NOT many people know that parents can transfer their retirement accounts such as 401k and IRA to their children tax free. For instance, you have a 401k of $150,000. At the age of 65, you transfer the 401k to your son and your son keeps the $150,000 as a 401k in your name in his custody but owned by him. There is no transfer tax on this transaction. But let’s say that your son has made some wrong financial decisions and has borrowed too much money on his credit cards and decides to seek Chapter 7 bankruptcy relief. On his Chapter 7 petition he declares on schedule B that he has two retirement accounts, one is his own PERS from the city, the other the $150,000 401k that he inherited from you. On schedule C, he exempts both retirement accounts. Naturally, the Chapter 7 trustee objects to the claim of exemption for the $150,000 and argues that the $150,000 is not exempt because it is a 401k that was inherited therefore the retirement exemption does not apply. Who is correct?
Section 522(d)(12) of the bankruptcy code exempts “Retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under section 401, 403,408,408A, 414,457, or 501(a) of the Internal Revenue Code of 1986. In other words, these are accounts which have been certified by the IRS to be retirement accounts. Let’s say the $150,000 is in cash wrapped in saran wrap and hidden behind your restroom water closet. This may qualify under provisions of the 1100 A.D. British Internal Revenue Code, but it certainly will not qualify as a retirement account under the American Internal Revenue Code of 1986. If your 401k plan is prepared by a person who failed all his math subjects in high school and college and whose college degree is in physical education with a minor in yoga, you may think you have a 401k plan, but that plan probably would not be one that is approved by the IRS under the Internal Revenue Code of 1986. Normally, 401k plans are prepared by actuaries. Actuaries are people who do not need to look at their fingers and toes to count, and they know how many strands of hair they have on their heads at any given time by extrapolating the number or hairs they were born with. If Mayans had actuaries, they would have known that December 21, 2012 was not the end of the world, that’s how accurate at math actuaries are. The Mayans obviously ran out of fingers to count because as Mel Gibson (Apocalypto) knows very well, Mayans have a history of cutting heads from necks for the flimsiest of reasons. “What, you failed to file your 302 A.D. Mayan income tax return? Off with your head!”
In Re Seeling, in May 2007, the debtor inherited half of a tax deferred annuity account. She rolled the proceeds of the annuity into an IRA in the decedent’s name for her benefit. Four years later, the debtor filed for Chapter 7 relief. She scheduled the IRA, which was then worth $52,975, and claimed the full amount as exempt pursuant to Section 522(d)(12). The trustee objected to the claim of exemption arguing that the money lost its status as “retirement funds” when it was rolled over into the IRA. The court disagreed and overruled the trustee’s objection. To qualify for the Section 522(d)(12) exemption money must be “retirement funds”, and be held in an account exempt from taxation under Internal Revenue Code sections 401, 403, 409, 408A,414,457 or 501(a) but the court found that Section 511(d)(12) does not specify for whose retirement the money must be set apart. “This Court finds itself in agreement with what appears to be a consensus. Individual retirement accounts are tax exempt under 26 U.S.C.∫ 408 and accordingly are exempt under the Bankruptcy Code, pursuant to Section 522(d)(12). The Bankruptcy Code requires no forensic analysis in order to determine from where those funds arose…”
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Lawrence Bautista Yang specializes in bankruptcy, business, real estate and civil litigation and has successfully represented more than five thousand clients in California. Please call Angie, Barbara or Jess at (626) 284-1142 for an appointment at 1000 S Fremont Ave Bldg A-1 Suite 1125 Unit 58 Alhambra, CA 91803.
