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Your IRA Might Not Be Exempt Beginning with In re Daley, 459 BR 270 (Bkcy. EDTenn., 2011), some recent bankruptcy decisions have created doubt as to whether Individual Retirement Accounts (“IRA’s) created by major brokerage firms such as Merrill Lynch and Charles Schwab are exempt from the liquidation efforts of a Chapter 7 Trustee. For... Read More »
Your IRA Might Not Be Exempt
Beginning with In re Daley, 459 BR 270 (Bkcy. EDTenn., 2011), some recent bankruptcy decisions have created doubt as to whether Individual Retirement Accounts (“IRA’s) created by major brokerage firms such as Merrill Lynch and Charles Schwab are exempt from the liquidation efforts of a Chapter 7 Trustee. For years these brokerage firms have employed boiler plate Client Relationship Agreements (or similarly titled agreements) with their account holders that contain clauses similar to the “cross collateralization” clause made famous by your friendly local credit union, and such an Agreement existed in Daley. These clauses grant liens on all client accounts held at the brokerage firm (which would include an IRA) as security for the payment of any other indebtedness the account holder may have with the brokerage firm. These recent cases reason that it is the granting of a lien on the IRA that makes the account vulnerable to liquidation by a Chapter 7 Trustee.
The Courts that have reached this conclusion rely on IRC Section 408(e)(2), which provides that an IRA loses its tax exemption if the account holder engages in a “prohibited transaction”, which under IRC Section 4975(c)(1) includes “any direct or indirect—(B) lending of money or other extension of credit between a plan and a disqualified person” (emphasis supplied). Section 4975(e)(2)(A) provides that the term “disqualified person” includes a “fiduciary”, which is defined by Section 4975(e)(3)(A) as any person who “exercises any discretionary authority or control respecting management…or disposition of [the plan] assets”. The owners of self-directed IRA’s are held to be “fiduciaries” of an IRA, and as such are “disqualified persons”. Accordingly, the Daley court ruled that (1) once the account holder granted a lien on his or her IRA they had engaged in a “prohibited transaction” that caused the funds in said IRA to lose their “exempt from taxation” status under the Internal Revenue Code, and (2) loss of this tax exempt status meant that the IRA could not be claimed as exempt under Bankruptcy Code Section 522(d)(12), or any corresponding state exemption statute.
The IRA in Daley received a “favorable determination” by the IRS, which entitled it to a rebuttable presumption of exemption under Bankruptcy Code section 522(b)(4)(A). The Trustee in Daley was able to rebut the statutory presumption of exemption and proceed against the IRA. QUERY—Would the debtor have been better off if the IRA had not received a “favorable determination” by the IRS? The Daley court does not reach this question, but the Bankruptcy Code exemption statute suggests that the answer might be “yes”. Bankruptcy Code section 522 (b)(4)(B) provides that if the fund in question has not received an IRS “favorable determination” it nevertheless is exempt if (1) no “unfavorable determination” has ever been made by the IRS or any court, and (2) either the fund is in compliance with IRC regulations, or if the fund is not in compliance, the non-compliance is not the account holder’s fault. It is critical to note that this sub-section ( 522(b)(4)(B)) does not create are buttable presumption of exemption, but rather, states that the fund is exempt. It is curious that a fund receiving a “favorable determination” (such as in Daley) enjoys only a rebuttable presumption of exemption, whereas a non-compliant fund seems to enjoy an unqualified exemption providing the account holder did not cause the non-compliance. How does this make any sense?
The Daley ruling is currently on appeal to the Sixth Circuit, but the underlying holding is troubling on many levels. First, the big brokerage firms have created countless thousands of IRA’s for the general population so its effect could be far-reaching—good news for Chapter 7 Trustees but bad news for unsuspecting, struggling debtors. In addition, the debtor in Daley had no other accounts with Merrill Lynch and owed no money to Merrill, so the “cross collateralization” clause in question had no tangible application to the particular account holder. The Daley court held that it was just the existence of the complained of language in the Client Relationship Agreement that made the IRA fair game for the Chapter 7 Trustee. If the Court’s do not fix this unexpected (and presumably unintended) threat to retirement plans then Congress should adopt a statutory fix.
This is the case of Felicia Morris who comes from Chicago, Illinois who is interested in a conversation regarding debt relief. Ms. Morris filed a Chapter 13 back in 2008 and that case was subsequently dismissed so she is eligible to file another Chapter 13 if the facts bring them forward.
She does not own any real estate. She currently has a rental agreement where she lives with somebody else and the two of them pay the landlord equally. She has a 2002 Chevy Impala which is financed by PLS which is a Pay Day loan store so it’s a non-PMSI loan. She owes $2000 and the vehicle is worth approximately $2000.
In terms of personal property, she has no checking or savings account. She has minor household goods worth approximately $500 and normal clothing worth about $400. She does expect to receive a tax refund in the amount of $3600. She is single and she has for dependent children that live with her. She is currently not working. She has no income other than Social Security of $698 per month and food stamps of $700 per month. In terms of rent, her share is only $150. Her share of electric and gas is $150. She has $25 for laundry and dry cleaning and other than that, she has almost no expenses.
She did not earn any money from a job in the last three years. She did not receive any unemployment in the last three years. She did have a prior address in Chicago during the last two years. She has not owned a business in the last four years. She does not have a safety deposit box and she is not holding any property for anybody else. There are no co-debtors. There are student loans totaling $20,000. There is no tax debt, either state or federal.
In terms of debts, Ms. Morris has credit card debt of $800. No medical bills. And she has parking tickets in the amount of $4000. Now, since parking tickets are a non-dischargeable debt, I would do whatever I could to see if Ms. Morris can afford a Chapter 13 bankruptcy. I believe based on her income minus her expenses, there would be something available to do a Chapter 13 and repay the parking tickets over the next 3 to 5 years, saving her license and effectively reorganizing her debt. So Felicia Morris from Chicago, Illinois Chapter 13 is my recommendation for you.
This is the case of Carolyn Raney who is from Deerfield, Illinois who is coming to see me for a debt relief consultation. Ms. Raney filed a Chapter 7 back in 2002 so she is eligible once again since it’s been over eight years. She owns no real estate and she is currently living in a rental arrangement with a yearly lease which expires in June.
She does not have a vehicle. She has a Chase checking account with approximately $500 in it, a security deposit with the landlord of $2500, $100 for normal clothing, $1000 for normal household goods and she has term life insurance with a death benefit only. She receives maintenance at $1400 per month and she has two dogs. She is divorced with three children and she is currently working as a patient care coordinator in Buffalo Grove, Illinois.
In terms of income and expenses, she earns approximately $1950 per month. She also receives maintenance of $1400 per month so she is looking at about $3500 in income from all sources. In terms of monthly expenses, she’s got $1790 for rent, $50 for water and garbage, $250 for power and electric, $110 for cable television, $550 for food, $120 for clothing, $50 for laundry, $120 for medical, $350 for gas and tolls, $125 for recreation, $50 per month for auto insurance and $43 for life insurance. She also has kid’s health insurance for $200 per month. When you look at her income minus her expenses, there really is not enough money to repay the debt through a Chapter 13.
Over the last three years, she has earned approximately $29,000 per year. She did have a prior address back in 2009 and 2010 in Deerfield, Illinois. She does have a co-debtor on multiple accounts that would be affected if she files a Chapter 7. Remember, in a Chapter 7, only the debtor is eliminated of the debt. So a creditor would have a right to go after the co-debtor. In terms of income tax debt, there is federal debt owed from 2005, 2006 and 2007. Provided that Ms. Raney filed a return each year, those debts can be eliminated in a Chapter 7 bankruptcy.
So that is my recommendation. I would recommend a Chapter 7, get a fresh start, eliminate the debt, the credit card debt, the medical bills, and the personal loans and get back on your feet financially where you are able to support yourself and your children. So Chapter 7 is what I recommend for Ms. Raney from Deerfield.
This is the case of Gerald Cramer who comes to me from Homewood, Illinois about bankruptcy. Mr. Kramer filed a bankruptcy back in 1996, so long ago that he is not even sure if it’s a Chapter 7 or a Chapter 13 but that’s okay since it’s more than eight years ago. Mr. Kramer does not own any real estate. He is currently renting on a month to month basis. He has no vehicle whatsoever. He is using a vehicle that is in his wife’s name.
He has a checking account at Charter One with approximately $700 in it. He’s got minor household goods worth a couple thousand dollars and normal clothing worth approximately $1000. He does have a 401(k) with $7000 available. He does not have any pets, he does not expect a tax refund and he has no other interests in any stocks, bonds or corporations. He is currently married, sometimes separated. No dependent children. He works as a flight attendant for the last 24 years earning approximately $51,000 per year. At the end of the month, after he pays his taxes, he is left with $2700 net per month.
Let’s look to the all important expenses. $1400 per month rent. $50 electric and gas, $105 cellular phone, $138 for cable and Internet, $200 for food, $100 for clothing, laundry is $40. He also has $800 in child support to another person who lives in Chicago, Illinois. And he makes his credit card minimum payments of $200, leaving him with $3073 in expenses. So his expenses exceed his income by a few hundred dollars. Even if we take out the credit card payments that he’s currently making, he would still not have enough money per month to fund a Chapter 13 plan.
So based on that, I would recommend we talk about Chapter 7. The income falls a little bit above the median but with the vehicle payment, I think he’s going to qualify. He certainly does not have sufficient income to repay his creditors. So Chapter 7 would be my recommendation. The $22,000 in credit card debt would easily be eliminated in a Chapter 7 bankruptcy and that is my recommendation for Mr. Gerald Cramer from Homewood, Illinois.
One of the most frustrating experience is that people have in bankruptcy is thinking that they will be able to keep their tax refund and then losing it to either the IRS or the trustee. With a little bit of proper planning, it is possible to protect your tax refund. As an initial matter, I need to understand two things about your tax refund. First, your tax refund is probably the bankruptcy estate. It is an asset to the chapter seven trustee can block to three payment your unsecured creditors. Second the tax refund is actually a debt the IRS owes to you. When you have a tax refund, you have made an overpayment to the US Government. Your tax refund is actually a debt that the United States Treasury owes to you.
Let’s start with tax refund as an asset of the estate. When you file bankruptcy all of your property becomes property of the bankruptcy estate. The bankruptcy estate can be administered for the benefit of your general unsecured creditors. Most of your property can be protected with exemptions. Exemptions are what allow you to keep property during and after a bankruptcy so that you can get your fresh start.
So first things first, all property the estate must be listed on schedule B. Your tax refund has to be listed on schedule B even if you haven’t prepared or filed your tax return yet. This is because the tax refund is considered a contingent and unliquidated claim of the estate. If you fail to list your tax refund on the bankruptcy petition, you may lose the right to claim exemption the refund. In addition, the trustee could file an adversary proceeding to deny your discharge.
Once your tax refund is listed on schedule B, your bankruptcy attorney can use exemptions to protect it. There are several exemptions are available to protect a tax refund. If you’re using Washington State exemptions or Federal exemptions, you can use was called wild card. The wild card but you protect up to a certain amount of cash value in an asset, regardless of what kind of asset events. This is in contrast to specific exemptions the only allow you to protect your interests in a certain kind of property, for example homestead exemption only allows you protect your homestead and cannot be extended to something like your automobile. Additionally, part of your tax refund may actually be a benefit of social security. For example the earned income tax credit is actually a social security benefit. If part of your tax refund is Social Security benefit, then it can be protected using a Social Security exemption. The availability of exemptions to protect your tax refund depends on the type of bankruptcy that you file and all the facts of your case. You will need to talk your bankruptcy attorney to determine whether you have available exemptions to protect your tax refund in your specific case.
This issue with the tax refund is the IRS’s right of setoff and recoupment. Like I said before, your tax refund is actually a debt that the U.S. Treasury owes to you. Some clients have tax debts from prior years that are dischargeable in bankruptcy as well as a tax refund due the current year. In this case, the IRS may withhold your refund even though you file bankruptcy. This is because the IRS is setting off the debt that it owes to you -your tax refund – against the debt that you owe to the IRS for back taxes. The IRS can do this even if those taxes are dischargeable in bankruptcy.
Unfortunately there is nothing that you can do about it, if the IRS decides to exercise its right of setoff and recoupment. However, filing bankruptcy now and dealing with your tax debts this year is a better strategy than waiting and letting the IRS take your tax refund year after year. If you can discharge your taxes this year, you will be protecting your tax refund for years to come.
Many of my clients want to know if they can keep their tax refunds after the file bankruptcy. For many people, the tax refund is an important source of revenue and income during the year. It is possible a file bankruptcy and keep your tax refund, but you must follow the proper procedure. Additionally, if you owe the IRS any money, it may not be possible to protect your tax refund this year. However you can use the bankruptcy discharge to protect future tax refunds.
First of all, it is important to understand that your tax refund is property of the estate. That means that your tax refund must be listed on the schedule B of your bankruptcy petition. Schedule B as were you list all property the estate. However, listing your tax refund on schedule B of the bankruptcy petition does not mean to the chapter seven trustee gets to keep all or part of that refund. In many cases you are able to protect your tax refund with an exemption. If you fail to list your tax refund, they may lose your right to claim an exemption, and the chapter to seven trustee may be able to take your entire refund. In addition, failing to list the property on schedule B is grounds for denial of discharge. Therefore, it is very important but you check your bankruptcy petition to make sure that the tax refund is listed.
Anything that you list of property B can be protected with an exemption on schedule C. Exemptions allow you to protect your interest in property of the estate that otherwise be recoverable by the chapter seven trustee. Depending at what time of your case is filed is also possible pro rate the amount of the tax refund is actually property of the state and has to be listed on schedule B. Further, part of your tax refund may actually be a benefit of Social Security and can therefore be exempted in its entirety. For example the earned income credit is actually benefit of Social Security and therefore cannot be taken by the chapter seven trustee.
Even if your taxes can be discharged in bankruptcy, the IRS may still be able to take your tax refund. This is because the IRS has with called the right of set off and recoupment. The right of setoff and recoupment, basically, means that the eye Ross and cancel the debt that you ought to act with the doubt that it owes you. This is because the tax refund is it that the IRS owes to you. When you owe the IRS, and the IRS owes you, the IRS has the right to cancel the debt that it owes you by not paying your tax refund. The right of setoff and recoupment has nothing to do with whether the tax debt can be discharged in bankruptcy.
One way to try to avoid the IRS’ exercise of set off and recoupment if the file your bankruptcy before you file your taxes. If no tax return is been filed, then the IRS does not have a record of owing you tax refund. If all of your taxes are dischargeable in your bankruptcy, then the IRS may not take your tax refund. However if the IRS has any reason to believe that owes you a tax refund, then it may still claim his right to set off and recoupment. Unfortunately, if you owe the IRS money, then the IRS will do whatever it can to collect from you, even if the debt is dischargeable in your bankruptcy.
The shorter answer is yes, the filing fee is always paid in advance. The filing fee in Illinois is $306 for Chapter 7 bankruptcy and $281 for Chapter 13 bankruptcy. Typically in Chapter 7 bankruptcy, the attorneys’ fees are also paid up front; though your attorney may wish to offer you other payment arrangements for services rendered after the filing of your case.
In Chapter 13, typically, your attorneys’ fees are paid through your bankruptcy whereas your attorney might request a small amount of attorney’s fees upfront to prepare your documents; it would also be willing to accept a small amount of payment every month through your trustee payments.
We understand that it is a difficult time and we want to work with you. So let’s find an arrangement that will work for both of us.
The answer is no. A married couple does have the option to file jointly and often it’s the best decision due to the fact that it costs the same amount of money for a married couple to file as an individual but there is no requirement that a married couple files together. However, even if you are married and have a nonfiling spouse, their income and expenses will be taken into consideration when filing bankruptcy. The way the court sees it is, income and expenses are calculated as household expenses rather than individual expenses unless, in the very rare situation, households keep completely separate finances which is pretty rare.
Married couples do not need to file jointly however it is often advantageous. This is something you should discuss with your attorney in order to see whether it’s better to file together or separately.
This is a very complicated question with a relatively simple answer. The first consideration is where is your credit at the time of filing? If you are the kind of person who made minimum payments on all your debt for years and years and years and just had balances pile up on them and have a very good credit rating, bankruptcy will be a significant hit to your credit. But that’s often not the case with people who are considering bankruptcy. In fact, if you are considering filing bankruptcy, there’s a good chance that your credit is already not that great.
So while your credit might take a half step back, you will be able to move forward in a more positive direction by filing bankruptcy. And in the long run, and this is the most important point, in the long run your credit is going to be much better because until you clear up all your credit, you are not going to be able to rebuild. We offer a lot of education in our firm in order to help you rebuild your credit because we only want you as a client once. We don’t want to just get you out of debt; we want to keep you out of debt, too.
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