CLARK V. RAMEKER: WHAT DID THE SUPREME COURT REALLY SAY? WHAT IS HOLDING AND WHAT IS DICTA? DOES 522(b)(3) PRE-EMPT TEX. PROP. CODE SEC. 42.0021(a)?

By Guest Blogger Michael V. Baumer

On June 12, 2014, the U.S Supreme Court issued an opinion in Clark v. Rameker, 134 S.Ct. 2242 (2014) in which the court, in a 9-0 decision, affirmed a decision by the 7^th Circuit holding that an IRA inherited by a daughter from her mother is not exempt under 522(b)(3)(C).

It is important to note that although Clark determined whether inherited IRAs are exempt under 522(b)(3), the decision should also apply to whether inherited IRAs are exempt under 522(b)(2) and (d)(12). Both statutes exempt “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 Clark court concluded that funds in an inherited IRA are not “retirement funds,” although “retirement funds” is not defined in either the Bankruptcy Code or the Internal Revenue Code.

522(b)(1) says that a debtor can claim exemptions under 522(b)(2) which we commonly refer to as “federal exemptions,” or 522(b)(3)  which we commonly refer to as “state exemptions.” [522(b)(2) includes the “opt out” provision which allows the individual states to deny the federal exemptions to their residents.] It is not really that simple. The federal exemptions under 522(b)(2) are limited to the exemptions listed in 522(d). There is abundant case law that says that other federal exemptions not contained in 522(d) are not allowed in a bankruptcy case. And 522(b)(3) is not limited to exemptions allowable under state law. 522(b)(3)(A) specifically allows a debtor to exempt “any property that is exempt under federal law” [except 522(d)] as well as “State or local law.” 

In the first paragraph of its opinion, the Clark court stated “The question presented is whether funds contained in an inherited individual retirement account (IRA) qualify as ‘retirement funds’ within the meaning of this [522(b)(3)(C)] bankruptcy exemption. We hold that they do not.” Clark, at 2244.

The court almost casually notes “If the heir is the owner’s spouse, as is often the case, the spouse has a choice: He or she may ‘roll over’ the IRA funds into his or her own IRA, or he or she may keep the IRA as an inherited IRA (subject to the rules discussed below).” Clark, at 2245, (citing IRC Publication 590).

I think that this seemingly innocuous statement may actually give significant guidance to what the court might do in the case of an IRA inherited by a spouse. The court does acknowledge that a spouse may roll over the inherited IRA into his/her own IRA [in which case, it would qualify as a rollover IRA under 522(b)(4)(C)] or treat it as an inherited IRA. If the spouse elects to treat the IRA as an inherited IRA under the Internal Revenue Code, it seems only reasonable that it would/should also be treated as an inherited IRA under the Bankruptcy Code and would be subject to the court’s interpretation that funds in an inherited IRA are not retirement funds. If the spouse elects to roll over the IRA, it would no longer be an “inherited” IRA, but the spouse’s “own” IRA.

In Clark, the IRA was inherited by a daughter from her mother. This is very significant because the IRC provides substantially different treatment for inherited IRAs if the beneficiary is the spouse of the decedent or if the beneficiary is someone other than a spouse. The actual holding in Clark is that funds inherited by a child (someone other than a spouse) are not retirement funds and are not exempt under 522 (b)(3)(C).

To the extent that the court’s holding extends to spouses, it is dicta, not holding. In interpreting the phrase “retirement funds,” the court concluded that “retirement funds” are only retirement funds for the person who sets them aside for their own retirement. It would seem that this is typically not the case with married couples - they are saving for their joint retirement (singular), not their individual retirements (plural).

I would also note that the court engages in at least a little bit of public policy argument, in addition to judicial interpretation The court states that the purposes of bankruptcy exemptions are to “protect the debtor’s essential needs,” “to provide a debtor with the basic necessities of life so that she will not be left destitute and a public charge,” and “to ensure that debtors will be able to meet their basic needs.” Clark, at 2247. The court might want to consider 522(n) which allows a debtor to exempt an IRA with a value up to $1,245,475. In a joint case, that amount is doubled for a total of $2,490,950. And that does not include amounts in any other retirement plans. (Apparently, my notion of what is “basics” and “necessities” could be more expansive.)

Texas Property Code Sec. 42.0021(a) specifically provides that inherited IRAs are exempt to the same extent as they would be in the hands of the original owner of the IRA. Several commentators have expressed the opinion that inherited IRAs are exempt in a bankruptcy case using Texas exemptions, notwithstanding Clark. Many of those commentators note that the bankruptcy court opinion in Clark held that inherited IRAs are not exempt under the Wisconsin exemption statute. They distinguish this from the Texas exemptions which specifically provide that inherited IRAs are exempt. I think this interpretation is erroneous. The Supreme Court opinion in Clark never mentions whether inherited IRAs are exempt under Wisconsin law. The court held that inherited IRAs are not “retirement funds” as a matter of federal law under 522(b)(3)(C), so it never reached the issue of whether they can be exempt under applicable state law.

I am not sure how to reconcile this with 522(b)(3)(A) which permits a debtor to exempt “any property that is exempt under … State or local law.” The subsections of 522(b)(3) are stated in the conjunctive, not the disjunctive – debtors get to claim the exemptions in subsections (A), (B), and (C), so it would seem that even if a debtor is not entitled to exempt retirement accounts under 522(b)(3)(C), they should still be able to exempt them under 522(b)(3)(A) to the extent it is applicable. If Congress had intended that 522(b)(3)(C) would preempt 522(b)(3)(A), they coulda/shoulda/woulda done so explicitly. [They did, in fact, do this with the homestead caps under 522(o) and (p), which are expressly referenced in 522(b)(3)(A).]

My interpretation of the current status of the law based on what I understand Clark’s actually holding to be:

1.                  IRAs inherited from anyone other than a spouse are not exempt under 522(b)(3)(C). [Or 522(d)(12) – this is not part of the actual holding, but the statutory language is identical.]

2.                  IRAs inherited from a spouse which are not rolled over into the debtor’s own IRA should not be exempt under 522(b)(3)(C) or 522(d)(12), but should be treated as inherited IRAs.

3.                  IRAs inherited from a spouse which are rolled over into the debtor’s own IRA should be exempt under 522(b)(3)(C) or 522(d)(12).  Clark does not say that, but to the extent the statement in the opinion that inherited IRAs are not exempt is applied to a spouse is dicta, and the factual and legal basis for the opinion does not apply to spouses who elect to rollover an IRA inherited from a spouse. (Because they are treated differently under the IRC, they should also be treated differently under the Bankruptcy Code.)

4.                  Claiming an inherited IRA as exempt under Texas law is more problematic, at least as far as trying to read the judicial tea leaves.

a.                   Texas Property Code §42.0021(a) provides, in part:

"For purposes of this subsection, the interest of a person in a plan, annuity, account or contract acquired by reason of the death of another person, whether as an owner, participant, beneficiary, survivor, coannuitant, heir or legatee, is exempt to the same extent that the interest of the person from whom the plan, annuity, account or contract was exempt on the date of the person’s death."

It seems clear from the breadth of the language that the intent of the Texas legislature was to protect inherited retirement interests to the greatest extent possible. But how does Texas Property Code interact with the Bankruptcy Code in this context?

b.            In Clark the Bankruptcy Court held, in part, that the inherited IRA was not exempt because the Wisconsin exemption statute did not provide an exemption for inherited IRAs. The Supreme Court, however, never mentions whether the account was exempt under state law, but held that funds in an inherited IRA are not “retirement funds” under 522(b)(3)(C).

c.                Clark, however, never mentions 522(b)(3)(A) which allows a debtor to exempt “any property that is exempt under Federal Law, other than subsection (d) of this section or State or local law that is applicable on the date of filing of the petition.…” 522(b)(3)(A) does not contain the “retirement funds” language found in 522(b)(3)(C) or 522(d)(12).

d.             522(b)(3)(A), (B) and (C) are stated in the conjunctive – the debtor gets to claim (A), (B), and (C), so even if an inherited IRA is not exempt under 522(b)(3)(C), the debtor should still be able to exempt it under 522(b)(3)(A). Assuming that the state exemption statute allows a debtor to exempt an inherited IRA (as does the Texas Property Code), it should be allowed under this subsection.

With all that said, until we get further clarification, I would suggest that it is very risky to claim an IRA inherited from a spouse as exempt under federal exemptions, or to claim an IRA inherited from anyone under the Texas Property Code.

Any volunteers?