Inherited IRAs bankruptcy protection

Good news for people going through bankrupty who have anInherited IRAs!

Reversing a bankruptcy court, a district court has concluded that a debtor’s inherited IRA met the requirements for a bankruptcy exemption under 11 USC 522(b)(3)(C). (Clark, Brandon C., In re ,

(2012, DC WI)109 AFTR 2d 2012-405) Bankruptcy exemption requirements. A bankruptcy exemption under 11 USC 522(b)(3)(C) must meet two requirements: (1) the amount the debtor seeks

to exempt must be “retirement funds,” and ( 2) those retirement funds must be exempt from income taxation under one of several specified

Internal Revenue Code provisions, including Code Sec. 408, which provides a tax exemption for IRAs.


Facts. In August of 2000, Ruth Heffron established an individual retirement account (IRA) and named her daughter, Heidi Heffron-Clark, as the sole beneficiary. Ruth Heffron died in September of

2001. In November of 2001, Heidi established an inherited IRA, and in December of 2001, had the remaining balance in her mother’s IRA transferred to the inherited IRA. Heidi and her husband (the

debtors) took monthly distributions from the inherited IRA. Neither of the debtors was retired at the time.


On Oct. 28, 2010, the debtors filed a Chapter 7 bankruptcy petition, and claimed the inherited IRA (which contained $293,300) as exempt under 11 USC 522(b)(3)(C), and under Wisconsin law. The

bankruptcy trustee and a judgment creditor objected to the exemption, and the bankruptcy court ruled in their favor, denying the exemption. The debtors appealed to the federal district court.


The bankruptcy court held that the debtors’ inherited IRA did not contain “retirement funds.” Heidi, as owner of the inherited IRA, was required to begin taking distributions under the Code Sec. 401(a)(9)(B) required minimum distribution rules, even though she was still working. The bankruptcy court concluded that the funds in the inherited IRA could not be classified as “retirement funds”

because the funds were not segregated to meet the needs of, nor were they distributed on the occasion of, any person’s retirement.


District court reverses. The district court pointed out that all of the other bankruptcy courts and district courts that have addressed the applicability of the bankruptcy exemption to inherited IRAs have

ruled in favor of the debtors, except for the bankruptcy court here, and a bankruptcy court in the Fifth Circuit, which was reversed on appeal. The district court said that under the majority view, the funds in a debtor’s inherited IRA do not have to be the “retirement funds” of the debtor to satisfy the bankruptcy exemption requirements.


On reviewing the bankruptcy court’s decision here, the district court said that, contrary to the majority view, it could be argued that it is implicit in the Bankruptcy Code provisions specifying the property

of the debtor that “retirement funds” must mean retirement funds of the debtor. On the other hand, the district court said, words

excluded from a statute must have been excluded for a purpose, and the Bankruptcy Code omits a specific reference to the debtor’s interest in the retirement fund exemption even where there is a

specific reference to the debtor’s interest in other exemption provisions of the same Bankruptcy Code section.


The district court concluded that there may be reason to question whether inherited IRA funds should be exempt from bankruptcy as a matter of policy, but that changing the exemption was a matter for Congress. Thus, the district court reversed the bankruptcy court, and held that Heidi’s inherited IRA could be exempted from her bankruptcy estate.


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Jeffrey Brooks, CPA, CFP, MBA since 1976 has specialized in helping clients save significant taxes, help businesses increase their cash flow, revenues and profits while increasing their control and satisfaction. Jeff and his accounting firm sincerely cares about the happiness of his clients.

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