Recent Developments – What the New Bankruptcy Act
Means to Tax Professionals and Asset Protection
Practitioners
by
Leo J. Cushing, Esq., CPA, LLM
Cushing & Dolan, P.C.
Attorneys at Law
24 School Street, Suite 300
Boston, MA 02108
Telephone: (617) 523-1555
Fax: (617) 523-5653
lcushing@cushingdolan.com
leocushing@aol.com
www.cushingdolan.com
June 3, 2005
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Recent Developments – What the New Bankruptcy Act
Means to Tax Professionals and Asset Protection
Practitioners.
A.
IRAs & Other Retirement Assets; The “Bankruptcy Exemption
Theme”
Certain assets of a debtor are not considered property of the
estate for purposes of the bankruptcy petition. These assets include
401(k) plans, pensions and any other retirement plans maintained in
accordance with the Employee Retirement Income Security Act of 1974
("ERISA"). Since ERISA requires a clause be included prohibiting
assignment of benefits by a participant, retirement plans are not part of
the bankrupt estate in the first instance under Bankruptcy Code
Section 541(c)(2), since it is property which "contains a restriction on
the transfer of a beneficial interest in a trust that is enforceable under
applicable non-bankruptcy law is…” See Patterson v. Shumate, 504
U.S. 753 (1992).
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●
IRAs and Simplified Employee Pension Plans are not
maintained in accordance with ERISA so therefore such plans become,
at least initially, property of the bankrupt's estate, subject to certain
exemptions which are set forth in Bankruptcy Code Section 522(b)(1)
(federal exemptions) and Section 522(b)(2)(A) (state exemptions) (the
new "Act" re-designated Section 522(b)(2)(A) as Section 522(b)(3).
●
These Sections of the Bankruptcy Code provide what is
commonly referred to as the "Bankruptcy Exemption" scheme. It permits
debtors who claim the federal exemption scheme to exempt property
described in Section 522(b)(1), including "a payment under a stock
bonus, pension, profit sharing, annuity or similar plan or contract, on
account of illness, disability, death, age, or length of service, to the extent
reasonably necessary for the support of the debtor and any dependent of
the debtor. 11 U.S.C. § 522(d)(10)(E).
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Planning Note: It would be preferable to have an IRA excluded from
the bankruptcy estate rather than raised as an exemption since, even if
the plan was maintained "on account of illness, disability or age…"
the exemption would apply only to the extent the funds are "reasonably
necessary for the support of the debtor and any dependent of the
debtor."
Alternatively, Section 522(b)(2)(A), which is now 522(b)(3), provides for
the “state or other law exemption scheme," which allows a debtor to
exempt property protected under either non-bankruptcy federal law or
state or local law.
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B.
The Goldman Case
In the case In Re: Goldman, 192 BR 1 United States District Court,
District Massachusetts (1996), Judge Young ruled that Dr. Goldman who had
filed for Chapter 7 bankruptcy and asserted the "state" exemptions under
Section 522(b)(2)(A). (Goldman subsequently amended his petition to exempt
his rollover IRA pursuant to Bankruptcy Section 522(b)(1) and Section
522(d)(10)(E), but the Court nevertheless addressed the state exemption
scheme insofar as it relates to the protection of IRAs under applicable state
law.
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● Here, General Laws Chapter 235, §34 is applicable. This section
provides that while in general retirement plans (including IRAs) are exempt
from execution, the final sentence provides that, "The exemption for plans
maintained by an individual shall not apply to sums deposited in plans in
excess of 7% of total income of such individual within 5 years of the
individual's declaration of bankruptcy or entry of judgment.
● In this case, the Court did not distinguish between rollover
contributions and regular IRA contributions. The result was that the IRA
assets, to the extent of the account balance in excess of 7% of the total
income of the individual for the 5 years preceding the declaration of
bankruptcy, were subject to the bankruptcy trustee's recovery rights.
● The Bankruptcy Court calculated Dr. Goldman's total income for the
relevant 5 year period at $759,217 and determined that the 7% exemption to
which he is entitled is $53,145.19 out of a total balance of $286,000.
● The Court did not address whether IRAs would be exempt under the
federal bankruptcy scheme set forth in Section 522(b)(10)(E).
● The Patterson v. Shumate case had ruled that such a decision would
need to wait for the next case.
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● Rousey v. Jacoway, Supreme Court Docket No. 03-1407
April 4, 2005; (Judge Clarence Thomas). The case to which the
Patterson v. Shumate case was referring was decided on April 4,
2005, where the debtor asserted the federal exemption scheme
relying on Section 522(d)(10)(E). The Court found that IRAs
should be exempt under this bankruptcy exemption since it is a
"payment under a stock, bonus, pension, profit sharing, annuity or
similar plan, or a contract on account of illness, disability, death,
age, or length of service, to the extent reasonably necessary for
the support of a debtor and any dependent of a debtor."
The Court found that the debtor's right to payment from
IRAs is causally connected to their age because their accounts
qualify as IRAs under 26 U.S.C. 408(a), while the debtor's had a
non-forfeitable right to the balance held in those accounts, that
right was restricted by a 10% tax penalty that applies to
withdrawals from IRAs made before the account holder turns 59
1/2. This tax penalty is substantial and a deterrent to early
withdrawal. It suggests that Congress intended to preclude early
access to IRAs and the low rate of early withdrawals from around
the country are consistent with this notion.
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● This scheme effectively eliminates the debtor's right to payment of
their account balance so, in effect, IRAs provide a right to payment
on account of age.
● These are plans "similar" to stock, bonus, pension, profit sharing and
annuities.
● The case, however, was remanded to the lower Court for
"determination as to the extent reasonably necessary for the support
of the debtor and any dependent of the debtor…"
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C.
The Bankruptcy Act dated April 20, 2005
Section 224 of the Bankruptcy Act specifically includes within the
federal exemption scheme "retirement funds to the extent that those funds
are in a fund or account that is exempt from taxation under 401 (qualified
pension and profit sharing plans including 401(k) plans), 403 (qualified
annuity plans), 408 (IRAs), 408A (Roth IRAs), 414, 457 (state and local
government and tax-exempt defined compensation plans) or 501(a) of the
Internal Revenue Code, participation on amounts protected in the case of
IRAs.
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● The Bankruptcy Act, however, places a limit on the amount in an IRA
that can be protected.
● Specifically, new Section 522(n) provides: "For assets in individual
retirement accounts described in Section 408 or 408(A) of the Internal Revenue
Code, other than simplified employee pensioned under Section 408(k) of such
Code or a simple retirement account under Section 408(p) of such Code, the
aggregate value of such assets exempted under this action, without regard to
amounts attributable to a rollover contribution… and earnings thereon, shall
not exceed $1,000,000 in a case filed by a debtor who is an individual, except
that such amount may be increased if the interests of justice so require."
● Under the federal exemption scheme, $1,000,000 in IRA funds, in
addition to all amounts rolled into an IRA, are exempt.
● Educational IRAs and tuition prepayments are not property of the
estate. Under new 11 U.S.C. 541(d)(5) and 541(d)(6) funds placed in an
educational individual retirement account, as defined in Section 530(b)(1) of
the Code, not later than 365 days before the date of filing of the petition, will
not be considered property of the estate if the designated beneficiary of such
account was a child, grandchild, or a step-child of the debtor, for the taxable
year for which funds were placed in such account.
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In the case of funds placed in all such accounts having the same
designated beneficiary, not earlier than 720 days nor later than 365 days before
such date, so much of such funds as does not exceed $5,000 will be excluded as
property of the estate.
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D.
Forum Shopping – Homestead Exemptions
In the event of forum shopping, under 11 U.S.C. § 522(b)(3)(A), subject to
subsections (o) dealing with a homestead exemption claimed as to property
fraudulently transferred during 10 years prior to petition date and (p) dealing with
a homestead for property acquired in 1,215 days before petition, cannot exceed
$125,000, any property that is exempt under federal law, other than subsection (d)
of this section, state or local law that is applicable on the date of the filing of the
petition at the place in which the debtor's domicile has not been located for the
730 days immediately preceding the date of the filing of the petition, or, if the
debtor's domicile has not been located at a single state for such 730 day period, the
place in which the debtor's domicile was located for 180 days immediately
preceding the 730 day period, or for a longer portion of such 180 day period in the
other place.
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Planning Note: In order for a debtor to claim a state exemption
attributable to the state of the domicile of the debtor, the debtor needed
to live in the property for at least 180 days (or at least more time in
such state during the 180 days preceding the filing). This has now
been expanded to 730 days. If the debtor has not been in one state for
730 days, then use the state in which the petitioner spent the majority
of time for the 180 days prior to the 730 day period. New 522(b)(3)(A)
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E.
Homesteads
Homestead exemptions may be limited by new Section 522(o), Section
522(p), and Section 522(q).
●
Property fraudulently transferred during 10 year period prior
to petition date. Section 522(o)
The value of any real or personal property that the debtor or dependent
of the debtor uses as a residence, a cooperative that owns property that the
debtor or a dependent of the debtor uses as a residence, a burial plot for the
debtor or a dependent of the debtor, or real or personal property that the debtor
claims as a homestead shall be reduced to the extent that such values
attributable to any portion of any property that the debtor disposed of in the 10
year period ending on the date of the filing of the petition with the intent to
hinder, delay or defraud a creditor and that the debtor could not exempt, or
that portion that the debtor could not exempt under subsection (b) if on such
date the debtor had held the property as so disposed of.
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● Recently acquired property – New 522(p)
With respect to any real or personal property that the debtor or dependent
of the debtor uses as a residence, a cooperative that owns property that the debtor
or dependent of the debtor uses as a residence, a burial plot for the debtor or
dependent of the debtor, or real or personal property where the debtor or
dependent of the debtor claims as a homestead, except in the case of a family
farmer as a result of electing under Section (b)(3)(A) to exempt property under
state or local law, a debtor may not exempt any amount of interest that was
acquired by the debtor during the 1,215 day period preceding the date of the filing
of the petition that exceeds in the aggregate $125,000 in value. (4 years and 120
days)
● Exception
If the debtor's current principal residence and the debtor's previous and
current residences are located in the same state, the amount of such interest to
which the limitation applies does not include any interest transferred from a
debtor's previous principal residence which was acquired prior to the beginning
of such 1,215 day period.
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●
Bad Behavior Clause – Section 522(q)
Under new 11 U.S.C. 522(q), as a result of exempting property pursuant to
the state's statutory scheme of (b)(3)(A), a debtor may not exempt any amount
of any interest in property which exceeds in the aggregate $125,000 if the Court
determines that the debtor has been convicted of a felony, which under the
circumstances demonstrates that the filing of the case was an abuse of the
provisions of this title, or (1) the debtor owes a debt arising from any violation
of the federal securities law or state securities law, (2) or fraud, deceit or
manipulation in a fiduciary capacity or in connection with the purchase or sale
of any security registered under the Securities Exchange Act, (3) any civil
remedy under Section 1964 of Title 18, or (4) any criminal act, intentional tort,
or willful or reckless misconduct that causes serious physical injury or death to
another individual in the preceding 5 years.
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●
Fraudulent Transfers -- now 2 years
11 U.S.C. 548(a)(1) now provides that a trustee may avoid any transfer,
including any transfer to or for the benefit of an insider under an employment
contract, of an interest of the debtor in property, or any obligation, (including
any obligation to or for the benefit of an insider under an employment contract)
incurred by the debtor that was made or incurred or within 2 years before the
date of the filing of the petition…
●
Transfers to Self-Settled Trusts - New 548(e)(1)
The trustee may avoid any transfer of an interest of a debtor in property
that was made on or within 10 years before the date of filing of a petition if, (a)
such transfer was made to a self-settled trust or similar device, (b) such transfer
was by the debtor, (c) the debtor is a beneficiary of such trust or a similar
device, and (d) the debtor made such transfer with actual intent to hinder, delay
or defraud any entity to which the debtor was or became, on or after the date the
trust transfer was made indebted.
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●
Full Employment for Offer in Compromise Professionals
Not everyone will be eligible to file for bankruptcy. There is now a
“means test,” under Bankruptcy Section 707(B)(2), that requires that the debtor
determine his "current monthly income" as defined by New Section 101(10)(A).
If this exceeds by a prescribed margin his "monthly expenses" as defined by the
monthly living expense standards utilized by the Internal Revenue Service in
the context of negotiations of offers in compromise of tax debts, bankruptcy
relief may be unavailable. The means test does not apply to individuals whose
income falls below certain income levels. These income levels adjusted to 2005
are as follows:
1 person household
$44,885
2 person household
$55,942
3 person household
$69,694
4 person household
$78,899
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