Section 206(d)(1) of Title I of ERISA (the “anti-alienation provision”) provides that: “[e]ach pension plan shall provide that benefits provided under the plan may not be assigned or alienated.” The corresponding tax provision is Code §401(a)(13) which provides that “[a] trust shall not constitute a qualified trust under this Section unless the plan of which such trust is a part provides that benefits provided under the plan may not be assigned or alienated.” ERISA provides a means of enforcing its anti-alienation provision.
Non- Bankruptcy Cases
Outside the bankruptcy arena, Section 206(d)(1) of ERISA generally protects pension funds in an ERISA pension plan from the claims of creditors. SeeGuidry v. Sheet Metal Workers Pension Fund, 493 U.S. 365 (1990), holding that a labor union may not impose a constructive trust on pension benefits of a union official who breached fiduciary duties and embezzled funds.
In the bankruptcy arena, the Supreme Court of the United States, in Patterson v. Shumate, 112 S.Ct. 2242 (1992), held that assets in an “ERISA-qualified” plan are excluded from the bankruptcy estate. The basis for the holding is Bankruptcy Code §541(c)(2), which excludes from the bankruptcy estate a beneficial interest of the debtor in a trust where the trust contains a restriction on the transfer of the beneficial interest which is “enforceable under applicable nonbankruptcy law.”
While it appears clear from a careful reading of Patterson that the enforceable anti-alienation provision upon which the decision is premised is ERISA Section 206(d)(1), the plan involved in Patterson was also tax-qualified. The issue which has arisen since Patterson is the meaning of the undefined term “ERISA-qualified”. One line of cases follows the rule set forth in In re Hall, 151 Bankr. 412 (Bankr. W.D. Mich. 1993), which requires a plan to be subject to Section 206(d)(1) of ERISA and to also be in compliance with all IRS requirements (“tax-qualified”) in order to obtain the protection provided by Patterson. The other line of cases follows In re Hanes, 162 Bankr. 733 (Bankr. E.D. Va. 1994), and holds that a plan which is subject to the ERISA anti-alienation provision is protected under Patterson regardless of whether the plan is tax qualified. A Florida bankruptcy case which considers the issue, In re Harris, 188 Bankr. 444 (Bankr. M.D.Fla.1995), follows Hall.
Plans which are not subject to Title I of ERISA, and therefore are not subject to the above-cited anti-alienation provision, receive no benefit from the Patterson decision. Plans in this category include plans in which the only participants are the shareholders, partners, or sole proprietor and his or her spouse. See e.g., In re Witwer, 148 Bankr. 930 (Bankr. C.D. Cal. 1992). Witner was followed in In Re Fernandez, 236 B.R. 483 (Bankr. M.D. Fla. 1999), which held that if a plan is not operated within ERISA requirements, it is not exempt.
Other types of plans which are not subject to Title I of ERISA include excess benefit plans, governmental plans, most church plans, most IRAs and some SEP/IRAs.
Section 522(d)(10((E) of the Bankruptcy Code provides an exemption for certain retirement funds to the extent the funds are “reasonably necessary for the support of the debtor and any dependent of the debtor.” The courts are split as to whether §522(d)(E)(10) is applicable to IRA accounts. (E.g., Carmichael v. Osherow (In re Carmichael), 100 F.3d 375 (5th Cir. 1996); In re Link, 172 Bankr. 707 (Bankr. D. Mass. 1992), holding that §522(d)(E)(10) applies to IRA accounts; In re Moss, 143 Bankr. 465 (Bankr. W.D.Mich. 1992), holding that IRAs are not within the scope of §522(d)(E)(10)) Additionally, since a factual determination must be made as to what portion of a debtor’s retirement fund or IRA account falls within this exemption, §522(d)(E)(10) cannot be relied upon to provide full protection for non-ERISA plans.
Retirement benefits which are not protected by the Patterson rule may be protected by state statutes, such as Fla. Stat. §222.21, which provide creditor protection for tax qualified retirement plans, IRAs and SEPs. While there has been much litigation as to whether ERISA preempts such state statutes, the issue has been resolved in favor of Fla. Stat. §222.21, by the Eleventh Circuit Court of Appeal in Schlein v. Mills (In re Schlein), 8 F.3d 745 (11th Cir. 1993).
An example of the protection afforded by Fla. Stat. §222.21 is illustrated in the recent case of In re Groff, 234 B.R. 153 (Bankr. M.D. Fla. 1999). The debtor, as president, sole director and 85% shareholder of “RMGA”, an Indiana corporation, sponsored a Salary Reduction Simplified Employee Agreement (“SARSEP”) governed by Code §408(k). The debtor’s participation in the plan terminated in 1995, at which time he rolled over his entire SARSEP account into an individual retirement account. At the time he filed his bankruptcy petition the account balance was more than $400,000.
The court, citing In re Francisco, 204 B.R. 799 (Bankr. M.D. Fla.1996) and In re Schlein, supra, made short shrift of the Trustee’s spurious argument that Fla. Stat. §222.21 does not include IRAs or, alternatively, that §222.21 is preempted by ERISA. The more interesting argument of the Trustee was that the IRA was not qualified under Code §408, which is a prerequisite to §222.21 protection, because the funds were transferred from a non-qualified plan. SeeIn re Banderas, 236 B.R. 837 (Bankr. M.D. Fla.1998). The Trustee contended that the form of the plan was defective because it was not amended to comply with subsequent changes in the law, and that the plan was operationally defective because it was not administered in accordance with its terms. The court overruled the Trustee’s objections for failing to meet her burden of proof.
Still a Debate
As indicated above, the Patterson case is not the last word on the protection of retirement plans from the claims of creditors. The Courts’ debate over the meaning of “ERISA-qualified” is discussed by Houle in “Courts, Confusion and ERISA,” New Jersey Law Journal (June 6, 1994). The vulnerability of retirement funds of sole proprietors, partners and sole shareholders, and potentially majority shareholders, is discussed by Woodruff in “ERISA’s Hidden Traps for Owner-Employees,” LXVI, No. 11 Florida Bar Journal30 (December 1992) and “Are Interests in Florida Retirement Plans Really Safe From Creditors?,” Supra. See also DeBenedictis’ “Protecting Pensions,” ABA Journal (Sept. 1993). More recently, the authors of “Qualified Plans May Not Be Protected in Bankruptcy”, 23 ACTEC Notes 75 (Summer, 1997), illustrate the growing conflict among the Bankruptcy Courts in their interpretation of Patterson, and conclude that self-employed individuals who reside in states like Florida, which provide statutory protection for IRA accounts, have one method of gaining absolute protection for their current retirement funds, which is to terminate the currently tax qualified retirement plan and roll over the assets into an individual retirement account.
No Shield to Federal Tax Liens
ERISA’s anti-alienation provision does not shield against federal tax liens and judgment. SeeUnited States v. Sawaf, 74 F.3d 119 (6th Cir. 1996).
A debtor is not entitled to avoid a federal tax lien on an IRA. In Deming v. IRS (In re Deming), 1994 Bankr. LEXIS 1129 (Bankr. E.D. Pa. 1994), a debtor opened an individual retirement account with a bank. The IRA was in the form of a certificate of deposit that provided that the certificate was not transferable except on the books of the bank. In 1987, the IRS recorded a notice of federal tax lien arising from the debtor’s tax obligations for 1983. The debtor filed a voluntary Chapter 7 in bankruptcy in 1992 and in 1993 the debtor commenced adversary proceedings against the IRS to avoid the federal tax lien on his IRA. Debtor conceded that Code § 6334 did not list IRAs among the items exempt from IRS levy, but invoked Pennsylvania law which exempts tax deferred IRAs from execution by a judgment creditor. The Bankruptcy Court, however, granted the government’s motion for summary judgment holding that the debtor was not entitled to avoid the IRS’ lien on the IRA. The court noted that under Section 522(c)(2)(B) of the Bankruptcy Code, a properly noticed pre-petition lien entitles a taxing authority to proceed against even exempt property once the bankruptcy stay has been terminated either under Bankruptcy Code Section 362(b)(c) or a judicial order. Therefore, the court reasoned, that the debtor could not use Bankruptcy Code Section 522(h) to avoid the IRS lien on the IRA under Bankruptcy Code Section 522(b), since the IRS could still seize the IRA once the Bankruptcy Court’s jurisdiction over the property ended. Citing, Leuschner v. First Western Bank and Trust Company, 261 F. 2d 705 (9th Cir. 1958), the court in Deming determined that Pennsylvania’s state law exemption was ineffective against the IRS lien.
The court cited Michigan v. United States, 317 U.S. 338 (1943), for the principle that in enacting Code § 6321, Congress exercised its constitutional prerogative to lay and collect taxes. Pursuant to the Supremacy Laws of the United States Constitution, the court continued, the right of the Federal government to collect taxes overrides Pennsylvania’s Statute providing for the exemption of property. Therefore, a debtor cannot use bankruptcy to avoid an IRS lien on an IRA account even though state law exempted the IRAs for execution by creditors, because the federal taxing powers override state law. SeealsoShanbaum, discussed in the Section, above, entitled Exempt Property.
Lawler v .Suntrust Secs., Inc., 740 So. 2d 592 (Fla. Dist. Ct. App. 5th Dist. Ct. 1999) Lawler was a beneficiary of an IRA at Suntrust Bank, which was the Trustee. The IRS issued a Notice of Levy and the Bank complied. The Court held in favor of the Bank and held that an IRA is not exempt from IRS levy. The Court stated that state law restraints cannot affect the IRS’ ability to levy based on Federal law. The Court noted the “IRS has a well grounded reputation for being the King Kong of creditors in terms of collecting tax delinquencies.”
Florida Legislation Results in Additional State Bankruptcy Exemptions
Since January 1, 1999, Florida residents have had the benefit of several additional state bankruptcy exemptions. Fla. Stat. §222.21(2)(a) was amended to exempt Roth IRA’s from creditors’ claims, and Fla. Stat. §222.22 was amended to exempt medical savings accounts from the claims of creditors. The amendments were passed into law on May 22, 1998 without the governor’s signature. Additionally, effective July 1, 1998, the Florida Probate Code was amended to incorporate the Florida Prepaid College Program exemption. Florida Prepaid College Program contracts purchased pursuant to Fla. Stat. §240.551 are now exempted from the claims of probate creditors