“Lien Provision” Does Not Render IRA Non-Exemptible

Posted by NCBRC - June 19, 2013

The Sixth Circuit found that the debtor’s pledge of his IRA account against future indebtedness which he never incurred did not render the account non-exemptible in bankruptcy. Daley v. Mostoller (In re Daley), No. 12-6130 (June 17, 2013).

Two years prior to filing for bankruptcy, the debtor opened an IRA account with Merrill Lynch. Prior to opening the account the debtor entered into a “Client Relationship Agreement” with Merrill Lynch containing the following language: “All of your securities and other property in any account—margin or cash—in which you have an interest, or which at any time are in your possession or under your control, shall be subject to a lien for the discharge of any and all indebtedness or any other obligations you may have to Merrill Lynch.” This provision had the effect of pledging the IRA account as security on any future debts to Merrill Lynch the debtor may incur. The debtor, however, never incurred any debts to Merrill Lynch, never opened another Merrill Lynch account which could have been used to incur debt, nor did he otherwise use the IRA account.

The debtor sought to exempt the IRA from his bankruptcy estate pursuant to section 522(b)(3)(C) which provides that IRAs that enjoy tax exempt status under the Tax Code are exempt from the bankruptcy estate. In support of his position the debtor provided a favorable determination letter from the IRS.

The trustee objected, arguing that the debtor’s IRA lost its tax exempt status pursuant to Tax Code sections 408(e)(2)(A) and 4975(c)(1)(B). Section 408(e)(2)(A) provides that an IRA loses its tax exempt status when the owner engages in any activity prohibited by section 4975. Section 4975(c)(1)(B) prohibits “any direct or indirect” “lending of money or other extension of credit” between the IRA and its owner. By agreeing to allow Merrill Lynch to take a lien on the account to secure future debts, the trustee maintained, the debtor indirectly used his IRA to obtain credit from Merrill Lynch. Both the bankruptcy court and the district court agreed. The Sixth Circuit reversed.

In holding that the IRA was exempt, the Sixth Circuit found that despite the broad language of section 4975, “[t]he salient reality is that Daley never borrowed from the IRA, and Merrill Lynch never extended credit to Daley based on the existence of the IRA.” The fact that the debtor never opened a margin-trading or other account with Merrill Lynch which could have provided the basis for indebtedness rendered the lien provision contingent on an event that never occurred. The court noted that its decision was consistent with the 2011 IRS announcement that lien provisions like the one at issue in this case would not destroy an IRA’s tax exempt status in the absence of an actual extension of credit. IRS Announcement 2011-81, 2011-52 I.R.B. 1052.

The lower courts had relied, in part, on a Department of Labor advisory opinion stating that granting a security interest in an IRA to cover debt in a non- IRA account “would amount to an extension of credit by the IRA to the IRA owner.” Emp. Benefits Sec. Admin., U.S. Dep’t of Labor, Advisory Op. 2009-03A at 3. The Sixth Circuit found this authority unpersuasive because the Department of Labor itself has indicated that it is rethinking its position on the matter and because advisory opinions by the DOL have no precedential imperative and are limited to the case before the panel.

Daley opinion


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