In Re Jennifer K. Kuchta, 09-15538.

• Citation: 434 B.R. 837
• Decision Date: 16 April 2010
• Docket Number: No. 09-15538.,09-15538.
• Parties: In re Jennifer K. KUCHTA and Terrence B. Kuchta, Debtors.
• Court: United States Bankruptcy Courts. Sixth Circuit. U.S. Bankruptcy Court — Northern District of Ohio

434 B.R. 837

In re Jennifer K. KUCHTA and Terrence B. Kuchta, Debtors.

No. 09-15538.

United States Bankruptcy Court,

N.D. Ohio,

Eastern Division.

April 16, 2010.

Charles J. Van Ness, Mayfield Heights, OH, for Debtors.

MEMORANDUM OF OPINION

PAT E. MORGENSTERN-CLARREN, Bankruptcy Judge.

Prepetition, the debtor Jennifer Kuchta inherited the assets in an individual retirement account from her mother. She transferred the assets via a trustee-to-trustee transfer to an IRA that she established in her name as beneficiary of her mother, and has begun to take taxable distributions from it. The debtor claims that the IRA is not part of her bankruptcy estate or, alternatively, that it is exempt from her estate under either state or federal law. The trustee challenges this, and moves for turnover of the IRA. ¹ For the reasons stated below, the inherited IRA is part of the estate, the exemption under state law is disallowed, the exemption under federal law is allowed, and the trustee's turnover motion is denied.

JURISDICTION

The court has jurisdiction under 28 U.S.C. § 1334 and General Order No. 84 entered by the United States District Court for the Northern District of Ohio. This is a core proceeding under 28 U.S.C. § 157(b)(2)(B) and (E).

ISSUES

1. Where the debtor inherits an IRA prepetition from a non-spouse, is the IRA property of the bankruptcy estate?

2. If the inherited IRA is property of the bankruptcy estate, may the debtor exempt it from the estate under either:

a. Ohio Revised Code § 2329.66(A)(10)(c); or

b. 11 U.S.C. § 522(b)(3)(C)?

FACTS

The parties stipulated to these facts: ²

Helen Wisch died on June 21, 2005, naming the debtor Jennifer Kuchta as the beneficiary of four individual retirement accounts. The debtor elected to receive immediate distribution of all of the assets in two of the IRAs. She did not pay any penalty on this distribution. The debtor transferred the assets in the other two IRAs to an account that she established at U.S. Bank in the name of “Jennifer K. Kuchta, ABO [A Beneficiary Of] Helen L. Wisch, IRA Plan.” The funds in this account (the inherited IRA) came solely from the debtor's inheritance and not from any of her wages or personal earnings. The debtor is prohibited by law from making any contributions to the inherited IRA.

For purposes of understanding the facts, the court itself notes here that the debtor is required by law to begin to take distributions from the inherited IRA under a timetable established by regulation. Returning to the stipulations, the debtor elected the Five-Year Rule distribution option and began to receive distributions monthly from the inherited IRA. The distributions are taxable to the debtor in the year in which they are received. As with the other two IRAs that the debtor liquidated immediately, the debtor has not paid any penalty on the distributions received from the inherited IRA.

On June 17, 2009, Jennifer and Terrence Kuchta filed their chapter 7 case. Jennifer Kuchta claimed the inherited IRA as exempt under either Ohio Revised Code § 2329.66(A)(10)(c) ³ or 11 U.S.C. § 522(b)(3)(C). The IRA is valued at $7,259.07.

The debtor is 39 years old, married with one minor child, and is disabled.

DISCUSSION

I.

Traditional IRAs compared to Inherited IRAs

It is helpful to begin by focusing on the difference between a traditional IRA and an inherited IRA, a distinction that this court recently addressed in In re Warren and Michelle Reinhard, No. 08-15357, Docket 45 (order entered March 31, 2010):

A traditional IRA is intended to be a vehicle for individuals to save for their own retirement. To encourage people to participate, the Internal Revenue Code provides tax benefits to the taxpayer, with the exact benefits depending on the type of retirement vehicle selected by the individual. When the owner of an IRA dies, the Internal Revenue Code permits the contents of the IRA to go to someone other than the account owner's spouse, in which case the distribution is referred to as an inherited IRA. See 26 U.S.C. § 408(d)(3)(C). When an IRA is inherited by a non-spouse, the inheriting individual may not roll over any amounts into or out of the IRA, may not make contributions to it, and must begin to take distributions from it in a matter of years, regardless of the individual's health or age. See 26 U.S.C. § 408; 26 C.R.R. § 1.408-2(b)(7); IRS Publication 590 at 20 (2009).

II.

Is the Inherited IRA part of the Bankruptcy Estate under § 541?

The filing of a bankruptcy case creates a bankruptcy estate that generally consists of all legal and equitable interests of the debtor in property. 11 U.S.C. § 541(a). The debtor makes a cursory argument that the inherited IRA is not property of the estate because it is a “beneficial trust in an IRA that is exempt under ‘applicable non-bankruptcy law,’ to wit: R.C. 2329.66(a)(10)(c) [sic].” ⁴ The trustee responds that the debtor's interest is not in a trust because an IRA is not a spendthrift trust.

“Legislative history indicates section 541 is intended to be given a broad definition[.]” Johnston v. Hazlett (In re Johnston), 209 F.3d 611, 613 (6th Cir.2000). Section 541(c)(1) reinforces this by providing generally that a debtor's property is included in the estate even if there are restrictions on the debtor's ability to transfer the property. 11 U.S.C. § 541(c)(1). There is one narrow exception: under § 541(c)(2), if the debtor has a beneficial interest in a trust that has a restriction that is enforceable under nonbankruptcy law, then the restriction is also enforceable in a bankruptcy case. 11 U.S.C. § 541(c)(2). A classic example of such a trust is a spendthrift trust, called by that name because the trust “imposes a restraint on the voluntary and involuntary transfer of the beneficiary's interest in the trust property.” In re Delmoe, 365 B.R. 124, 128 (Bankr.S.D.Ohio 2007) (quoting Scott v. Bank One Trust Co., 62 Ohio St.3d 39, 44, 577 N.E.2d 1077 (1991)). Assets held in other kinds of trusts may, however, also be protected under § 541(c)(2). Patterson v. Shumate, 504 U.S. 753, 112 S.Ct. 2242, 119 L.Ed.2d 519 (1992); Taunt v. Gen. Ret. Sys. (In re Wilcox), 233 F.3d 899, 904 (6th Cir.2000).

“An inquiry under § 541(c)(2) normally has three parts: First, does the debtor have a beneficial interest in a trust? Second, is there a restriction on the transfer of that interest? Third, is the restriction enforceable under nonbankruptcy law?” In re Wilcox, 233 F.3d at 904. The debtor has the burden of proof on this issue. Rhiel v. Adams (In re Adams), 302 B.R. 535, 540 (B.A.P. 6th Cir.2003).

The Supreme Court considered various aspects of § 541(c)(2) in the cases of Patterson v. Shumate, 504 U.S. 753, 763, 112 S.Ct. 2242, 119 L.Ed.2d 519 (1992) and Rousey v. Jacoway, 544 U.S. 320, 125 S.Ct. 1561, 161 L.Ed.2d 563 (2005). In Patterson, the Court held that the debtor could exclude his ERISA-qualified pension plan from the bankruptcy estate under that section. In its discussion, the Court noted that “[a]lthough a debtor's interest [in an IRA] could not be excluded under § 541(c)(2) ..., that interest nevertheless could be exempted under § 522(d)(10)(E).” Patterson, 504 U.S. at 763, 112 S.Ct. 2242. The court returned to this specific statement in Rousey to support the holding in that case that IRAs may be exempted from the estate. Rousey, 544 U.S. at 326, 125 S.Ct. 1561. Under the Bankruptcy Code, an asset must first be property of the estate before it can be taken out of the estate. This seems to lead logically to the conclusion that an IRA is property of the estate. Nevertheless, the decisions did not specifically address the issue raised here, which is whether the IRA is not property of the estate because it is a trust within the meaning of § 541(c)(2).

The term “trust” is not defined in the Bankruptcy Code. Internal Revenue Code § 408 provides that “[f]or purposes of this section, the term ‘individual retirement account’ means a trust....” 26 U.S.C. § 408(a). The limiting language-“for purposes of this section”-is significant. For purposes of the tax code, an IRA is a trust. This is not, however, a controlling definition for the Bankruptcy Code. See In re Adams, 302 B.R. at 542 (noting that “special treatment [as a trust under § 401(a) ] is expressly limited to the Internal Revenue Code and so does not apply at all to the Bankruptcy Code.”).

In the absence of a federal definition, the bankruptcy court looks to applicable state law. Stevenson v. J.C. Bradford & Co. (In re Cannon), 277 F.3d 838, 849 (6th Cir.2002) (looking to state law to define express trust); In re Adams, 302 B.R. at 540 (looking to state law to define a trust for purposes of § 541(c)(2)); Booth v. Vaughan (In re Booth), 260 B.R. 281, 290-91 (6th Cir. BAP 2001) (court looked to state law to define “constructive trust” for the purpose of § 541(c)(2)).

Under Ohio law:

a trust is created by “an explicit declaration of trust, or circumstances which show beyond reasonable doubt that a trust was intended to be created, accompanied with an intention to create a trust, followed by an actual conveyance ... of definite property ... vesting the legal title presently in a person capable of holding it, to hold as trustee for the benefit of a cestui que trust.”

In re Adams, 302 B.R. at 540 (quoting Ulmer v. Fulton, 129 Ohio St. 323, 195 N.E. 557, 564 (1935)). For “a trust to be a trust, the legal title of the res must immediately pass to the trustee....” Kelly v. May Assocs. Fed. Credit Union, No. 23423, 2008 WL 836014, at *4 (Ohio Ct.App. Mar. 31, 2008) (quoting First Nat'l Bank of Cincinnati v. Tenney, 165 Ohio St. 513, 518, 138 N.E.2d 15 (1956)). The Kelly court considered whether a disputed IRA was a trust under Ohio law; in concluding that it was not, the court pointed out that legal title to funds in an IRA ordinarily remains with the owner and does not pass to the trustee. But see

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