Yesterday, the Sixth Circuit Court of Appeals made a favorable ruling for bankruptcy debtors in the case of Daley v. Mostoller.
Generally speaking, the assets in an individual retirement account are off limits from tax collectors and creditors in bankruptcy. Yet if the owner of a retirement account uses it in a prohibited way, the taxation and bankruptcy protection disappears. After saving $66,000 in an IRA with Merrill Lynch, James Daley filed a Chapter 7 bankruptcy petition. The bankruptcy court and the district court thought that Daley had impermissibly used the IRA to extend himself credit by granting Merrill Lynch a lien on the retirement funds to cover any potential future debts to the firm. We reverse.
[Read the full case at www.ca6.uscourts.gov]
This is great news as Merrill Lynch is a giant in the individual retirement account field and it has required IRA owners to agree to their cross collateralized lien provisions over the past several years. In the last year, bankruptcy trustees out of the Eastern District of Michigan, especially the Detroit Division, have been attacking these accounts owned by bankruptcy debtors. The bankruptcy trustees allege – similarly to the trustee in Daley v. Mostoller – that by agreeing to allow a lien on the account in the event that the IRA owner takes on a debt with Merrill Lynch, then the account is no longer a valid individual retirement account under the Internal Revenue Code and thus, not allowed the particular exemption for accounts exempt from taxation under the IRC.
The Daley Court addressed this argument by pointing out that while the IRA owner signed to allow a lien in the case of the debt, if there is never a debt incurred by a bankruptcy debtor with Merrill Lynch, no lien is ever placed on that IRA. The Court cited IRS Announcement 2011-81, 2011-52 I.R.B. 1052, stating that the mere existence of cross-collateralization agreement does not disqualify an IRA from its tax exempt status.
The ultimate conclusion is that for this lien / cross-collateralization provision to have any impact on the tax exempt status of the IRA – which would negate the bankruptcy exemption – some other act must take place to activate that lien, such as a debt incurred through Merrill Lynch.
As an attorney prepares to file a bankruptcy in the Sixth Circuit, it is critical to find whether or not the bankruptcy debtor has a Merrill Lynch IRA and whether or not the bankruptcy debtor has ever taken a loan from either Merrill Lynch or the individual retirement account. It should also be discussed whether or not any action was taken by the bankruptcy debtor that may compromise the tax exempt status of the account according to the Internal Revenue Code.
If you are preparing to file bankruptcy as a debtor in the Sixth Circuit and own an IRA serviced by Merrill Lynch, you should discuss these issues with your attorney. If your attorney is not familiar with the case law, you need to find a different attorney.
If you are planning to file bankruptcy as a debtor and have an IRA, but not with Merrill Lynch, you should contact your IRA servicer to see if you have similar lien / cross-collateralization provision and follow up with your attorney from there.
