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Learning of new attacks being made against debtors who own Individual Retirement Accounts I am reminded of Al Pachino’s line in the last Godfather movie:  “Just when I thought I was out, they pull me back in!”    As reported by Illinois law professor Robert M. Lawless in a recent article posted on CreditSlips.org, some Chapter 7 Trustees are reopening and issue that most of us thought was finally settled in 2005 when Congress passed the latest bankruptcy reform act.  

The Bankruptcy Reform Act of 2005 states that  retirement funds held in tax exempt accounts would be protected in bankruptcy cases up to one million dollars.  Funds held in IRA accounts are exempt from federal taxation, so at last debtors could be sure that the retirement nest egg was safe. 

Some Chapter 7 Trustees are now questioning whether certain IRA accounts should be given tax favored treatment since the fine print of the account agreements allow the brokerage firm to use the IRA funds to repay other loans taken out by the debtor from the same brokerage firm.  Since the tax code prohibits tax qualified IRA accounts from making loans to the account holder, the Chapter 7 trustees argue that accounts with such loan provisions are not tax exempt and thus not protected under the Bankruptcy Code. 

The bankruptcy court for the Eastern District of Tennessee recently ruled that IRA accounts with such loan provisions are not exempt, and that case is currently on appeal in the Sixth Circuit Court of Appeals. In re Daley, 459 BR 270 (Bkcy. EDTenn., 2011).

Nebraska exemption statute 25-1563.01 states that IRA accounts are exempt from the claim of creditors “to the extent reasonably necessary for the support of the debtor and any dependant of the debtor.”  Prior to the Bankruptcy Reform Act the issue commonly litigated in bankruptcy court was whether the amount held in the IRA account was “reasonably necessary” to support the debtor’s family, and if the Trustees succeed in their arguments this issue will come back to life.

Until this new attack of the trustees is finally decided, I would recommend that debtor attorneys claim both the new federal exemption and the older Nebraska exemption to IRA accounts in the bankruptcy proceeding, and that they inform their clients of the possible risk they may face if they hold substantial IRA assets.