Supreme Court of the United States

Transcription

1 No IN THE Supreme Court of the United States BRANDON C. CLARK AND HEIDI K. HEFFRON-CLARK, v. Petitioners, WILLIAM J. RAMEKER, TRUSTEE, ET AL. Respondents. On Writ of Certiorari to the United States Court of Appeals for the Seventh Circuit BRIEF AMICUS CURIAE OF PROFESSOR SEYMOUR GOLDBERG IN SUPPORT OF RESPONDENTS CATHERINE L. STEEGE JENNER & BLOCK LLP 353 N. Clark Street Chicago, IL MATTHEW S. HELLMAN Counsel of Record ADAM G. UNIKOWSKY JENNER & BLOCK LLP 1099 New York Ave., N.W. Washington, DC (202) Counsel for Amicus

2 i TABLE OF CONTENTS TABLE OF CONTENTS... i TABLE OF AUTHORITIES... ii INTEREST OF AMICUS... 1 INTRODUCTION AND SUMMARY OF ARGUMENT... 2 ARGUMENT... 4 I. Funds in IRAs are Retirement Funds A. Funds in a Traditional IRA are Retirement Funds B. Funds in a Roth IRA are Retirement Funds II. Funds in Inherited IRAs are not Retirement Funds III. The Same Principles Apply To Other Types Of Retirement Accounts CONCLUSION... 16

3 STATUTES ii TABLE OF AUTHORITIES 11 U.S.C. 522(b)(3)(C)... 2, 3, 9, U.S.C. 72(t) U.S.C. 219(a) U.S.C. 219(d)(4) U.S.C. 401(k)(2)(B)(i)(III) U.S.C. 401(a)(9)(C) U.S.C. 402(c)(11) U.S.C. 408(a)(6) U.S.C. 408(d)(1) U.S.C. 408(d)(3)(C)... 9, 16 OTHER AUTHORITIES 26 C.F.R C.F.R A C.F.R A , 7, 8 Seymour Goldberg, Inherited IRAs: What Every Practitioner Must Know (1st ed. 2013)... 11, 15 I.R.S. News Release I.R (Oct. 18, 2012) I.R.S. Notice , C.B , 16 I.R.S. Priv. Ltr. Rul (June 16, 1999) I.R.S. Publication 590 (2014)... 5, 9, 10, 14

4 iii Richard L. Kaplan, Retirement Funding and the Curious Evolution of Individual Retirement Accounts, 7 Elder L.J. 283 (1999)... 8 Rev. Proc , C.B

5 1 INTEREST OF AMICUS 1 Professor Seymour Goldberg is a senior partner in the law firm of Goldberg & Goldberg, P.C. He is Professor Emeritus of Law and Taxation at Long Island University and is the former director of the Tax Institute of Long Island University, C.W. Post Campus. Professor Goldberg is the recipient of the American Jurisprudence Award in Federal Estate and Gift Taxation from St. John s University School of Law. He is a former member of the IRS Northeast Pension Liaison Group and has been involved in conducting continuing education outreach programs with the IRS on the retirement distribution rules. He is the recipient of outstanding discussion leader awards from both the American Institute of Certified Public Accountants and the Foundation For Accounting Education. He has applied for and obtained more than 85 IRS private letter rulings on IRA distribution issues, estate and gift tax issues and fiduciary income tax issues. He has served as an instructor in continuing legal education programs on the IRA Distribution Rules for a number of legal associations including the New York State Bar, New Jersey Institute of Continuing Legal Education, Association of 1 No counsel for any party has authored this brief in whole or in part, and no party or counsel for a party has made a monetary contribution to the preparation or submission of this brief. All parties have been timely notified of the undersigned s intent to file this brief; both petitioner and respondent have consented to the filing of this brief. Petitioners written consent for the submission of this brief is on file with the Clerk of the Court. Letters of consent from Respondents accompany this brief.

6 2 the Bar of the City of New York, Suffolk Academy of Law and Nassau Academy of Law. Professor Goldberg is the author of numerous books on the taxation of IRAs, including Goldberg, Inherited IRAs: What Every Practitioner Must Know (American Bar Association, 1st ed. 2013); Goldberg, IRA Guide to IRS Compliance Issues Including IRA Trust Violations (American Bar Association, 1st ed. 2013); and Goldberg, The IRA Distribution Rules: IRS Compliance and Audit Issues (American Institute of Certified Public Accountants, 1st ed. 2012). In addition, Professor Goldberg is the author of a manual for the American Bar Association on the trust accounting rules, Goldberg, Fundamentals of Trust Accounting Income and Principal Rules Under the Revised New York State Laws (American Bar Association, 1st ed. 2014). Professor Goldberg has a strong professional interest in this case. First, Professor Goldberg regularly advises clients on the legal consequences of creating or inheriting an IRA, including in the context of bankruptcy. Second, this case depends on whether funds in an inherited IRA are properly characterized as retirement funds. Given Professor Goldberg s expertise in the tax treatment of inherited IRAs as it relates to retirement planning, Professor Goldberg has a professional interest in that question being resolved correctly. INTRODUCTION AND SUMMARY OF ARGUMENT Under 11 U.S.C. 522(b)(3)(C), a debtor may exempt from the bankruptcy estate retirement funds to the extent that those funds are in a fund or ac-

7 3 count that is exempt from taxation under section 401, 403, 408, 408A, 414, 457, or 501(a) of the Internal Revenue Code of This provision makes clear that not all funds that are in a fund or account that is exempt from taxation under one of the enumerated provisions can be exempted from the bankruptcy estate. Rather, for purposes of 522(b)(3)(C), only retirement funds that are in such a fund or account can be exempted from the bankruptcy estate. This case presents the question of whether funds in an inherited IRA are retirement funds under 522(b)(3)(C). The Bankruptcy Code does not expressly define the phrase retirement funds. Nevertheless, an analysis of the tax treatment of different types of accounts under the Internal Revenue Code provisions enumerated in 522(b)(3)(C) provides a straightforward answer to the question of whether those accounts contain retirement funds. As explained below, certain types of accounts, such as IRAs, are taxed in a manner to encourage individuals to save funds in those accounts for retirement. For instance, individuals can invest money in their IRAs before payment of taxes during their working lives, but will be penalized if they remove those funds from the IRA before they reach retirement age. Indeed, that is why an IRA is called an Individual Retirement Account it is an account subject to unique taxation rules that encourage individuals to use the money in their accounts for their retirement. Accordingly, funds in IRAs are retirement funds. In contrast, inherited IRAs are taxed in precisely the opposite manner from IRAs. Whereas IRA owners are encouraged to add money to IRAs, nonspouse

8 4 beneficiaries are prohibited from adding money to IRAs. And whereas IRA owners are generally prohibited from removing funds from their IRAs prior to retirement age without incurring a penalty, nonspouse beneficiaries are generally required to commence immediate distributions from inherited IRAs, even when they have not yet reached retirement age. Although under certain circumstances nonspouse beneficiaries can wait for five years before taking distributions, in such cases the nonspouse beneficiaries are required to then take out the full amount in the inherited IRA account, even if they have not yet reached retirement age. In this sense, inherited IRAs are better characterized as anti-retirement funds: they are structured so as to require immediate consumption of the funds rather than to promote future savings. Accordingly, they are not retirement funds under the Bankruptcy Code. ARGUMENT I. FUNDS IN IRAS ARE RETIREMENT FUNDS. The Internal Revenue Code authorizes taxpayers to create several types of accounts which are given special tax treatment so as to encourage taxpayers to put retirement savings into those accounts. Below, we focus primarily on two popular types of retirement accounts: the Traditional IRA (the type of IRA owned by Petitioner s mother) and the Roth IRA. As explained below, the tax treatment of these accounts makes indisputably clear that these accounts contain retirement funds.

9 5 A. Funds in a Traditional IRA are Retirement Funds. Petitioner s mother owned a Traditional IRA. A Traditional IRA has several features that make it a tax-advantaged way to save for retirement hence the name, Individual Retirement Account. First, funds contributed to a Traditional IRA are tax-deductible (subject to certain exceptions, such as high-income taxpayers), and are taxed only when withdrawn from the Traditional IRA. See 26 U.S.C. 219(a), 408(d)(1). This is tax-advantageous because people are typically in a higher tax bracket when they work than after they retire. Second, individuals who withdraw funds from a Traditional IRA before age 59½ generally must pay a penalty (subject to certain narrowly-defined exceptions, such as when those funds are used for medical expenses). See 26 U.S.C. 72(t). This is to discourage withdrawals before retirement. Third, a Traditional IRA owner is required to begin taking minimum distributions when he achieves his required beginning date, which is generally April 1 of the calendar year after the IRA owner attains age 70½. See 26 U.S.C. 401(a)(9)(C), 408(a)(6); 26 C.F.R , Q&A-3; IRS Publication 590, at 34 (2014). At the required beginning date, the Traditional IRA owner s required minimum distributions are based on certain December 31 account balances and applicable tables found in Appendix C of IRS Publication 590. See IRS Publication 590, at 35-36, Such distributions are required because the funds in Traditional IRAs are tax-deferred, not tax-exempt. Congress did not in-

10 6 tend for Traditional IRA owners to permanently avoid taxation for income in those accounts; instead, Congress intended for Traditional IRA owners to pay taxes later in life. The required minimum distributions ensure that, for persons with ordinary life expectancies, they will pay taxes on their income at some point in their lives. Taken together, these features of a Traditional IRA make it highly tax-advantageous for individuals to delay any withdrawals until they are (a) over age 59½, and (b) no longer working which typically will mean that they are retired in order to withdraw funds. And the Traditional IRA affirmatively requires an individual to take distributions during the later part of his retirement years. Thus, a Traditional IRA contains retirement funds. B. Funds in a Roth IRA are Retirement Funds. The Roth IRA differs from the Traditional IRA in that contributions to a Roth IRA are not tax deductible, but withdrawals from a Roth IRA including any growth in that investment are generally taxfree. Like a Traditional IRA, however, the Roth IRA is structured so that persons may use the funds within the Roth IRA for retirement. As with Traditional IRAs, Congress has imposed penalties for withdrawals of investment income from a Roth IRA before the age of 59½ (subject to a narrow list of specified exceptions). 26 C.F.R A-6, at A-1(a), (b). To be sure, an individual can generally withdraw the principal from a Roth IRA penalty-free at any time. 2 2 See 26 C.F.R A-6, at A-5(b) for a technical exception.

11 7 This is because that individual has already paid taxes on the principal, so there is no reason to restrict him from withdrawing his own after-tax funds. However, one cannot generally withdraw the earnings from a Roth IRA before the age of 59½ without paying a penalty. The earnings part of a Roth IRA is tax-advantaged it is tax-exempt income and so, because Congress gave special tax treatment to the earnings for the purpose of assisting a person in saving for retirement, Congress has imposed a penalty for using that money before retirement age. Unlike with Traditional IRAs, Roth IRA owners are not required to receive mandatory distributions. 26 C.F.R A-2, at A-2. This is because Roth IRAs are tax-exempt rather than tax-deferred. Thus, for Traditional IRAs, Congress required distributions to limit the ability of persons to defer taxation and to ensure that they paid taxes eventually. In contrast, for Roth IRAs, this consideration does not apply because no tax is being deferred. Petitioner contends that [a]n individual may withdraw his contributions to a Roth IRA without penalty for any reason at all, and asserts that in light of this characteristic, Roth IRAs are allpurpose investment kitties. Pet. Br. 25. This is misleading. First, Petitioner s careful assertion that a person may withdraw his contributions to a Roth IRA, id. (emphasis added) obscures the fact that the person may not withdraw the earnings on those contributions without penalty and the very reason that the Roth IRA is a good investment is that the earnings are tax-free and there are no mandatory distributions for the Roth IRA owner. 26 C.F.R A-6, at A-1(a), (b) (imposing restrictions on dis-

12 8 tributions). Second, Roth IRAs are not all-purpose investment kitties. Before age 59½, the investment income from a Roth IRA cannot be used for all purposes without penalty. Rather, the investment income from a Roth IRA can only be used for a narrow set of specified purposes without incurring penalties. See 26 C.F.R A-6, at A-1(b)(2). Moreover, when a person withdraws principal from the Roth IRA and spends it on other purposes before age 59½, he is not using the Roth IRA as an investment kitty ; rather, he is spending the after-tax funds that he has already put into the Roth IRA. Far from being a good investment, spending the principal in a Roth IRA before age 59½ is a financially harmful decision that an individual should only undertake under emergency circumstances, because it reduces that individual s future tax-exempt income. Indeed, the law review article cited in Petitioner s brief makes this very point. Richard L. Kaplan, Retirement Funding and the Curious Evolution of Individual Retirement Accounts, 7 Elder L.J. 283, 292 (1999) (cited at Pet. Br. 26) (noting that the early withdrawal penalty applies to both regular and Roth IRAs in equal measure and that [a]s a result, tapping an IRA for preretirement expenditures is a very expensive source of funds ). II. FUNDS IN INHERITED IRAS ARE NOT RETIREMENT FUNDS. When an IRA owner dies, the IRA is transferred to the owner s selected beneficiary. An inherited IRA is a nonprobate asset that generally passes by operation of law to the IRA owner s selected beneficiary; it is not a probate asset unless it is payable to the deceased IRA owner s estate. Thus, in effect, the des-

13 9 ignated beneficiary of the deceased IRA owner owns the IRA owner s account after the death of the IRA owner. See Rev. Proc , C.B The Internal Revenue Code imposes different tax treatment for inherited IRAs depending on whether the beneficiary is a spouse or a nonspouse. When the beneficiary is a spouse, she is entitled to roll over the IRA into her own account, as if she had established the IRA herself. If she selects this option, then these funds clearly retain their character as retirement funds. See IRS Publication 590, at 18. In contrast, when the beneficiary is a nonspouse, she may not roll over the IRA into her own account. Rather, the nonspouse beneficiary must re-title the inherited IRA in a manner that identifies it as an IRA with respect to a deceased individual and also identifies the deceased individual and the beneficiary, for example, Tom Smith as beneficiary of John Smith. I.R.S. Notice , C.B. 395, at A- 13. Thus, Petitioner errs in contending that the conversion of an IRA into an inherited IRA requires a direct transfer of retirement funds under 11 U.S.C. 522(b)(4)(C). Pet. Br Rather, the IRA turns into an inherited IRA by direct operation of law. See 26 U.S.C. 408(d)(3)(C)(ii) ( [A]n individual retirement account... shall be treated as inherited if (I) the individual for whose benefit the account... is maintained acquired such account by reason of the death of another individual, and (II) such individual was not the surviving spouse of such other individual (emphasis added)). Inherited IRAs are subject to tax treatment that is the polar opposite of the tax treatment of non-

14 10 inherited IRAs. There are two fundamental differences between non-inherited IRAs and inherited IRAs. First, an IRA owner is encouraged to put money into non-inherited IRAs by getting special tax treatment for such contributions (or, in the case of a Roth IRA, for earnings). But nonspouse beneficiaries are prohibited from putting money into inherited IRAs or rolling them over. 26 U.S.C. 219(d)(4), 408(d)(3)(C). This is a marker that funds in inherited IRAs are not intended to be retirement funds. Second, as noted above, an IRA owner is ordinarily prohibited from withdrawing money from noninherited IRAs before retirement age without paying a penalty. In contrast, nonspouse beneficiaries may take any or all of their money out of their inherited IRAs at any time without penalty as long as the postdeath required minimum distributions are timely received. Moreover, nonspouse beneficiaries are required to withdraw money from inherited IRAs regardless of age. More specifically, Publication 590 contains rules for individuals who inherit IRAs for which the owner died before [the] required beginning date. Publication 590, at 37. These rules apply to persons who inherit traditional IRAs from persons who died before their required beginning date (i.e., generally April 1 after the calendar year that the owner attains age 70½). In addition, these rules apply to everyone who inherits a Roth IRA. See id. at 76. Under these rules, post-death required minimum distributions to a nonspouse designated beneficiary must generally commence in the calendar year after the death of the IRA owner. See id. at

15 11 Typically, nonspouse designated beneficiaries receive payouts based on their own life expectancy, unless they choose to accelerate such payments. The following example illustrates how such payouts occur: Marvin, an IRA owner, died at age 68 on June 1, The individual designated beneficiary of his IRA account is his daughter, Margaret, who survived him. Margaret s date of birth was October 15, See Seymour Goldberg, Inherited IRA s: What Every Practitioner Must Know ( Goldberg ), example 5, at (1st ed. 2013). Because Marvin died in 2012 at age 68, he did not have to receive any required minimum distributions for the year of his death. This is so because he died prior to his required beginning date. His required beginning day is generally April 1 after the calendar year that Marvin attains age 70½. See Goldberg, at 22. Margaret can generally use the life expectancy method in determining her required minimum distributions from Marvin s deceased IRA account. Because Margaret attains age 40 in the calendar year 2013, she determines her required minimum distributions from Marvin s deceased IRA account commencing in the calendar year 2013 over a termcertain period of 43.6 years. See Goldberg, example 5, at The reason that owners of an inherited IRA may receive payouts distributed over their lives, rather than receiving an immediate lump-sum payout, is to avoid the adverse tax consequences associated with a lump-sum payout that may push the taxpayer into a higher tax bracket. The facts of this case illustrate

16 12 that possibility. Petitioner s inherited IRA was worth nearly $300,000. If Petitioner was forced to take the entire IRA as a lump-sum payment, then portions of that IRA could possibly be taxed at a 33% tax rate, which may have been higher than Petitioner s mother s tax rate at any point in her life. Given that the purpose of the traditional IRA is to tax the funds at a lower rate when they are distributed than when they are earned, this outcome would be unfair and defeat the purpose of the IRA. This consideration does not apply to tax-exempt Roth IRAs, but Congress elected to give parallel tax treatment of all inherited IRAs rather than create distinct tax rules depending on the particular type of IRA at issue. Relying on the ability to distribute inherited IRA distributions over a nonspouse beneficiary s life expectancy, Petitioner notes that it is theoretically possible for an inherited IRA to increase in value in a given year. This will occur if the rate of return for the IRA exceeds the value of the minimum distribution in a given year. See Pet. Br Petitioner fails to mention, however, that if this occurs, the nonspouse beneficiary will be forced to withdraw even more money the next year to ensure that the IRA is depleted by the end of her life expectancy. In the above example, suppose Margaret, with a life expectancy of 43.6 years, inherited a $300,000 IRA. In the first year, she will be required to withdraw $300,000 / 43.6 = $6,881. Suppose the IRA grows at a 2.3% rate, however, so that the IRA earns $6,900 in interest. Despite the distribution, the IRA will grow to $300,000 + $6,900 - $6,881 = $300,019. However, the next year, Margaret s remaining term-certain life expectancy is now 42.6 years. Accordingly, she must

17 13 withdraw more money than the previous year: $300,019 / 42.6 = $7,043. If the IRA continues to grow at a 2.3% interest rate, it will earn $6,900 in interest, and so the value of Margaret s IRA will decrease: $300,019 + $6,900 - $7,043 = $299,876. The next year, Margaret will be required to withdraw $299,876 / 41.6 = $7,209, and the value of the IRA will decrease even more. Moreover, the distributions will continue to rise each year in light of Margaret s decreasing term-certain life expectancy, until the IRA is fully depleted. More generally, although an inherited IRA may temporarily increase if the rate of return exceeds the required annual distribution, these temporary increases in value will quickly be offset by increases in required annual payouts, regardless of whether the nonspouse beneficiary has reached retirement age. Thus, Petitioner is incorrect to assert that [t]he Internal Revenue Code thus allows an IRA to operate similarly in the hands of a beneficiary as in the hands of the initial owner: namely, as a tax-exempt account that can increase in value leading up to its holder s retirement, Pet. Br. 28. The Internal Revenue Code does not treat inherited IRAs similarly to ordinary IRAs; ordinary IRAs grow in value because persons can put money in and are restricted from taking money out without penalty at certain ages, and inherited IRAs grow in value only as a temporary byproduct of earnings and low initial minimum distributions due to a long life expectancy. Indeed, there are perhaps no two types of accounts that are given less similar tax treatment than ordinary and inherited IRAs.

18 14 Petitioner appears to argue that an inherited IRA contains retirement funds merely due to the theoretical possibility that an inherited IRA may temporarily increase in value. But if that were true, any account, including a simple checking account, would automatically contain retirement funds, merely because of the possibility that it could grow under some set of circumstances. In fact, a checking account actually is more like a retirement account than an inherited IRA, because a person may add money to the checking account and is not required to take mandatory distributions. In sum, if an inherited IRA contains retirement funds, then all funds are retirement funds. That cannot be the law. The tax rules that apply when the nonspouse beneficiary dies further establish that an inherited IRA is not a retirement account. A nonspouse beneficiary may select a successor-in-interest to her rights to receive the post-death required minimum distributions from the original IRA account. I.R.S. Priv. Ltr. Rul (June 16, 1999). The beneficiaries of a deceased beneficiary continue to use the remaining term-certain period of the designated beneficiary. See IRS Publication 590, at 37. This is true regardless of whether the successor-in-interest has reached retirement age. In the above example, suppose that Margaret dies at age 60 in 2033 and then leaves the inherited IRA to her grandson Michael. Because Margaret s remaining term-certain life expectancy at the time of her death at age 60 is 23.6 years (i.e., 43.6 minus 20 years), Michael will receive the remainder of the funds in the IRA commencing in 2034 over a 22.6-year period after he inherits the IRA. This will occur regardless of whether Michael has

19 15 reached retirement age. For example, if Michael is 20 years old in 2033 when he inherits his grandmother s IRA, all the funds in the inherited IRA will be distributed by the time he turns 44. It is difficult to regard these funds as retirement funds when the Internal Revenue Code often will make it impossible for the successor-in-interest to receive those funds during retirement. III. THE SAME PRINCIPLES APPLY TO OTHER TYPES OF RETIREMENT ACCOUNTS. As noted above, the Bankruptcy Code permits a debtor to exempt 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 This provision applies not only to IRAs (which are governed by Sections 408 and 408A) but other types of retirement accounts, such as employer-provided retirement funds (Section 401), employee annuity funds (Section 403), and various plans by state and local governments and certain tax-exempt employers (Sections 414 and 457). The taxation of these accounts varies in its particulars, but has one common characteristic: the original owner of such an account may add money and use the account to save for retirement, whereas the nonspouse beneficiary may not add money and is generally required to commence immediate distributions. For instance, the owner of a 401(k) account may add $17,500 per year to the account, see I.R.S. News Release IR (Oct. 18, 2012), and generally cannot receive distributions until he turns 59½, 26 U.S.C. 401(k)(2)(B)(i)(III). In contrast, the own-

20 16 er of an inherited 401(k) is subject to the payment limitations in the plan document, which typically require the beneficiary to withdraw the funds within a relatively limited number of years (e.g., 5 or 10 years). As a result, individuals who inherit such accounts typically transfer the funds in those accounts into an inherited IRA, so that they may at least take distributions over their life expectancy as explained above. 3 Thus, for any inherited retirement account, the Internal Revenue Code generally requires the beneficiary to commence distributions of portions of those accounts after the death of the IRA owner. This tax treatment is inconsistent with the characterization of these accounts as containing retirement funds. CONCLUSION For the foregoing reasons, the judgment of the Seventh Circuit should be affirmed. 3 Such transfers were not permitted, however, when 11 U.S.C. 522(b)(3)(C) was enacted in 2005; they became legal pursuant to a subsequent amendment of 26 U.S.C. 402(c)(11). See I.R.S. Notice , C.B. 395, V; Goldberg, at 25.

21 February 2014 CATHERINE L. STEEGE JENNER & BLOCK LLP 353 N. Clark Street Chicago, IL (202) Respectfully submitted, MATTHEW S. HELLMAN Counsel of Record ADAM G. UNIKOWSKY JENNER & BLOCK LLP 1099 New York Ave., N.W. Washington, DC (202) Counsel for Amicus