Profit-sharing plan and IRAs were not exempt from debtors’ bankruptcy estate

A bankruptcy court properly held that a debtor’s profit-sharing plan and two individual retirement accounts (IRAs) were not exempt from his bankruptcy estate, according to the U.S. District Court of Massachusetts. The debtor failed to obtain a favorable IRS determination letter or operate the profit-sharing plan in substantial compliance with applicable tax law, and the IRAs contained funds transferred from the profit-sharing plan and were not disclosed to the bankruptcy trustee as required.

About six months before a debtor filed for bankruptcy protection, he transferred $469,894 from his profit-sharing plan into his two IRAs. After the debtor filed a petition for bankruptcy, he disclosed his various assets and liabilities, including the profit-sharing plan’s assets, but he did not disclose his two IRAs on any schedules of assets and liabilities. However, the debtor did inadvertently mention the IRAs once at a creditors’ meeting. Based on that disclosure, the bankruptcy trustee filed a motion for turnover of the IRAs and later a motion for summary judgment on its motion for turnover of the IRAs. The bankruptcy court issued an order, permitting the trustee’s motion for summary judgment. The bankruptcy court granted other motions from the bankruptcy trustee and denied several motions from the debtor. The debtor appealed the bankruptcy court’s rulings, arguing that the court erred in finding that profit-sharing plan and the IRAs were not exempt from the debtor’s bankruptcy estate, and that the debtor failed to disclose and did conceal the two IRAs.

The debtor relied on a purported IRS favorable determination letter for the profit-sharing plan to argue that the plan was exempt from the bankruptcy estate. The district court explained that the letter that the debtor relied upon stated on its face that the IRS opinion was not a ruling or determination as to whether the plan was a qualified plan under Code Sec. 401(a). The letter, received after the IRS examined the plan, only referred to one year’s tax return and one transaction concerning a loan from the plan to the debtor’s son.

A plan may still be exempt from the bankruptcy estate under Bankruptcy Code Sec. 522(b)(4)(B) if the fund is in substantial compliance with the applicable requirements of the Internal Revenue Code, or if not in substantial compliance, the debtor is not materially responsible for the failure. However, the district court found that the debtor did not satisfy either of these requirements. Over the life of the plan, the debtor routinely engaged in prohibited transactions, as defined by Code Sec. 4975, by using the plan’s funds to enrich the interests of himself, his family, and other disqualified persons. Several real estate sales and leases between the plan and the debtor’s family were prohibited transactions, including a loan to the debtor’s son. Since the debtor actively managed the plan, the debtor was materially responsible for the plan’s failure to comply with the applicable tax law. Thus, the funds were not exempt from the debtor’s bankruptcy estate.

Furthermore, the IRAs were not exempt because they were funded from the nonexempt profit-sharing plan’s assets. The district court explained that plan funds that are subject to taxation remain subject to taxation when they are moved to IRAs. However, even if the IRAs would otherwise have been exempt, the debtor’s failure to disclose the existence of the IRAs to the bankruptcy court barred his claim of exemption. The district court stated that the record provides evidence of both nondisclosure and concealment of the IRAs. The bankruptcy court had found that the debtor’s failure to disclose was not a mere mistake because he failed to take advantage of numerous opportunities to disclose the existence of the IRAs and actively misrepresented material facts in both an expedited motion and a hearing. In addition, the bankruptcy court determined that all of these omissions and actions displayed a pattern of bad faith concealment that spanned the entire three-and-a-half years of the debtor’s bankruptcy case. The district court stated that these findings were well supported and not clearly erroneous. Moreover, the district court noted that the debtor’s failure to disclose caused unnecessary delay of the proceedings since the trustee had to investigate the true state of the debtor’s assets.

The district court determined that the bankruptcy court’s findings were not clearly erroneous and the bankruptcy court’s rulings were not in error. Thus, the district court affirmed the orders of the bankruptcy court and dismissed the debtor’s appeals.

Source: Daniels v. Agin (DC MA).

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer’s Benefits Reports.

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