Florida Bankruptcy Lawyer Blog

This article starts by stating, “[a]n individual has two goals when filing for bankruptcy: (1) obtaining relief from creditors . . . in the form of a discharge injunction; and (2) retaining as much property as the law permits the debtor to retain in furtherance of the ‘fresh start,’ the relief coming in the form of exemptions.”

This article will focus on the second goal – retaining as much property as the law permits, namely retaining the monies in an “inherited” IRA by using Florida law or Federal law, with an emphasis on the current state of the law in the Middle District of Florida.

When Grandpa Joe opened his IRA, he was allowed to appoint a beneficiary. When a person (beneficiary) receives an IRA from someone other than their spouse, such IRA is deemed an “inherited IRA,” and is treated differently under the Tax Code.

This treatment under the Tax Code is important because Florida laws and Courts base their treatment of the exempt status of the IRA in bankruptcy on how the account is treated under the Internal Revenue Code.

The issue presents itself more and more frequently these days where individuals inherit an IRA from someone other that their spouses; increasingly, these individuals find themselves facing bankruptcy for diverse reasons, and find themselves concerned with losing their inheritance to the local bankruptcy trustee.

Two recent Bankruptcy Court decisions in Florida, In re Ard, 435 B.R. 719 (Bankr. M.D. Fla. 2010) and In re Mathusa, 446 B.R. 601 (Bankr. M.D. Fla. 2011), have addressed this issue in divergent ways.

First, the United States Bankruptcy Court for the Middle District of Florida, Tampa Division, answered this exact question in a 2010 opinion, In re Ard. There, the debtor filed a voluntary chapter 7 petition in 2009. She claimed as an exemption, on Schedule C of her bankruptcy filing, a Morgan Stanley Smith Barney Account pursuant to Florida’s exemption statutes. This account was not originated by her, but rather originally established by her father, who had died some years back. The trustee filed an objection to this claimed exemption, and the Bankruptcy Court sustained the trustees objection.

The Court started its analysis with a background of the Florida exemption statutes. “Section 222.21(2), Florida Statutes, provides for an exemption from creditors' claims of funds and accounts maintained ‘in accordance with a plan or governing instrument that has been determined ... to be exempt from taxation’ under Section 408 and certain other provisions of the Internal Revenue Code.”

Section 408 allows for the distribution of IRAs upon the death of the IRA owner. There are special rules of distribution applicable to inherited IRAs under the Internal Revenue Code, namely, beneficiaries have two options in taking a distribution, first, by withdrawing all of the funds within five years after the death of the original IRA holder; or second, by taking annual distributions over the beneficiary's lifespan.

Additionally, once received, “[d]istributions to the beneficiary are taxable as ordinary income.” , Thus “inherited” IRAs are treated differently than original IRAs. The trustee argued in In re Ard, that the “[e]xemption of a ‘fund or account,’ under Section 222.21(2)(a) is determined by its tax exempt status,” and that because an “inherited” IRA is treated differently than an original IRA under the Code, it therefore falls outside the scope of section 222.21(2)(a).

The Bankruptcy Judge agreed with this reasoning, and ruled that the inherited IRA was not exempt, and thus property of the estate. Thus under the logic of In re Ard, a person will not be able to claim as exempt the “inherited” IRA they received from Grandpa Joe.

Interestingly, the debtor in In re Ard relied solely upon the Florida exemption statute, and that was perhaps her undoing.

Conversely, the United States Bankruptcy Court for the Middle District of Florida, Orlando Division, issued an opinion in March 2011, in favor of exemption.

In In re Mathusa, the debtors filed for relief under chapter 7 of the Bankruptcy Code on July 29, 2010. There, “[t]he debtors claimed an exemption under [both] Florida Statutes § 222.21(2) and Bankruptcy Code §§ 522(b)(3)(C) / 522(d)(12) for funds held in the ‘Raymond James Financial Services, Inc. IRA Retirement Account.”

This was an IRA established by the debtors mother; upon her mothers death, the remaining principal of the IRA was distributed to the debtors. The debtors made a trustee-to-trustee transfer of the IRA and complied with all the required formalities for an inherited IRA under the Internal Revenue Code.

In this case, the issue was whether an inherited IRA loses its tax exempt status so that beneficiaries . . . are precluded from exempting funds held in an inherited IRA. The trustee here made the same argument as the trustee in In re Ard, that “an inherited IRA does not qualify for exemption under Florida Statutes § 222.21(2) or Bankruptcy Code §§ 522(b)(3)(C) / 522(d)(12).”

The Orlando Bankruptcy Judge relied upon the only Bankruptcy Appellate Panel's opinion, In re Nessa, 426 B.R. 312 (8th Cir. BAP 2010), in its determination of how to treat inherited IRAs. The Nessa court found that, “[f]or an IRA to be exempt under § 522(d)(12), it must meet only two requirements: "(1) the amount the debtor seeks to exempt must be retirement funds; and (2) the retirement funds must be in an account that is exempt from taxation under one of the provisions of the Internal Revenue Code set forth therein."

Because the debtor did not take the funds directly, but rather followed the necessary formalities to preserve its tax exempt status, the Nessa court concluded that “[t]he debtor's inherited IRA was exempt from taxation under section 408 of the Internal Revenue Code and thus satisfied the requirements of § 522(d)(12).

The Mathusa court stated that, “[a]lthough Florida has opted-out of the federal exemption scheme provided in § 522(d), § 522(b)(3)(C) applies to Florida bankruptcy proceedings.”

The Orlando Court further stated that, “[a]n inherited IRA is a retirement fund under § 522(b)(3)(C) and is exempt from taxation under § 408 of the Internal Revenue Code.” Therefore, because an “inherited” IRA is exempt from taxation, this court held that “[t]he debtors' inherited IRA is exempt from claims of creditors pursuant to § 522(b)(3)(C).”

Hence, there is no easy answer to the question of whether an inherited IRA is exempt under Florida or Federal law in the Middle District of Florida. These two courts, which are approximately 70 miles apart, issued two diverse opinions on the same issue.

The main distinguishing feature between these two cases is that one of the debtors filed under the Florida Statutes alone, and the other debtor filed under the Florida Statutes and the Federal Bankruptcy Statutes.

If you are an individual faced with this uncertainty, do yourself a favor and seek the advice of an attorney; they will better be able to assist you in your goal of retaining as much property as the law permits, namely retaining the monies in an inherited IRA. Grandpa Joe may be rolling over in his final resting place knowing that his hard earned money may be going to the beneficiary's creditors.

I anticipate quite a bit of litigation on this issue as the greatest generation passes it's savings on to its beneficiaries.

This blog was written by Jordan Wilcox. Jordan is a law student at Ave Maria School of Law.

This blog was lightly edited by Carmen Dellutri, Esq., founder of The Dellutri Law Group, P.A. Currently, the firm has offices in Port Charlotte, Fort Myers, Naples and Sarasota. Mr. Dellutri also sits on the Board of American Board of Certification. Mr. Dellutri is also one of the founders of the Bankruptcy Law Network, Debt Law Network, Credit Law Network, and Mortgage Law Network. Mr. Dellutri also writes for the firm's personal injury litigation blog, www.faircreditreportingactblog.com and www.fairdebtcollectionpracticesactblog.com, and the firm's mortgage modification blog.