A bankruptcy judge in Trenton, N.J., found a loophole in Clark v. Rameker that allowed her to declare that an inherited individual retirement account is not property of the estate, regardless of whether it would be an exempt asset.
The loophole was state law.
The debtor inherited a $34,000 IRA from her mother a few months before filing under chapter 7. The debtor listed the IRA in her schedules but claimed it was not an asset of the estate. The trustee objected, citing the Supreme Court’s 2014 Clark opinion and contending the IRA was an asset and not exempt.
Bankruptcy Judge Christine M. Gravelle sided with the debtor in her May 20 opinion and held that the IRA was not an estate asset, even though she conceded that “this ruling conflicts with the significant policy concerns outlined in Clark v. Rameker.” Rather than focusing on the exemption statute, Section 522(b)(3)(c), Judge Gravelle based her decision on Section 541(c)(2), which provides that a restriction on the transfer of a debtor’s interest in a trust is enforceable in bankruptcy.
The saving grace for the debtor was New Jersey law, which provides that a “qualifying trust” is exempt from the claims of creditors and “shall be excluded from the estate in bankruptcy.” The statute goes on to define a qualifying trust as one that complies with Section 408 of the Internal Revenue Code.
Judge Gravelle was hemmed in by the Third Circuit’s 1997 decision in Yuhas, which held that ordinary IRAs are not part of the bankrupt estate. She said that Yuhas “effectively operates to prevent IRAs from ever becom[ing] estate property.”
Because Yuhas dealt with ordinary IRAs, not inherited IRAs, the judge was obliged to analyze the five-part test under that case, along with the IRS Code, before concluding that the inherited IRA in question was a qualifying trust.
Judge Gravelle said that Clark was of “limited applicability” because it dealt with a claimed exemption, not with the question of whether an inherited IRA is property of the estate. Consequently, it was irrelevant whether an inherited IRA constitutes “retirement funds,” the pivotal factor in Clark leading to the Supreme Court’s conclusion that the funds were not exempt assets under Section 522.