In re Daley, 10–34110.

• Decision Date: 11 October 2011
• Docket Number: No. 10–34110.,10–34110.
• Citation: 459 B.R. 270
• Parties: In re James L. DALEY, Jr., Debtor.
• Court: U.S. Bankruptcy Court — Eastern District of Tennessee

459 B.R. 270

In re James L. DALEY, Jr., Debtor.

No. 10–34110.

United States Bankruptcy Court, E.D. Tennessee.

Oct. 11, 2011.

John P. Newton, Jr., Esq., Law Offices of Mayer & Newton, Knoxville, TN, for Debtor.

Al Holifield, Esq., Holifield & Associates, PLLC, Knoxville, TN, Ann Mostoller, Esq., Mostoller, Stulberg, Whitfield & Allen, Oak Ridge, TN, for Trustee.

MEMORANDUM

RICHARD STAIR, JR., Bankruptcy Judge.

This contested matter is before the court on the Trustee's Objection to Debtor's Claim of Exemption filed by Ann Mostoller, Chapter 7 Trustee, on November 11, 2010, as amended by the Amended Objection to Debtor's Claim of Exemption filed on May 10, 2011, objecting to the Debtor's claimed exemption in a Merrill Lynch Individual Retirement Account (Merrill Lynch IRA) in the amount of $61,646.00. In support of her Objection, the Trustee argues that the Debtor engaged in a prohibited transaction causing the Merrill Lynch IRA to lose its tax exempt status, thus precluding the Debtor from claiming it exempt under Tennessee and bankruptcy law. The Debtor opposes the Trustee's Objection, arguing that the Merrill Lynch IRA is a qualified IRA and denying that he engaged in a prohibited transaction.

Having determined that an evidentiary hearing was not necessary and that all issues could be decided upon stipulations and briefs, the parties, as required by the Scheduling Order entered on June 23, 2011, filed a Stipulation of Facts and Documents on July 8, 2011, followed by an Amended Stipulation of Facts and Documents, which was filed on July 20, 2011. The Trustee filed her Brief in Support of Trustee's Objection to Debtor's Claim of Exemption on July 22, 2011, and the Debtor's Brief in Response to Trustee Objection to Exemptions was filed by the Debtor on August 5, 2011. Oral argument was heard on September 29, 2011.

As set forth in the Scheduling Order, the issues to be decided from the Debtor's perspective are:

a. Whether the [Merrill Lynch] IRA is qualified under the applicable IRS Code section;

b. If the [Merrill Lynch] IRA is not “qualified” under the applicable IRS Code section, is the Debtor entitled to allowance of the exemption claims for the Merrill Lynch IRA account under [Tennessee Code Annotated § 26–2–105(b) and 11 U.S.C. § 522(b)(3)(C)]; and

c. If the [Merrill Lynch] IRA account is “qualified” under the IRS Code, is the exemption allowed under [Tennessee Code Annotated § 26–2–105(b) and 11 U.S.C. § 522(b)(3)(C)].

From the Trustee's perspective, the issues are:

a. Whether the Debtor engaged in a prohibited transaction as defined in 26 U.S.C. § 4975 regarding the [Merrill Lynch] IRA? b. If a prohibited transaction did occur under 26 U.S.C. § 4975, does the [Merrill Lynch] IRA lose its status as an IRA under 26 U.S.C. § 408 and is no longer tax exempt?

c. If the [Merrill Lynch] IRA is no longer exempt under 26 U.S.C. § 408 may the Debtor claim an exemption allowed under T.C.A. § 26–2–105(b) and 11 U.S.C. § 522(b)(3)(C)?

I

The following facts are not in dispute. The Debtor filed the Voluntary Petition commencing his bankruptcy case under Chapter 7 on August 25, 2010. At that time, he held an interest in a Merrill Lynch IRA, account number 56614488, which he valued in his Schedule B at $61,646.00 and which he claimed exempt on his Schedule C, as amended on June 14, 2011. Stips. at ¶ 1. In establishing the Merrill Lynch IRA, the Debtor executed a Merrill Lynch Client Relationship Agreement on May 16, 2008, completing the section of the Client Relationship Agreement entitled “For SEP/Simple Account Only” and designating the Account Type as a rollover. Stips. at ¶ 2; EX. A. Per a determination letter from the Internal Revenue Service dated September 23, 2003, the Merrill Lynch IRA “satisfies the requirements of Code section 408[.]” Stips. at ¶ 5; Coll. Ex.. D.

The Merrill Lynch IRA is the only account applied for by the Debtor on May 16, 2008, and is the only account that he holds with Merrill Lynch. Stips. at ¶ 6. The Debtor did not fill out the section of the Client Relationship Agreement entitled “Accounts: CMA, Beyond Banking, CMA SubAccount, or IIA” and did not check any of the “Decline Margin Lending” boxes included within the Accounts section of the Merrill Lynch Client Relationship Agreement. Ex. A. Similarly, he did not complete the section entitled “UTMA or UGMA.” Ex. A. The Debtor has never borrowed any funds from the Merrill Lynch IRA, which is self-directed, nor has he ever requested advancement of a margin loan against his funds. Stips. at ¶ 7; Ex. C at 8[82].

II

Pursuant to 11 U.S.C. § 541, the Debtor's bankruptcy estate, inclusive of all property and interests in property owned by him, was created when he filed the Voluntary Petition. Nevertheless, Section 522 of the Bankruptcy Code provides the statutory authority for claiming exemptions in property, stating, in material part:

(b)(1) Notwithstanding section 541 of this title, an individual debtor may exempt from property of the estate the property listed in either paragraph (2) or, in the alternative, paragraph (3) of this subsection. In joint cases filed under section 302 of this title ... one debtor may not elect to exempt property listed in paragraph (2) and the other debtor elect to exempt property listed in paragraph (3) of this subsection. If the parties cannot agree on the alternative to be elected, they shall be deemed to elect paragraph (2), where such election is permitted under the law of the jurisdiction where the case is filed.

(2) Property listed in this paragraph is property that is specified under subsection (d), unless the State law that is applicable to the debtor under paragraph (3)(A) specifically does not so authorize.

(3) Property listed in this paragraph is—

(A) subject to subsections ( o ) and (p), 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 the filing of the petition to the place in which the debtor's domicile has been located for the 730 days immediately preceding the date of the filing of the petition or if the debtor's domicile has not been located in a single State for such 730–day period, the place in which the debtor's domicile was located for 180 days immediately preceding the 730–day period or for a longer portion of such 180–day period than in any other place; [and]

(B) any interest in property in which the debtor had, immediately before the commencement of the case, an interest as a tenant by the entirety or joint tenant to the extent that such interest as a tenant by the entirety or joint tenant is exempt from process under applicable nonbankruptcy law[.]

11 U.S.C. § 522. Under subsection (b)'s “opt out” provision, a number of states, including Tennessee, require debtors to use their exemptions rather than the federal exemptions enumerated in § 522(d). See Tenn.Code Ann. § 26–2–112 (2000).¹ Additionally, § 522(b) was impacted by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, including, as material to this contested matter, the addition of subsections (b)(3) and (b)(4) to expand the scope of exemptions for qualifying retirement funds beyond an exemption under any state law.

Property that is exempt “is subtracted from the bankruptcy estate and not distributed to creditors ... [to ensure that a debtor] retains sufficient property to obtain a fresh start and to provide the debtor with the basic necessities of life so that he will not be left entirely destitute by his creditors.” In re Arwood, 289 B.R. 889, 892 (Bankr.E.D.Tenn.2003) (quoting Lawrence v. Jahn (In re Lawrence), 219 B.R. 786, 792 (E.D.Tenn.1998)). Accordingly, exemptions are determined as of the date upon which the bankruptcy case is commenced, are construed liberally in favor of debtors, and “should be construed in light of the purpose for which [they are] created.” Lebovitz v. Hagemeyer (In re Lebovitz), 360 B.R. 612, 618–19 (6th Cir. BAP 2007); In re Chapman, 424 B.R. 823, 826 (Bankr.E.D.Tenn.2010). Any party in interest may object to a debtor's claimed exemptions, see Fed. R. Bankr.P. 4003, and as the objecting party, the Trustee bears the burden of proof by a preponderance of the evidence that the Debtor's exemption in the Merrill Lynch IRA has been improperly claimed; however, if she fails to carry the burden of proof, the exemption will retain its prima facie presumption of correctness and will stand. In re Garbett, 410 B.R. 280, 284 (Bankr.E.D.Tenn.2009).

As the bases for exempting the Merrill Lynch IRA, the Debtor relies upon Tennessee Code Annotated § 26–2–105(b), which provides that “any funds or other assets payable to a participant or beneficiary from, or any interest of any participant or beneficiary in, a retirement plan which is qualified under § ... 408 ... are exempt from any and all claims of creditors of the participant or beneficiary, except the state of Tennessee[,]” and 11 U.S.C. § 522(b)(3)(C), which exempts “retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section ... 408 ... of the Internal Revenue Code of 1986.” Section 522(b)(4) provides that the following provisions are applicable to subsection (b)(3)(C):

(A) If the retirement funds are in a retirement fund that has received a favorable determination under section 7805 of the Internal Revenue Code of 1986, and that determination is in effect as of the date of the filing of the petition in a case under this title, those funds shall be presumed to be exempt from the estate.

(B) If the retirement funds are in a retirement fund that has not received a favorable determination under such section 7805, those funds are exempt from the estate if the debtor demonstrates that—

(i) no prior determination to the contrary has been made by a court or the Internal Revenue Service; and

(ii)(I) the retirement fund is in substantial compliance with the applicable requirements of the ...