Loss of Bankruptcy Exemption of IRA Due to "Prohibited Transactions"

Bankruptcy Lawyer - Chapter 13 Bankruptcy Lawyer Jordan E. Bublick has an office in Miami and has over 25 years of experience in filing chapter 13 and chapter 7 bankruptcy cases. His office is located in Miami at 1221 Brickell Ave., 9th Fl., Miami and may be reached at (305) 891-4055. www.bublicklaw.com  

In 2007, the Bankruptcy Court issued its decision in the case of In re Willis, 07-11010-BKC-PGH (S.D Fla. 2007)(Hyman, J.) which reviewed the IRA exemption in bankruptcy or the unfortunate lack thereof due to "prohibited transactions."

Although the bankruptcy code generally provides for the exemption of IRAs in bankruptcy, this exemption may be lost if the bankruptcy court determines that the IRA has lost it tax exempt status by engaging in "prohibited transactions." The IRS's initial favorable determination of an IRA is as to its form and is different from a bankruptcy court's review of the conduct under the plan and the loss of tax exempt status.

The bankruptcy code provides in section 522(b)(3)(C) for the exemption of "retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of 1986." The bankruptcy code also provides a rebuttable presumption that retirement funds are exempt if a favorable determination is received from the IRS. The bankruptcy code further sets forth a certain analysis if the retirement funds have not received a favorable IRS determination.

A bankruptcy trustee or creditor may attempt to rebut the presumption of exemption provided by the bankruptcy code for retirement funds that received a favorable determination by presenting evidence that the retirement fund was improperly operating under the applicable IRC provisions. In the In re Plunk decision, the Fifth Circuit Court of Appeals held that the bankruptcy court is permitted to reach an independent decision regarding a retirement plan's qualified status and is not bound by the IRS's previous determination. In re Plunk, 481 F.3d 302 (5th Cir. 2007). The Plunk court explained that there was no risk of conflicting decisions as the IRS's determination was only as to the retirement plan's structure while the court would be reviewing alleged misconduct that could disqualify the plan.

Section 408 of the IRC generally provides that IRA's are exempt from taxation unless "prohibited transactions" are engaged in by the owner or beneficiary of the IRA. If prohibited transactions are engaged in, the account ceases to be a qualified IRA as of the first day of the taxable year where a prohibited transaction is engaged in. Prohibited transactions includes a sale of property, the lending of money, and the transfer of income or assets by the plan to a "disqualified person" which is defined as a fiduciary of the plan such as any person who exercises authority or control over the plan.Jordan E. Bublick is a Miami Personal Bankruptcy Lawyer with over 25 years of experience in filing chapter 13 and chapter 7 bankruptcies. Miami Personal Bankruptcy Lawyer Jordan E. Bublick has filed over 8,000 chapter 13 and chapter 7 cases.