The Supremes Take Another Bankruptcy Case
Yesterday, the Supreme Court agreed to hear Clark v. Rameker to decide whether inherited IRAs are exempt from a bankruptcy estate. The cert grant brings the number of Supreme Court bankruptcy cases this term to three. Take note, Nina Totenberg!
The Bankruptcy Code exempts IRAs (and some other retirement assets) from the bankruptcy estate. Exempt assets are not available to pay creditors and belong to the debtor after the bankruptcy case is over. In Clark, the U.S. Court of Appeals for the Seventh Circuit in Chicago had to rule on whether inherited IRAs enjoy the same protection as a debtor's own IRA. The Seventh Circuit decided the IRA the debtor had inherited from her mother was not exempt from the bankruptcy estate. The ruling conflicted with a Fifth Circuit decision, creating a need for Supreme Court guidance.
Although I have sometimes been critical of the Court for taking on what I see as less important bankruptcy issues at the expense of issues that are more systemically meaningful, the issue of inherited IRAs in bankruptcy does strike me as worthy of a space on the Court's scarce docket of cases. Granted, not a lot of bankruptcy debtors have substantial inherited IRAs, but with over 1 million bankruptcy cases this year (and in most years, more than that), many of them will. Also, the case will have implications in cases that don't get filed--cases where debtors do not file so as to protect assets that otherwise would have to be turned over to the trustee. Most importantly, Clark involves a clear rule -- either inherited IRAs are exempt or they are not -- and it is exactly this sort of clear rule on which there is a need for uniformity in a national bankruptcy system, particularly where the question decides whether a debtor keeps an asset. In an uniform system of bankruptcy, a debtor in Louisiana will keep the same assets as a debtor in Illinois.
On the merits, the Seventh Circuit probably got it right. The statutory language exempts from the bankruptcy estate "retirement funds" that are exempt for taxation in [specific sections of the Internal Revenue Code that propriety prevents listing in a family blog]. Like most any legal issue that gets this far, there are good statutory arguments on both sides. Inherited IRAs do enjoy tax advantages such that one can pretty easily say they are exempt from taxation, but are inherited IRAs "retirement funds?"
The question does not admit of an easy answer. An inherited IRA undoubtedly represents "retirement funds" as the IRA is the retirement funds for the decedent, and it is this understanding of the term to which the Fifth Circuit gave primacy. The Seventh Circuit, however, emphasized a more temporal component to the definition -- an inherited IRA is not the retirement funds in the hands of the person who received the inheritance. As the Seventh Circuit explained:
To see this, suppose [the decedent] had withdrawn the entire $300,000 from her IRA, paying the penalty tax if necessary, waited a month, then given the money to [the daughter]. The money would have been “retirement funds” while in [the decedent's] IRA, but not thereafter; in [the daughter's] bank account the money would be no different from any other assets she could save or spend at will.
Either court's outcome is a linguistically plausible reading of the statutory language, again illustrating the relative uselessness of hard statutory textualism.
The answer becomes clearer once one considers whether there is any compelling reason to exempt categorically inherited IRAs from the legitimate claims of creditors. For IRAs, the reasoning seems to be a policy favoring protection of retirement savings so as to leave persons destitute in their later years. An inherited IRA is just as likely (if not more so) to represent a windfall to a debtor as it is to be a component of retirement planning. Moreover, Congress specifically treats other inheritances less favorably than much of the debtor's other property, sweeping in inheritances received up to six months after the bankruptcy filing instead of leaving them to the usual rule that whatever the debtor receives after bankruptcy belongs to the debtor.
Given the relative equipoise in statutory language, the Supremes will do well here to turn to nontextual sources of guidance in reaching their decision (although I am not holding by breath on it happening). Regardless, it is good to see bankruptcy get more attention on the Court's docket.
IRA nest egg photo courtesy of Shutterstock.