The debtor in this bankruptcy case was a resident of Florida and claimed an exemption for his IRA under Florida’s set of exemptions. Under normal circumstances the trustee would not object to the exemption claimed and the IRA would indeed not be included as an asset of the bankruptcy estate.
However, the debtor engaged in a series of prohibited transactions with his IRA. He had the IRA purchase a condominium in Puerto Rico which he impermissibly stayed in for no viable IRA-related purpose. Additionally, the debtor and his wife purchased two used automobiles with IRA funds. The IRA paid for thousands of dollars in repairs for the vehicles and the wife drove one of the vehicles extensively. These acts of self-dealing constitute prohibited transactions under the Internal Revenue Code. The debtor did not contest this finding.
The Eleventh Circuit Court, upon review of the decisions of the Bankruptcy Court and the District Court to which an appeal was taken, sustained the determination that the debtor could not exempt the IRA from inclusion in the bankruptcy estate. However, the Eleventh Circuit based its decision on the fact that the IRA was not maintained in accordance with the IRA’s plan or governing instrument…a requirement of Florida’s exemption statute. It found that the governing instrument signed by the debtor specifically stated: “I acknowledge that I have not and will not engage in any prohibited transactions within my retirement account or its asset holdings.” Further, in bold the governing instrument stated: “A prohibited transaction is a transaction between a plan and a disqualified person that is prohibited by law.” There was no ambiguity in the exemption requirements. The debtor’s engagement in prohibited transactions was a direct violation of the governing instrument and therefore the debtor’s claim of exemption had to fail.
This result seems fairly obvious. Why, then, did the debtor take this case all the way to the Eleventh Circuit? The debtor argued that so long as the IRA was originally established in compliance with the Internal Revenue Code, the IRA qualified for exemption under the Florida law. And to not grant the exemption to debtor would be inequitable. Strange as it may seem, the debtor simply chose not to take cognizance of the requirement that the plan be maintained in accordance with its governing instrument. The court summarily dismissed the debtor’s argument not wishing to consider substituting its judgment for the unambiguous Florida statute.
The lesson in this case is that even black letter law; namely, that an IRA qualifies as an exempt asset in a bankruptcy case, cannot be relied upon without carefully reviewing all of the facts. Take nothing for granted. Question extensively all aspects of any possible exempt assets.