Inherited IRA Excluded From Debtor's Bankruptcy Estate

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By Diane Davis

May 25 — An inherited individual retirement account (IRA) is excluded from a debtor's bankruptcy estate because it is a “qualifying trust” under New Jersey law, a bankruptcy court in New Jersey held May 20 ( In re Norris, 2016 BL 162043, Bankr. D.N.J., No. 3:15-bk-26458-CMG, 5/20/16 ).

Judge Christine M. Gravelle of the U.S. Bankruptcy Court for the District of New Jersey denied the Chapter 7 trustee's objection related to the debtor's inherited IRA. The court relied on Third Circuit precedent in In re Yuhas, 104 F.3d 612 (3d Cir. 1997), which held that a New Jersey statute operated to exclude IRAs from the bankruptcy estate.

All legal or equitable interests of the debtor in property as of the filing of the bankruptcy petition become part of the bankruptcy estate under Bankruptcy Code Section 541(a)(1). Under Section 541(c)(2), an exception to this rule is “a restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law.”

The applicable nonbankruptcy law is New Jersey statute N.J.S.A. 25:2-1(b), which provides that “any property held in a qualifying trust and any distributions from a qualifying trust, regardless of the distribution plan elected for the qualifying trust, shall be exempt from all claims of creditors and shall be excluded from the bankruptcy estate.”

Debtor Claims Inherited IRA Is Exempt

Debtor Bridgette Norris filed for Chapter 7 protection in which a debtor's nonexempt assets are liquidated by a trustee, and the proceeds are distributed to creditors. Five months before filing her petition, the debtor's stepmother passed away, leaving an inherited IRA naming the debtor as beneficiary.

The debtor amended her bankruptcy schedules to exempt the inherited IRA with a value of $33,900 from her bankruptcy estate under Bankruptcy Code Section 522(d)(12). The debtor amended her schedules a second time to claim that the inherited IRA was not part of the bankruptcy estate.

Chapter 7 trustee Andrea Dobin objected to the claimed exemption. According to the trustee, Clark v. Rameker, 2014 BL 162980, 134 S.Ct. 2242 (2014) (26 BBLR 825, 6/19/14), supports her position that an inherited IRA is so distinct from an IRA as to lead to the conclusion that an inherited IRA can't qualify under Internal Revenue Code § 408(a).

Clark 's Application ‘Limited.'

The bankruptcy court disagreed with the trustee, concluding that Clark was of “limited applicability to this case.”

In Clark, the debtor claimed an exemption for his inherited IRA under the Bankruptcy Code, the court said. In this case, however, the exemption isn't applicable because the inherited IRA isn't property of the bankruptcy estate, the court said. The court must follow the state statute and the Third Circuit law that interprets it, the court said.

“If an inherited IRA is a ‘qualifying trust' under the Statute, it is not property of the estate, regardless of whether the asset constitutes ‘retirement funds' under the Section 522 exemption statute and regardless of the different tax treatment and purposes when compared to an IRA,” the court said.

Under Clark, an inherited IRA can't be considered “retirement funds” for the purposes of the Bankruptcy Code, the court said. The Clark court also noted that inherited IRAs don't serve the purpose of traditional and Roth IRAs — “to provide tax incentives for accountholders to contribute regularly and over time to their retirement savings,” the court said.

Other Case Precedent

The court also looked to In re Andolino, 2015 BL 49123, 525 B.R. 588 (Bankr. D.N.J. 2015), which found an inherited IRA to be a qualifying trust and not property of the bankruptcy estate. The court in Andolino determined that Clark doesn't automatically lead to the conclusion that an inherited IRA isn't a qualifying trust. When an IRA is inherited, it merely becomes subject to a new set of rules governing the tax treatment and disposition of the underlying funds, the Andolino court said.

“[I]nherited IRAs are ‘still protected from taxation for a time period that is provided under the IRS,” and I.R.C. § 408 doesn't provide a provision terminating an IRA's qualified trust status upon inheritance by a beneficiary, the court said, citing Andolino.

“[I]f a trust satisfies section 541(c)(2)‘s requirements, all of the debtor's interest in the trust “is completely excluded from . . . the bankruptcy estate,” according to , pt. II, ch. 69 (D. Michael Lynn et al. eds., 2016).

Trustee's Focus Is Wrong

The trustee incorrectly “focused on whether an inherited IRA may be exempted in bankruptcy, not whether the asset constitutes property of the estate in the first place,” the court said. According to the trustee, this is implicit in such a ruling that there has been a finding that the inherited IRA is property of the estate. Even with that assumption, Section 541(a)(2) requires each court to apply the applicable non-bankruptcy law of its state, the court said, and the New Jersey statute requires that inherited IRAs be qualified and maintained under I.R.C. § 408. The statute also restricts transfer, the court said. The trustee hasn't cited to any part of I.R.C.§ 408 that disqualified an inherited IRA's trust status, the court said.

William H. Oliver, Jr., Esq., represented debtor Bridgette Norris; Andrea Dobin of Trenk, DiPasquale, Della Fera & Sodono, P.C., represented herself as trustee.

To contact the reporter on this story: Diane Davis in Washington at ddavis@bna.com

To contact the editor responsible for this story: Jay Horowitz at jhorowitz@bna.com