petition activity. If the exemption is allowed, the Debtor is permitted to protect retirement funds totaling nearly $700,000, resulting in unsecured creditors receiving a 1% distribution under the Chapter 13 plan. This is the natural result of the Debtor dedicating his disposable income to the Plan yet being able to pay only a nominal amount to unsecured claims — without dipping into the retirement money claimed as exempt.
Based on how Congress structured the law with strong protections for IRAs and other retirement funds and how the Internal Revenue Service ("IRS") has interpreted the applicable rules, the Debtor's claim of exemption in the IRA is entirely permissible. Despite the pre-petition transactions called into question by the Trustee, the exemption is valid and cannot be disallowed.
This matter is before the Court on the objection filed by the Chapter 13 Trustee to the Debtor's claim of an exemption in an IRA with Charles Schwab in the approximate amount of $690,000. The Trustee contends that the exemption should be disallowed because the IRA lost its eligibility as a qualified plan under applicable provisions of the Internal Revenue Code based on the Debtor's pre-petition conduct.
The Trustee also objects to confirmation of the Debtor's Chapter 13 plan and seeks to have the case reconverted to Chapter 7 on the same basis as the exemption objection. The Trustee contends that the plan does not satisfy Section 1325(a)(4) of the Bankruptcy Code because it does not pay creditors as much as they would receive in a Chapter 7 case. However, his "best interest of creditors objection" is tied solely to the exemption of the IRA preventing those funds from being distributed to creditors.
The Debtor proposed a plan that pays 1% to unsecured creditors. If the Debtor's exemption is disallowed, it would result in a 100% payout to unsecured creditors since the value of the IRA is more than five times the amount of his unsecured debt. In short, the decision regarding the validity of the exemption will not only govern the exemption objection but also whether the Debtor's Chapter 13 plan can be confirmed. Likewise, the Court's decision may effectively dictate the result of the motion to convert since disallowance of the exemption could make any Chapter 13 plan impossible to confirm in light of the Debtor's limited income outside of the retirement money.
One thing is clear from a review of the applicable statutes, case law, and other authority: there is no overriding bankruptcy principle at issue here. Rather, this is simply a matter of whether the Debtor's IRA is no longer a qualified account under IRS rules. If it is a qualified plan, then it does not matter how large the IRA account is or how small the distribution to unsecured creditors would be. In other words, the potential effect on unsecured creditors is irrelevant, and the Debtor either
Although the Debtor testified during the hearing on this matter, all relevant facts have been formally stipulated or are not in dispute. The Debtor, who is above the age of 59½, has been the sole owner of the Charles Schwab IRA since at least early 2016. The IRS has approved the IRA account as one that is proper as to form, but certain transactions involving the Debtor's IRA lead the Trustee to contend that the IRA lost its qualified status shortly before the bankruptcy.
On March 15, 2016, the Debtor withdrew $327,978.13 from the IRA. On that same date, the Debtor used the withdrawn funds to purchase a house jointly with his spouse and titled it in both of their names.
About one week later, on March 21, 2016, the Debtor received approval from BankTennessee for a $252,000 mortgage based on placing a lien on the house purchased with funds contributed from the IRA. The BankTennessee loan was funded on or before May 10, 2016. On that date, the Debtor deposited $246,945 back into the same IRA from the proceeds of the mortgage loan. He subsequently paid taxes, as a retirement distribution, on the portion of the funds withdrawn from the IRA but not deposited back into the IRA.
On August 5, 2016, less than three months after the transaction involving the mortgage and deposit of funds back into the IRA, the Debtor filed a voluntary petition under Chapter 7. The Debtor's original schedules did not list the IRA nor claim an exemption. Nevertheless, the Chapter 7 Trustee became aware of the existence of the IRA and raised issues about it, prompting the Debtor to convert the bankruptcy to a Chapter 13 case.
The Debtor has no pre-petition priority debt and has unsecured debt totaling approximately $127,700, based on the scheduled debts and proofs of claim filed up to the time of the exemption hearing. Therefore,
A bankruptcy filing creates an estate containing all legal and equitable interests of a debtor in property as of the commencement of the case wherever located and by whomever held. 11 U.S.C. § 541(a). A debtor may remove certain property as a source of payment to creditors by claiming an exemption in the property. 11 U.S.C. § 522(b). Exemptions are to be construed liberally in favor of the debtor. A party objecting to a debtor's claim of exemptions "has the burden of proving that the exemptions are not properly claimed." Fed. R. Bankr. P. 4003(c). Menninger v. Schramm (In re Schramm), 431 B.R. 397, 400 (6th Cir. 2010).
The Trustee objects to the Debtor's claimed exemption in the IRA account because he says the entire IRA was destroyed as exemptible property when the Debtor engaged in a prohibited transaction (as defined by 26 U.S.C. § 408 and 26 U.S.C. § 4975) by "borrowing" funds from the account to purchase a home. More specifically, the Trustee argues that, even though the Debtor is above age 59½ and repaid most all of the funds within 60 days (and paid any required taxes on the rest), the nature of the transaction transformed the otherwise qualified and exemptible IRA under 26 U.S.C. § 408 into an unqualified IRA and therefore a non-exempt asset due to a prohibited transaction under 26 U.S.C. § 4975.
The Debtor has claimed the IRA exempt pursuant to T.C.A. § 26-2-111(1)(D) and § 26-2-105(b).
Although Tennessee has opted out of the federal exemptions provided by Section 522(d) of the Bankruptcy Code, Section
The Bankruptcy Code does not independently define what is properly exempt as a retirement fund. It simply defaults to the Internal Revenue Code. Exempt property includes any retirement funds in an account that qualifies for favorable tax treatment under specified sections of the Internal Revenue Code.
Section 522(b)(4) of the Bankruptcy Code directs how exemption law applies when there is a "rollover distribution" where the owner of an IRA receives a distribution and then places the money in a new IRA or returns the money to the old IRA within 60 days. Once again the Bankruptcy Code defaults to the Internal Revenue Code in defining what is a proper transaction.
The Tennessee exemption statute references Section 408 of the Internal Revenue Code, as does Section 522(b)(4)(D)(ii) of the Bankruptcy Code. The legislative history of Section 522(b)(3)(C) of the Bankruptcy Code indicates that the section was added so that states that opt out of the federal exemption scheme would be provided identical exemption rights in retirement funds for debtors. 4 COLLIER ON BANKRUPTCY ¶ 552.LH[5], at 552-131 (Alan N. Resnick & Henry J. Sommer eds., 16th ed. 2013). It is clear from these references that distributions made pursuant to the 60-day rollover rule retain their status as exempt
This statutory scheme is much more straightforward than the Trustee contends. He reads into this statutory structure a host of restrictions about what can — and cannot — happen during the critical 60-day period. In fact, the Trustee's interpretation makes virtually no distinction between a transfer directly from one IRA to another retirement account versus a "distribution" and subsequent "deposit" since he contends that the only purpose of the 60-day "rollover" provision is to accommodate portability from one account to another. Under his view, any time the account holder personally benefits from the money during the rollover period, it causes the entire account to lose its qualified status.
Section 4975(c) of the Internal Revenue Code defines a prohibited transaction as any direct or indirect transaction that involves various activities between an IRA and a disqualified person — such as buying and selling property and loaning money.
The Chapter 13 Trustee's position is based on misconceptions regarding both the pertinent facts and the relevant law. Factually, the Trustee's position disregards or downplays key points. First, the Debtor was above the age of 59½ and was entitled to a distribution of some or all of the money in the IRA without penalty and without needing to disguise it as a loan or engaging in an improper investment. Therefore, the argument that the Court should somehow recharacterize this transaction as a "borrowing" of money has much less appeal than it might if the Debtor were under the age of 59½ and had greater restrictions on receiving the funds without adverse tax consequences.
It is certainly true that the Debtor did not replace the identical money that he took out of the IRA. It is undisputed that the Debtor put the money from the IRA distribution into the purchase of a house and that he subsequently — but within 60 days — placed money borrowed from the bank from a home mortgage back into the IRA. Applicable law simply does not support the proposition that the same money that came out of the IRA has to be used for the "rollover" into an IRA within the 60-day rule.
The Trustee's legal position is based on his interpretation of 26 U.S.C. § 4975 and largely overlooks other contrary interpretations and other pertinent sections of the Internal Revenue Code and the Bankruptcy Code, as well as the most reasonable interpretation of the 60-day rollover policy.
For example, Technical Advice Memorandum ("TAM") 90100007 issued March 9, 1990, provides a clear IRS interpretation that the 60-day rollover rule is not exclusively for the portability of IRAs but instead is a once-a-year resource available to the beneficiary of the IRA. I.R.S. Tech. Adv. Mem. 90100007 (March 9, 1990). A TAM is "guidance furnished by the Office of Chief Counsel upon the request of an IRS director [ ] or an area director in response to technical or procedural questions that develop during a proceeding. While a TAM represents a final determination of the position of the IRS, it only governs the specific issue in the particular case in which the advice is issued." https://www.irs.gov/newsroom/understanding-irs-guidance-a-brief-primer (providing IRS definition of TAM). In this case, the specific question addressed in the TAM is directly on point:
The answer was unequivocally yes:
There is more to support this conclusion. In a Tax Memorandum Decision, Zaklama v. C.I.R., T.C. Memo. 2012-346 (2012), married taxpayers were asking the Tax Court to determine that their tax deficiencies were incorrect because they properly took withdrawals from their IRAs. In ruling on
The Tax Court cites the Treasury Regulations for support. Regulation 26 C.F.R. § 1.408-4 (Treas. Reg. § 1.408-4) provides for the 60-day rule and allows the money distributed to be paid back from "the same amount of money and
Furthermore, the IRS recognizes the flexibility of the 60-day rollover rule in various situations. Publication 590A, which is provided by the IRS to taxpayers as guidance on tax issues relating to IRAs, specifically confirms that a rollover into the same IRA is permissible under the rollover rules:
I.R.S. Pub. No. 590A, Cat. No. 66302J (December 28, 2016), https://www.irs.gov/forms-pubs/about-publication-590a.
These IRS instructions support an interpretation of the applicable law quite different from the Trustee's approach. If the only purpose of the rollover rule is to facilitate portability from one IRA account to another IRA account, then what would be the logic of saying that someone can "reinvest" in the same IRA account from which the money was withdrawn?
In fact, the 60-day rule does not even apply to direct transfers from one IRA to another IRA or to rollovers directly from an IRA to an Employer Sponsored Retirement Plan. It only applies to direct distributions to the individual who then rolls it over into a qualified account within 60 days. The 60-day rule would be largely superfluous if it did not permit the account owner to receive the money and use it within the 60-day period without destroying the character of the IRA's exempt nature. The 60-day rule would never serve a useful purpose for the holder of the IRA if the money would automatically lose its qualified status unless the exact same funds went into another qualified account.
The Bankruptcy Court for the Eastern District of North Carolina faced a similar situation and reached the same result in In re Rudd, No. 12-08130-8-JRL, 2013 WL 2684541 (Bankr. E.D. N.C., June 12, 2013). In that case, the trustee likewise argued that the debtor's personal use of funds distributed from an IRA constituted a prohibited transaction and destroyed the qualified nature of the fund. Judge Leonard rejected the argument, citing much of the same authority relied upon by this Court. As the court in Rudd stated:
Id. at *5.
Just as the Rudd court found that using the funds during the 60-day rollover period for personal living expenses did not destroy the exempt status, this Court finds that using the money for interim funding for the purchase of a house before the home mortgage was put in place did not destroy the exempt status of the Debtor's IRA. See also, In re Quevedo, No. BK17-40970, 2017 WL 4773103, at *2 (Bankr. D. Neb. Oct. 20, 2017) (citation omitted) ("Here, the trustee's objection to the claim of exemption was filed within 60 days after the debtor received the proceeds of her pension plan. Had she not spent the funds, she was still within the grace period to roll them into another account, during which time they may well have retained their exempt status.").
The limited authority available on this topic clearly indicates that the 60-day rollover rule is not dependent on how the money was used in the interim, is not limited to merely facilitating portability from one IRA to another, and does not require that the exact same funds go back into the IRA when the rollover occurs. The overriding requirement of the rollover rule is simply that the rollover occur within the specified time period, which is what happened here.
The Trustee has asked the Court to impose additional requirements that are beyond what the law dictates. Tax and bankruptcy law is complicated enough without the Court adding a layer of restrictions and hurdles not readily apparent from the statutes. Imposing an overly expansive interpretation of what constitutes a prohibited transaction would run counter to the well-established principle that exemption issues should be liberally construed in favor of debtors.
The Trustee has failed to satisfy his burden in objecting to the exemption. In the face of a valid exemption in the IRA, the objection to confirmation of the Chapter 13 plan likewise fails. Since the exemption issue was the only justification for conversion of the case to Chapter 7, that request is also without merit. Accordingly, the Trustee's objection to the Debtor's claim of exemptions, his objection to confirmation of the Debtor's Chapter 13 plan, and his motion to convert to Chapter 7 will all be denied. A separate order reflecting this decision will be entered contemporaneously with the entry of this opinion.
The purpose of the statute is to allow Tennessee citizens to exempt a portion of payments received as a replacement for lost earnings, with its application limited to retirement-type benefits such as "a stock bonus, pension, profitsharing, annuity, or similar plan or contract on account of death, age or length of service." In making a determination as to whether the Debtor's payments fit within the scope of § 26-2-111(1)(D), the Court's focus is two-fold: whether the payments are received pursuant to one of the enumerated types of plans or contracts and whether they are "on account of death, age or length of service." In re Vickers, 408 B.R. 131, 138, (Bankr. E.D. Tenn. 2009).
The Court in Vickers, listed several factors for the Court to consider when deciding if payments were intended as retirement benefits or a replacement of income including, but not limited to: "Were the payments designed or intended to be a wage substitute? ... Were the contributions made over time? ... Do multiple contributors exist? ... What is the return on investment? ... What control may the Debtor exercise over the asset?" Id. at 139-140. Based on the stipulations, the Debtor's one-time withdrawal of funds repaid within 60 days does not support an exemption based on T.C.A. § 26-2-111(1)(D).
