1 Recent Developments – What the New Bankruptcy Act Means to Tax Professionals and Asset Protection Practitioners by Leo J. Cushing, Esq., CPA, LLM Cushing & Dolan, P.C. Attorneys at Law 24 School Street, Suite 300 Boston, MA Telephone: (617) Fax: (617) June 3, 2005

2 Recent Developments – What the New Bankruptcy Act Means to Tax Professionals and Asset Protection Practitioners. A.IRAs & Other Retirement Assets; The “Bankruptcy Exemption Theme ” Certain assets of a debtor are not considered property of the estate for purposes of the bankruptcy petition. These assets include 401(k) plans, pensions and any other retirement plans maintained in accordance with the Employee Retirement Income Security Act of 1974 ("ERISA"). Since ERISA requires a clause be included prohibiting assignment of benefits by a participant, retirement plans are not part of the bankrupt estate in the first instance under Bankruptcy Code Section 541(c)(2), since it is property which "contains a restriction on the transfer of a beneficial interest in a trust that is enforceable under applicable non-bankruptcy law is…” See Patterson v. Shumate, 504 U.S. 753 (1992).

3 ●IRAs and Simplified Employee Pension Plans are not maintained in accordance with ERISA so therefore such plans become, at least initially, property of the bankrupt's estate, subject to certain exemptions which are set forth in Bankruptcy Code Section 522(b)(1) (federal exemptions) and Section 522(b)(2)(A) (state exemptions) (the new "Act" re-designated Section 522(b)(2)(A) as Section 522(b)(3). ●These Sections of the Bankruptcy Code provide what is commonly referred to as the "Bankruptcy Exemption" scheme. It permits debtors who claim the federal exemption scheme to exempt property described in Section 522(b)(1), including "a payment under a stock bonus, pension, profit sharing, annuity or similar plan or contract, on account of illness, disability, death, age, or length of service, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor. 11 U.S.C. § 522(d)(10)(E).

4 Planning Note: It would be preferable to have an IRA excluded from the bankruptcy estate rather than raised as an exemption since, even if the plan was maintained "on account of illness, disability or age…" the exemption would apply only to the extent the funds are "reasonably necessary for the support of the debtor and any dependent of the debtor." Alternatively, Section 522(b)(2)(A), which is now 522(b)(3), provides for the “state or other law exemption scheme," which allows a debtor to exempt property protected under either non-bankruptcy federal law or state or local law.

5 B.The Goldman Case In the case In Re: Goldman, 192 BR 1 United States District Court, District Massachusetts (1996), Judge Young ruled that Dr. Goldman who had filed for Chapter 7 bankruptcy and asserted the "state" exemptions under Section 522(b)(2)(A). (Goldman subsequently amended his petition to exempt his rollover IRA pursuant to Bankruptcy Section 522(b)(1) and Section 522(d)(10)(E), but the Court nevertheless addressed the state exemption scheme insofar as it relates to the protection of IRAs under applicable state law.

6 ● Here, General Laws Chapter 235, §34 is applicable. This section provides that while in general retirement plans (including IRAs) are exempt from execution, the final sentence provides that, "The exemption for plans maintained by an individual shall not apply to sums deposited in plans in excess of 7% of total income of such individual within 5 years of the individual's declaration of bankruptcy or entry of judgment. ● In this case, the Court did not distinguish between rollover contributions and regular IRA contributions. The result was that the IRA assets, to the extent of the account balance in excess of 7% of the total income of the individual for the 5 years preceding the declaration of bankruptcy, were subject to the bankruptcy trustee's recovery rights. ● The Bankruptcy Court calculated Dr. Goldman's total income for the relevant 5 year period at $759,217 and determined that the 7% exemption to which he is entitled is $53, out of a total balance of $286,000. ● The Court did not address whether IRAs would be exempt under the federal bankruptcy scheme set forth in Section 522(b)(10)(E). ● The Patterson v. Shumate case had ruled that such a decision would need to wait for the next case.

7 ● Rousey v. Jacoway, Supreme Court Docket No April 4, 2005; (Judge Clarence Thomas). The case to which the Patterson v. Shumate case was referring was decided on April 4, 2005, where the debtor asserted the federal exemption scheme relying on Section 522(d)(10)(E). The Court found that IRAs should be exempt under this bankruptcy exemption since it is a "payment under a stock, bonus, pension, profit sharing, annuity or similar plan, or a contract on account of illness, disability, death, age, or length of service, to the extent reasonably necessary for the support of a debtor and any dependent of a debtor." The Court found that the debtor's right to payment from IRAs is causally connected to their age because their accounts qualify as IRAs under 26 U.S.C. 408(a), while the debtor's had a non-forfeitable right to the balance held in those accounts, that right was restricted by a 10% tax penalty that applies to withdrawals from IRAs made before the account holder turns 59 1/2. This tax penalty is substantial and a deterrent to early withdrawal. It suggests that Congress intended to preclude early access to IRAs and the low rate of early withdrawals from around the country are consistent with this notion.

8 ● This scheme effectively eliminates the debtor's right to payment of their account balance so, in effect, IRAs provide a right to payment on account of age. ● These are plans "similar" to stock, bonus, pension, profit sharing and annuities. ● The case, however, was remanded to the lower Court for "determination as to the extent reasonably necessary for the support of the debtor and any dependent of the debtor…"

9 C.The Bankruptcy Act dated April 20, 2005 Section 224 of the Bankruptcy Act specifically includes within the federal exemption scheme "retirement funds to the extent that those funds are in a fund or account that is exempt from taxation under 401 (qualified pension and profit sharing plans including 401(k) plans), 403 (qualified annuity plans), 408 (IRAs), 408A (Roth IRAs), 414, 457 (state and local government and tax-exempt defined compensation plans) or 501(a) of the Internal Revenue Code, participation on amounts protected in the case of IRAs.

10 ● The Bankruptcy Act, however, places a limit on the amount in an IRA that can be protected. ● Specifically, new Section 522(n) provides: "For assets in individual retirement accounts described in Section 408 or 408(A) of the Internal Revenue Code, other than simplified employee pensioned under Section 408(k) of such Code or a simple retirement account under Section 408(p) of such Code, the aggregate value of such assets exempted under this action, without regard to amounts attributable to a rollover contribution… and earnings thereon, shall not exceed $1,000,000 in a case filed by a debtor who is an individual, except that such amount may be increased if the interests of justice so require." ● Under the federal exemption scheme, $1,000,000 in IRA funds, in addition to all amounts rolled into an IRA, are exempt. ● Educational IRAs and tuition prepayments are not property of the estate. Under new 11 U.S.C. 541(d)(5) and 541(d)(6) funds placed in an educational individual retirement account, as defined in Section 530(b)(1) of the Code, not later than 365 days before the date of filing of the petition, will not be considered property of the estate if the designated beneficiary of such account was a child, grandchild, or a step-child of the debtor, for the taxable year for which funds were placed in such account.

11 In the case of funds placed in all such accounts having the same designated beneficiary, not earlier than 720 days nor later than 365 days before such date, so much of such funds as does not exceed $5,000 will be excluded as property of the estate.

12 D.Forum Shopping – Homestead Exemptions In the event of forum shopping, under 11 U.S.C. § 522(b)(3)(A), subject to subsections (o) dealing with a homestead exemption claimed as to property fraudulently transferred during 10 years prior to petition date and (p) dealing with a homestead for property acquired in 1,215 days before petition, cannot exceed $125,000, any property that is exempt under federal law, other than subsection (d) of this section, state or local law that is applicable on the date of the filing of the petition at the place in which the debtor's domicile has not 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 at 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 in the other place.

13 Planning Note: In order for a debtor to claim a state exemption attributable to the state of the domicile of the debtor, the debtor needed to live in the property for at least 180 days (or at least more time in such state during the 180 days preceding the filing). This has now been expanded to 730 days. If the debtor has not been in one state for 730 days, then use the state in which the petitioner spent the majority of time for the 180 days prior to the 730 day period. New 522(b)(3)(A)

14 E.Homesteads Homestead exemptions may be limited by new Section 522(o), Section 522(p), and Section 522(q). ●Property fraudulently transferred during 10 year period prior to petition date. Section 522(o) The value of any real or personal property that the debtor or dependent of the debtor uses as a residence, a cooperative that owns property that the debtor or a dependent of the debtor uses as a residence, a burial plot for the debtor or a dependent of the debtor, or real or personal property that the debtor claims as a homestead shall be reduced to the extent that such values attributable to any portion of any property that the debtor disposed of in the 10 year period ending on the date of the filing of the petition with the intent to hinder, delay or defraud a creditor and that the debtor could not exempt, or that portion that the debtor could not exempt under subsection (b) if on such date the debtor had held the property as so disposed of.

15 ●Recently acquired property – New 522(p) With respect to any real or personal property that the debtor or dependent of the debtor uses as a residence, a cooperative that owns property that the debtor or dependent of the debtor uses as a residence, a burial plot for the debtor or dependent of the debtor, or real or personal property where the debtor or dependent of the debtor claims as a homestead, except in the case of a family farmer as a result of electing under Section (b)(3)(A) to exempt property under state or local law, a debtor may not exempt any amount of interest that was acquired by the debtor during the 1,215 day period preceding the date of the filing of the petition that exceeds in the aggregate $125,000 in value. (4 years and 120 days) ●Exception If the debtor's current principal residence and the debtor's previous and current residences are located in the same state, the amount of such interest to which the limitation applies does not include any interest transferred from a debtor's previous principal residence which was acquired prior to the beginning of such 1,215 day period.

16 ●Bad Behavior Clause – Section 522(q) Under new 11 U.S.C. 522(q), as a result of exempting property pursuant to the state's statutory scheme of (b)(3)(A), a debtor may not exempt any amount of any interest in property which exceeds in the aggregate $125,000 if the Court determines that the debtor has been convicted of a felony, which under the circumstances demonstrates that the filing of the case was an abuse of the provisions of this title, or (1) the debtor owes a debt arising from any violation of the federal securities law or state securities law, (2) or fraud, deceit or manipulation in a fiduciary capacity or in connection with the purchase or sale of any security registered under the Securities Exchange Act, (3) any civil remedy under Section 1964 of Title 18, or (4) any criminal act, intentional tort, or willful or reckless misconduct that causes serious physical injury or death to another individual in the preceding 5 years.

17 ●Fraudulent Transfers -- now 2 years 11 U.S.C. 548(a)(1) now provides that a trustee may avoid any transfer, including any transfer to or for the benefit of an insider under an employment contract, of an interest of the debtor in property, or any obligation, (including any obligation to or for the benefit of an insider under an employment contract) incurred by the debtor that was made or incurred or within 2 years before the date of the filing of the petition… ●Transfers to Self-Settled Trusts - New 548(e)(1) The trustee may avoid any transfer of an interest of a debtor in property that was made on or within 10 years before the date of filing of a petition if, (a) such transfer was made to a self-settled trust or similar device, (b) such transfer was by the debtor, (c) the debtor is a beneficiary of such trust or a similar device, and (d) the debtor made such transfer with actual intent to hinder, delay or defraud any entity to which the debtor was or became, on or after the date the trust transfer was made indebted.

18 ●Full Employment for Offer in Compromise Professionals Not everyone will be eligible to file for bankruptcy. There is now a “means test,” under Bankruptcy Section 707(B)(2), that requires that the debtor determine his "current monthly income" as defined by New Section 101(10)(A). If this exceeds by a prescribed margin his "monthly expenses" as defined by the monthly living expense standards utilized by the Internal Revenue Service in the context of negotiations of offers in compromise of tax debts, bankruptcy relief may be unavailable. The means test does not apply to individuals whose income falls below certain income levels. These income levels adjusted to 2005 are as follows: 1 person household$44,885 2 person household$55,942 3 person household$69,694 4 person household$78,899