Daimon William Jacobs
Truth will always be truth, regardless of lack of understanding, disbelief or ignorance.1
We have now reached the fourth and (hopefully) ultimate chapter of what is beginning to feel like a Sisyphean saga; in other words, the Court is prepared to issue a final and appealable order in this protracted and enduring matter. After three rounds of summary judgment motions and orders, the Court held an evidentiary hearing on the merits of the issues remaining before it: whether an account holding debtor‘s retirement funds is property of his bankruptcy estate, and if so, whether it is exempt from collection and distribution by the bankruptcy trustee under state or federal law. Having reached a decision, the Court is ready to push the rock up the hill one final time. The following findings of
Jurisdiction
This Court has jurisdiction over this matter pursuant to
Background
Before we go any further, a review of the landscape and major characters is in order. On June 8, 2021 (the “Petition Date“), Daimon William Jacobs (“Debtor“) filed a voluntary petition for relief under chapter 7 of the bankruptcy code (the “Petition“). Patrick J. Malloy III (“Trustee“) was appointed to serve as the chapter 7 trustee in this case. Prior to the Petition Date, Debtor‘s wholly-owned LLC, Breakthrough Management LLC (“Breakthrough“), created a trust as part of an employer sponsored one-participant 401(k) deferred compensation profit-sharing retirement plan (the “Solo 401k“).3 Debtor ultimately placed the assets of the Solo 401k trust in a checking account at Solera Bank ending in #0319 (the “Disputed Account“).4 In Schedule C filed with the Petition, Debtor claimed the entire Disputed Account, with a balance of $198,306.44 as of June 6, 2021, as exempt under Oklahoma law.5 Trustee filed an objection, alleging that all funds in the Disputed Account were non-exempt property of the estate, and sought summary judgment on that basis.
This Court granted partial summary judgment in favor of Trustee, finding certain funds in the Disputed Account, referred to as the 401k Loan Proceeds and the Roth IRA Rollover funds, were property of Debtor‘s bankruptcy estate and not protected by any claimed state law exemption.6 On summary judgment, the Court was unable to resolve the issues of 1) whether the residue of funds in the Disputed Account (the “Remaining Funds“)7 were property of Debtor‘s estate; and 2) if so, whether they were exempt under Oklahoma law.
In Jacobs I, the Court first discussed whether the Solo 401k was excluded from property of the estate by operation of
The plot thickened when Debtor chose to amend his Schedule C to rely on federal, as opposed to state, law to exempt the Solo 401k from the estate, specifically
Undeterred, Trustee filed a third motion for summary judgment, this time limiting the scope of his request to Debtor‘s claim of exemption for the 401k Loan Proceeds and the Roth IRA Rollover funds under
In anticipation of the final hearing in this matter, Debtor, apparently secure in the belief that a moving target is harder to hit, filed another round of amendments to his Schedule C.15 It is unclear to the Court what Debtor seeks to accomplish with these amendments.16 The amendments appear to break the Disputed Account into several smaller pieces, bouncing between state and federal exemptions for most of the funds, including reliance on
Additional Findings of Fact
In addition to the findings of fact contained in Jacobs I, the following additional findings are made based on issues raised and evidence presented at the Hearing:
- Breakthrough Management LLC
- Trustee‘s expert
- Leave of absence
- Loan repayment
- Debtor‘s control of investments under the Solo 401k
- Debtor‘s post-petition treatment of Solo 401k trust account
- Debtor‘s work history
Debtor testified Breakthrough was in good standing with the State of Oklahoma in January 2021, when the Solo 401k plan was adopted.20
Trustee presented Steven Rutherford (“Rutherford“) as an expert on the issue of whether Debtor was eligible to establish the Solo 401k. Rutherford opined that he did not believe Debtor was eligible to form the Solo 401k because: 1) Debtor was not self-employed; 2) Debtor did not record typical business deductions for Breakthrough, resulting in the overpayment of tax during tax years 2020 and 2021; 3) Debtor‘s practice of operating on a cash basis, without the use of receipts, invoices, or an active business bank account, made it impossible to verify his business activity; and 4) Breakthrough appeared to operate without any license related to the practice of public accounting.
Rutherford was also asked to opine about Debtor‘s operation and use of the Solo 401k after its formation. In his opinion, 1) the same fiduciary responsibilities apply to all retirement plans under
Debtor provided evidence he submitted a request to “management” of Breakthrough on June 2, 2021, that he be allowed to take a one-year leave of absence from his employment (the “Leave Request“).24 Additional evidence indicated that the Leave Request was granted on June 3, 2021, allowing Debtor to take a leave of absence from June 4, 2021, until June 3, 2022.25 Trustee alleges the Leave Request was not executed or “papered up” until several months after the Petition Date. At the Hearing, Debtor insisted that the Leave Request was executed and granted just prior to the Petition Date. Trustee read Debtor‘s prior deposition testimony into the record, which made a vague inference that Debtor‘s Hearing testimony may lack veracity. As will be discussed below, the Court need not make a factual finding regarding the timing of the Leave Request due to its irrelevance to the issues at hand.
Debtor made no effort to repay the 401k Loan when it became due. He also acknowledged that the purpose of the Leave Request was to defer his repayment obligation on the 401k Loan, which first become due after the Petition Date, for a period of one year.
The Adoption Agreement for the Solo 401k includes a section regarding “Investment Control” that allows participants under the plan to control the investment of assets within their accounts for all balances and future contributions.26
Debtor testified that he has not made any additional contributions to the Solo 401k, as either employer or employee, since the Petition Date. Nor has he taken any action to invest funds held in the Disputed Account in an interest-bearing or other risk-bearing account.
Trustee introduced a spreadsheet generated by Debtor showing Debtor‘s client/contact list and business activity for the years 2020 and 2021. Debtor testified that the financial services he performed in 2020 were completed through the Breakthrough business entity, generating $7,650 in revenue, all of which was declared as profit by Debtor on his 2020 I.R.S. Form
To the extent that the “Conclusions of Law” contain items that should more appropriately be considered “Findings of Fact,” those findings are incorporated herein by this reference.
Conclusions of Law
Commencement of a case under the Bankruptcy Code creates an estate comprised of, among other things, “all legal or equitable interests of the debtor in property as of the commencement of the case,” “wherever located and by whomever held.”31 Debtor‘s interest in a profit-sharing retirement plan such as the Solo 401k certainly falls within this definition. But what the Code giveth, the Code can also taketh away. Section 541(c)(2) excludes from property of the estate a beneficial interest of a debtor in a trust containing a “restriction on the transfer” of that interest “that is enforceable under applicable nonbankruptcy law.”32 Oklahoma law provides the necessary restraint on alienation in sections 326-28 of title 60 of the Oklahoma Statutes. As discussed in Jacobs I, Oklahoma courts have applied those statutory provisions to require that a profit-sharing plan, as the relevant trust, in addition to containing the necessary restriction on transfer, must also qualify for tax exemption under federal law, in this case
Before we get to the main narrative, the Court feels it must emphasize an essential, but possibly overlooked, plot
I. The Solo 401k was qualified for tax exemption under I.R.C. § 401(a) on the Petition Date.
“In the context of employer retirement plans and arrangements, ‘qualified’ has a specific meaning. For a plan to ‘qualify’ under the provisions of the I.R.C., it must comply with the provisions of I.R.C. Section 401.”39 It is Debtor‘s burden to show the Solo 401k was qualified, as “[f]ailure to meet one of the section 401(a) requirements disqualifies the plan.”40 In general, to qualify for tax exemption under
A. The Solo 401k met the requirements under I.R.C. § 401(a) as to form on the Petition Date.
According to the I.R.S., “[t]here are two basic steps in setting up a qualified plan.”43 “First, you adopt a written plan. Then, you invest the plan assets.”44 “A form failure occurs when a plan document does not contain required language or terms.”45 Trustee does not dispute the written plan document adopted by Breakthrough satisfies the requirements of
a retirement plan that on the first day of the plan year—
covered only one individual (or the individual and the individual‘s spouse) and the individual (or the individual and the individual‘s spouse) owned 100 percent of the plan sponsor (whether or not incorporated)[.]49
The I.R.S. notes that “[t]he one-participant 401(k) plan isn‘t a new type of 401(k) plan. It‘s a traditional 401(k) plan covering a business owner with no employees . . . . These plans have the same rules and requirements as any other 401(k) plan.”50
A retirement plan qualified for tax benefits, i.e., a qualified plan, must be “established by an employer for the exclusive benefit of employees or their beneficiaries[.]”51 Such a plan “can include coverage for a self-employed individual.”52 Section
Trustee argues that Debtor‘s entire Solo 401k retirement plan should be “disregarded as a sham transaction.”57 Trustee asserts Debtor was not “self-employed” based on:
- A lack of records or other documentary evidence indicating Debtor‘s self-employment prior to January 2021;
- Breakthrough and Debtor‘s lack of revenue or income between January 2021 and the Petition Date;
- Debtor‘s statements in Schedule I of the Petition, indicating:
- he earned no income from self-employment in the 6 months prior to the Petition Date;
- he expected no such earnings in the future;
- he was unemployed on the Petition Date;
- he was not employed by Breakthrough on the Petition Date; and
- Evidence that Breakthrough approved the Leave Request dated just prior to the Petition Date.
The Court finds Trustee‘s concern regarding Debtor‘s self-employment status a tempest in a teapot. Looking to the statute, the Court finds the term “self-employed individual” applied squarely to Debtor when Breakthrough adopted the Solo 401k. Breakthrough is a single-member limited liability corporation organized under the laws of the state of Oklahoma in existence in January 2021 when the Solo 401k was adopted.58 Debtor was the sole owner of Breakthrough and treated it as a disregarded entity for tax purposes.59 Debtor is the only participant covered by the Solo 401k, and he performed all professional services for Breakthrough. Those services were its only material income-producing factor. Trustee agrees that all plan documentation supporting the Solo 401k was in order on the Petition Date, including the
Debtor testified that he was paid entirely in cash when he performed financial services on behalf of Breakthrough. He reported keeping a record of client payments on a spreadsheet, but not a single penny of Breakthrough revenue was deposited into any bank account. As a result, there are no independent bank or business records available to verify Debtor‘s self-reporting of Breakthrough‘s operational revenue. Debtor‘s records show all revenue generated in 2020 by Breakthrough occurred between September and December. Breakthrough likewise generated no revenue during the first 8 months of 2021. This is consistent with Debtor‘s statements on Schedule I to the Petition that he earned no income during the 6 months prior to the Petition Date. On Schedule I, Debtor indicated that he did not “expect an increase or decrease [of income] within the year after” the Petition Date, yet later reported earning $11,320 between September and December of 2021.62
Trustee has not articulated any cogent argument in support of his position that Debtor does not qualify as self-employed. Trustee‘s expert offered several objections to the way Debtor disclosed his income and employment status in his bankruptcy schedules and the way Debtor failed to deduct any expenses for Breakthrough in calculating his net earnings on his 2020 tax return. But none of these objections change the facts on the ground. In January 2021, Debtor fell within the definition of self-employment found in
Trustee alleges the Leave Request was fraudulently backdated, i.e., was not executed until a later date after payments on the 401k Loan were already due and owing. Trustee may be correct. Debtor testified that the Leave Request was executed and approved in early June 2021, immediately prior to the Petition Date, and was executed with the specific intention of deferring Debtor‘s repayment obligation on the 401k Loan. While the Court found Debtor‘s testimony regarding the Leave Request to be unconvincing and evasive,
B. The Solo 401k met the operating requirements under I.R.C. § 401(a) on the Petition Date.
Generally, “[a]n operational failure occurs when: (1) a plan, in operation, does not meet the section 401(a) requirements, . . . and (2) a plan fails to follow the terms of the plan document[.]”64 According to the I.R.S., a “qualification failure means any failure that adversely affects the qualification of a plan.”65 Among the things that will cause a plan disqualification are:
- the employer failed to timely amend the plan for a law change;
- the plan fails to satisfy the minimum coverage requirements;
- the contributions or benefits are determined to be discriminatory in favor of highly compensated employees or owners;
- the plan fails to satisfy the minimum vesting standards;
- the contribution or benefits for the benefit of one or more participants exceed the maximum permitted levels.66
Other violations can occur that, while requiring correction through excise taxes or income taxes, do not affect the qualification of the plan. These include:
- the employer failing to make the necessary contribution;
- the employer making contributions greater than the maximum allowed/deductible amount;
- the trust participating in a prohibited transaction;
- failure to report a taxable distribution from the plan on participant‘s Form 1040; and
- failure to report a loan that violated
I.R.C. § 72(p) .67
“Under [I.R.C.] section 401(a)(2) a trust is not qualified unless under the trust instrument it is impossible . . . for any part of the trust corpus or income to be used for, or diverted to, purposes other than for the exclusive benefit of such employees
Debtor acknowledged that neither he nor Breakthrough performed services or generated revenue between January 2021 and the Petition Date; nor did Breakthrough make any contributions on Debtor‘s behalf to the Solo 401k during that time. Debtor‘s history of operating Breakthrough only between the months of September and December puts both facts in context. Trustee has cited no authority that a seasonal business is unable to support a qualified retirement plan under
Trustee originally claimed the 401k Loan received by Debtor as a participant of the Solo 401k in the days before the Petition Date was a sham and prohibited transaction that would cause the entire account to lose its qualification under
Trustee has presented no authority that a business sponsoring a profit-sharing retirement plan under
II. Debtor‘s post-petition operation of the Solo 401k did not disqualify the account under I.R.C. § 401(a) .
Trustee takes the position that after the Petition Date, Debtor engaged in a series of prohibited transactions that caused the Solo 401k to be disqualified from coverage under
- Early distributions from Disputed Account
“Amounts paid to plan participants from a qualified plan are called distributions.”80
to pay a 10% additional tax on the distribution in addition to the usual income tax due.83 As one court has noted:
The IRS rules permit (and at times require) owners to take allowed distributions from an IRA, regardless of whether the funds will be used for a wise or ill-advised purpose. Whether used for a grocery bill or gambling spree, the IRS makes no inquiry as to the use of the funds and demands only that the owner remit any owed taxes on the distribution, now regarded as taxable income, to the IRS. The IRS rules limit how plan assets can be used and when they can be withdrawn but do not regulate the purpose for which the funds are used after they are withdrawn by the beneficiary and cease to be plan assets.84
Although the court in In re Moore was referring to distributions from an IRA account, the principle espoused there applies equally to distributions from a qualified employer-sponsored retirement plan under
Not every withdrawal of assets from a retirement plan is treated as a distribution. Certain transactions between a qualified retirement plan and a “disqualified person”87 are prohibited by law.88 A “prohibited
(D) transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan; or
(E) act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account[.]89
These types of prohibited transactions are often referred to as “self-dealing.”90 An exception applies, however, when a taxpayer receives benefits to which they are entitled as a participant of the retirement plan, including the ability to withdraw funds from their own account, subject to the terms that would apply to any other participant of a qualified plan, such as payment of taxes or penalties.91 This includes the ability of any participant to withdraw assets from a qualified retirement plan as an early distribution, subject to payment of the corresponding income and excise taxes that such an early distribution would incur.92 Once plan assets are
underlying trust account, they are no longer considered trust assets, and are no longer subject to
In 2009, The Department of Labor addressed the issue of whether a distribution from an IRA to a disqualified person would be considered a prohibited transaction under
With respect to your first question regarding whether the IRA distributions to the Trust constitute prohibited transactions, it is the opinion of the Department that, notwithstanding the Trust‘s status as a disqualified person under Code section 4975(e)(2), neither the trustee‘s decision to take a benefit distribution from the IRA in accordance with the terms of the IRA, nor the Trust‘s receipt of the benefit distribution as the IRA beneficiary, is a prohibited transaction under Code section 4975(c). Code section 4975(d)(9) provides that the prohibited transaction provisions in Code section 4975(c) shall not apply to the receipt by a disqualified person of any benefit to which he may be entitled as a participant or beneficiary in a plan provided that the benefit is computed and paid on a basis which is consistent with the terms of the plan as applied to all other participants and beneficiaries.
. . .
Thus, the Department believes these provisions should be read together as stating that ordinary benefit distributions are not prohibited transactions, to the extent that the benefit is computed and paid on a basis consistent with the terms of the plan, and applied to all other participants and beneficiaries. This position is consistent with the Supreme Court‘s decision in Lockheed Corp. v. Spink, 517 US 882 (1996), holding that although employees of the employer maintaining the plan are “parties in interest” under ERISA‘s prohibited transaction provisions, the payment of benefits due to plan participants pursuant to the terms of an otherwise lawful plan is not a “transaction” within the sense that Congress used that term in ERISA section 406 to define “prohibited transactions.” Furthermore, although a plan participant or IRA owner also may be a fiduciary of the plan or IRA, it does not necessarily follow that all decisions made by a participant or IRA owner with respect to the plan or IRA are fiduciary decisions. Rather, just as a plan participant‘s decision to elect to take a permissible benefit distribution from an employer-sponsored plan is not a fiduciary act by the participant, an IRA owner‘s decision to make an otherwise permissible benefit distribution to himself or herself in accordance with the terms of the IRA is not an act by the IRA owner as a fiduciary within the meaning of the prohibitions in Code sections 4975(c)(1)(D) and (E).94
After the Petition Date, Debtor orchestrated numerous withdrawals from the Disputed Account, either as cash, transfers to his personal bank account, or direct transfers to creditors (the “Unauthorized Withdrawals“).99 Debtor testified that each Unauthorized Withdrawal was used for personal living expenses; i.e., none of the withdrawn funds were invested in other assets or used to pay expenses of Breakthrough. As soon as the Court became aware of the Unauthorized Withdrawals, it ordered Debtor to cease such activity, due to the pending issue of whether the
Disputed Account was property of the estate, or subject to various exemption claims.100 In all, Debtor removed approximately $55,000 in Unauthorized Withdrawals from the Disputed Account.
At the Hearing, both Debtor and Trustee characterized the Unauthorized Withdrawals as if they were simply draws against the 401k Loan Proceeds. Debtor presented evidence that he kept a running tally of the Unauthorized Withdrawals, which he designated “Loan Receivable Balance.”101 Despite this misconception, the Court finds no relationship between the Unauthorized Withdrawals and the 401k Loan Proceeds.
On the Petition Date, the 401k Loan Proceeds and the Roth IRA Rollover funds became non-exempt property of Debtor‘s estate.102 The only funds in the Disputed Account that arguably remained property of the Debtor on the Petition Date were the Remaining Funds.103 Each Unauthorized
Trustee declares each Unauthorized Withdrawal from the Disputed Account to be a prohibited transaction and evidence of self-dealing under
ii. Failure to repay the 401k Loan and the effect of the Leave Request
As noted in Jacobs I, Debtor executed the 401k Loan in the days immediately preceding the Petition Date.106 The 401k Loan complied with the relevant I.R.S. requirements and the Solo 401k plan documents, such that it was not deemed an immediate distribution to Debtor.107 Upon failure to repay such a loan according to its terms, “a deemed distribution occurs as a result of the failure to make such payments.”108 I.R.S. regulations govern the timing and amount of such deemed distribution.109 If, as alleged by Debtor, a participant
Under its original terms, the first quarterly installment payment of the 401k Loan became due on September 1, 2021.112 In documents dated June 2 & 3, 2021, Debtor purportedly requested and approved the Leave Request, allowing for a leave of absence from his employment with Breakthrough from June 4, 2021 to June 3, 2022.113 Trustee alleges the Leave Request was backdated in an improper effort to rehabilitate the 401k Loan after it had initially become due under its terms. Trustee also points out that Debtor engaged in the same type of work for Breakthrough customers when he was supposedly on leave from Breakthrough, casting additional doubt on the bona fides of the Leave Request. Fortunately, the Court need not sort out this factual rat‘s nest; when or whether Debtor took a “bona fide leave of absence” from his employment with Breakthrough has no bearing on the issues before this Court.
Debtor acknowledges he made no payments toward the 401k Loan prior to September 1, 2021, but testified that he has made some sporadic payments since that time. Whether and when repayments on the 401k Loan were required to begin will affect whether and when an actual distribution of those funds to Debtor has been deemed to occur. That will, in turn, affect whether and when Debtor will incur tax consequences related to the 401k Loan.114
iii. Debtor‘s post-petition treatment of the Disputed Account
In a belt-and-suspenders effort to protect the assets in the Solo 401k, despite taking the position that the Disputed Account never became property of his bankruptcy estate, Debtor claimed it as exempt under various state and federal statutes.115 Such claims of exemption made the funds in the account at least arguably property of the estate, subject to the stay provisions of
Debtor readily admits he has taken no action since the Petition Date to cause either himself, as participant, or Breakthrough, as employer, to make additional contributions to the Solo 401k or to invest the funds in the Disputed Account in a more lucrative investment vehicle. Trustee suggests Debtor‘s failure to make additional contributions to the Solo 401k is evidence that its initial creation was a sham and that Debtor never intended to make regular contributions toward his retirement. Trustee also believes Debtor‘s failure to move the funds from the non-interest-bearing checking account at Solera Bank into a risk-bearing investment is further evidence of this conspiratorial sham. But if Debtor had taken either of those actions, Trustee would likely be here complaining that Debtor was trying to obtain possession of or exercise control over the Disputed Account in violation of
The Court acknowledges Debtor‘s treatment of the Solo 401k after the Petition Date raises red flags suggesting Debtor may not intend to treat the Solo 401k as a permanent retirement vehicle going forward.119 But the Court cannot take that activity into consideration when making the
present determination, which must be restricted to “the law and facts as they exist on the date of filing the petition.”120 As we saw in Jacobs I, a debtor cannot take action after the filing of a bankruptcy petition that will alter the exempt status of estate property.121 The Court finds the corollary is also true: post-petition actions taken by a debtor will not permit a trustee to claw property into the estate that was solidly outside the bankruptcy estate on the petition date. As the United States Supreme Court noted a century ago:
[T]he point of time which is to separate the old situation from the new in the bankrupt‘s affairs is the date when the petition is filed. This has been recognized in our decisions. Thus we have said that the law discloses a purpose ‘to fix the line of cleavage’ with special regard to the conditions existing when the petition is filed, and that it is then that the bankruptcy proceeding is initiated, that the hands of the bankrupt and of his creditors are stayed and that his estate passes actually or potentially into
the control of the bankruptcy court[.]122
Were the Court to review Debtor‘s operation of the Solo 401k as of the date of the Hearing, it may have come to a different conclusion. Despite raising a multitude of objections, Trustee has not offered any compelling reason why the Court should consider Debtor‘s post-petition actions in making its determination that the Solo 401k was a qualified retirement plan under
III. The Remaining Funds are not property of Debtor‘s estate.
On the Petition Date, all of Debtor‘s property became property of his bankruptcy estate, except those items specifically listed in
There are two primary requirements contained in these statutes. First, that the [retirement plan] be tax exempt under the current Federal Tax Laws. 60 O.S.1981 § 326. Second, the [retirement plan] must contain provisions indicating the parties’ intent that the [retirement plan] be inalienable and protected. 60 O.S.1981 § 328. Section 327 merely creates the option of declaring an [retirement plan] as exempt.128
Section 401(a) of the Internal Revenue Code provides the requirements that a trust forming part of a retirement plan, such as profit-sharing plan, must meet for the trust to be a qualified trust entitled to preferential tax treatment under section
IV. The Court finds no cause to change its prior ruling regarding the Roth IRA Rollover funds.
In Jacobs I, the Court found the Roth IRA Rollover funds were not excluded by
7. With respect to the transfer of $42,033.93 from the Roth IRA on January 21, 2021 to the subject 401k, the Debtor acknowledges that, pursuant to IRS regulations, the transfer was a “prohibited transaction” and that it was not “supposed to occur.” He additionally stated that as of the date of his 2004 exam on 4/08/2022, he had not undone the transfer. As of the date of the commencement of these proceedings, the referenced Roth monies were on deposit in the subject 401k account.135
To which Debtor responded:
[Debtor] admits numbered paragraph 7 of the Trustee‘s [First] Motion but specifically asserts that the referenced “transfer” was not a prohibited transaction but rather an invalid rollover. [Debtor] additionally stated that “he had not undone the transfer,” and that he had not been allowed to correct the transfer and is seeking guidance though the Department of Labor. The Trustee used the term “prohibited transaction” in his questioning of [Debtor] and [Debtor]
mistakenly responded affirmatively to the Trustee‘s question.136
Further, Debtor stated:
Based on the expertise and advice of E-Trade, [Debtor] honestly and mistakenly believed that he had transferred the Disputed Funds into an eligible retirement plan. It only upon the Trustee‘s action in the above-styled matter that [Debtor] learned of the invalid rollover. Finally, though [Debtor] has not rolled the Disputed Funds back into the E-Trade Roth IRA, [Debtor] intends to do so as soon as practically possible. [Debtor] is currently enjoined from correcting the invalid rollover by the terms of
11 U.S.C. § 362(a) . Upon the Court‘s permission or the expiration of the11 U.S.C. § 362(a) in this case, [Debtor] will return the Disputed funds to the E-Trade Roth IRA and self-certify the rollover under Rev. Proc. 2016-47. [Debtor]‘s return of the funds to the E-Trade Roth IRA and self-certification will permit [Debtor] to report the contribution as a valid rollover unless later informed otherwise by the IRS.137
Based on Debtor‘s admission that the Roth IRA Rollover was an invalid rollover that he had not taken steps to reverse it as of the Petition Date, the Court determined:
Debtor acknowledges that the Roth IRA Rollover on January 19, 2021, of $42,033.93 from the E*Trade Roth IRA into the Disputed Account was considered an “invalid rollover” by the IRS. Because the Solo 401k was not eligible to receive the Roth IRA funds, the transfer was considered a taxable distribution to Debtor as of March 20, 2021, which was 60 days from the original transfer. As of the Petition Date, the Roth IRA Rollover funds had lost their protected status under
I.R.C. § 408A ; they were the equivalent of cash sitting in the Disputed Account, subject to the unfettered control and discretion of Debtor. Such funds come into the estate under§ 541(a)(1) .138
Since the entry of Jacobs I, Debtor has filed a series of amendments to his exemption claims on Schedule C.139 In his most recent volleys, Debtor renews his claims of exemption for the Roth IRA Rollover funds under state and federal law, both of which the Court previously rejected.140 While Debtor‘s exposition is not entirely clear, he appears to ask the Court to reconsider its conclusion based on an entirely new version of the facts:
- After the invalid rollover of the Roth IRA Rollover funds from E*Trade into Solera Bank account #5691 and before the Petition Date, Debtor transferred at least $162,000 from account #5691 to his former spouse.
- The Roth IRA Rollover funds were part of the transfer to his former spouse, meaning the funds were not in the Disputed Account on the Petition Date.
- An I.R.S. Form 1099-R has been issued verifying the distribution of the Roth IRA Rollover funds to Debtor.141
V. Debtor may not rely on federal exemptions under § 522(d).
Debtor has filed an amendment to Schedule C declaring an exemption for “Post-Petition use of Solora [sic] 401k loan” in the amount of $48,500 under
Trustee suggests that the Solo 401k account was created by Debtor to perpetrate some kind of fraud on the I.R.S.—and possibly his creditors—to gain access to funds in the Disputed Account without paying the appropriate taxes and penalties. Trustee has yet to present evidence that Debtor gained a single advantage from moving his retirement funds from the (unquestionably excluded or exempt) E*Trade accounts into the Solo 401k trust account at Solera Bank. Both the Roth IRA Rollover funds and the 401k Loan Proceeds became property of the bankruptcy estate due to, in effect, unforced procedural errors committed by the Debtor. Because the Solo 401k met the requirements of
Trustee alleges Debtor has engaged in bad-faith conduct with regard to his post-petition tax obligations, his remedy does not lie with this Court.148
The moral of this story is found in the deeply ingrained policy behind
This result at first may seem counterintuitive in the bankruptcy context, because funds to which a debtor may have some limited access are now excluded from the estate. Under traditional common law trust principles and bankruptcy law, this would not be the case. However, the fact that these funds are excluded from the estate reflects a reconciliation between the congressional intent to protect retirement funds, the congressional desire for consistency in the treatment of assets both within and outside the bankruptcy context, and the broad concept of property of the estate. See, e.g., Patterson, 504 U.S. at 764, 112 S.Ct.
at 2249 (“our decision today ensures that the treatment of pension benefits will not vary based on the beneficiary‘s bankruptcy status.“); Butner v. United States, 440 U.S. 48, 55, 99 S.Ct. 914, 918, 59 L.Ed.2d 136 (1979) (“Uniform treatment of property interests prevent[s] a party from receiving ‘a windfall merely by reason of the happenstance of bankruptcy.’ [citation omitted]“); Anderson v. Raine (In re Moore), 907 F.2d 1476, 1480 (4th Cir.1990) (“We see no evidence that Congress intended to invite a creditor to push a debtor into involuntary bankruptcy in order to reach his ERISA funds.“); see also Guidry v. Sheet Metal Workers Nat. Pension Fund, 493 U.S. 365, 376, 110 S.Ct. 680, 687, 107 L.Ed.2d 782 (1990) (holding that ERISA represents
the congressional choice to “safeguard a stream of income for pensioners . . . even if that decision prevents others from securing relief for the wrongs done them.“).150
This case is yet another example where congressional policy to protect and encourage retirement savings outweighs its interest in maximizing the value of a debtor‘s estate for distribution to creditors.151 The outcome is neither remarkable nor surprising.
Conclusion
Trustee‘s Objection is sustained in part and overruled in part. Trustee‘s Objection to exemption of the Roth IRA Rollover funds and the 401k Loan Proceeds is sustained. As previously found in Jacobs I and Jacobs III, both the Roth IRA Rollover funds, consisting of $42,033.93, and the 401k Loan Proceeds, consisting of $48,500, held in the Disputed Account, are property of Debtor‘s estate. Those funds are not subject to exemption under
A separate order consistent with this Memorandum Opinion is entered concurrently herewith.
Dated this 29th day of August, 2024.
BY THE COURT:
TERRENCE L. MICHAEL, CHIEF JUDGE
UNITED STATES BANKRUPTCY COURT
7950.8
Notes
Taxability of beneficiary of exempt trust.--Except as otherwise provided in this section, any amount actually distributed to any distributee by any employees’ trust described in section 401(a) which is exempt from tax under section 501(a) shall be taxable to the distributee, in the taxable year of the distributee in which distributed, under section 72 (relating to annuities).
See alsoFor purposes of [
(A) a fiduciary;
. . .
(C) an employer any of whose employees are covered by the plan; [or]
. . .
(E) an owner, direct or indirect, of 50 percent or more of--(i) the combined voting power of all classes of stock entitled to vote or the total value of shares of all classes of stock of a corporation, . . .which is an employer or an employee organization described in subparagraph (C)[.]
Fiduciary.--For purposes of this section, the term “fiduciary” means any person who--
(A) exercises any discretionary authority or discretionary control respecting management of such plan or exercises any authority or control respecting management or disposition of its assets, [or]
. . .
(C) has any discretionary authority or discretionary responsibility in the administration of such plan.
Exemptions.--Except as provided in subsection (f)(6), the prohibitions provided in subsection (c) shall not apply to--(9) receipt by a disqualified person of any benefit to which he may be entitled as a participant or beneficiary in the plan, so long as the benefit is computed and paid on a basis which is consistent with the terms of the plan as applied to all other participants and beneficiaries[.]
See also Advisory Opinion, supra note 89, at *3 n.2 (“Disqualified persons under the Code most likely to receive benefit distributions as participants, and thus be affected by Code section 4975(d)(9), would be participants or beneficiaries who are also plan fiduciaries, officers, directors or 10 percent or more shareholders of the employer who are employees covered by the plan; or owner-employees who own 50 percent or more of the employer.” (emphasis added)); I.R.S., Retirement Plan Investments FAQs, https://www.irs.gov/retirement-plans/retirement-plan-investments-faqs (last updated Apr. 25, 2024) (“Certain transactions are exempt from being treated as prohibited transactions. For example, a prohibited transaction does not take place if a disqualified person receives a benefit to which he or she is entitled as a plan participant or beneficiary. However, the benefit must be figured and paid under the same terms as for all other participants and beneficiaries.” (emphasis added)); Indep. Bank v. Baarstad, 2018 Ill. App. 2d 170496, at *6.Q-10: If a participant fails to make the installment payments required under the terms of a loan that satisfied the requirements of Q&A-3 of this section when made, when does a deemed distribution occur and what is the amount of the deemed distribution?
A-10: (a) Timing of deemed distribution. Failure to make any installment payment when due in accordance with the terms of the loan violates section 72(p)(2)(C) and, accordingly, results in a deemed distribution at the time of such failure. However, the plan administrator may allow a cure period and section 72(p)(2)(C) will not be considered to have been violated if the installment payment is made not later than the end of the cure period, which period cannot continue beyond the last day of the calendar quarter following the calendar quarter in which the required installment payment was due.
(b) Amount of deemed distribution. If a loan satisfies Q&A-3 of this section when made, but there is a failure to pay the installment payments required under the terms of the loan (taking into account any cure period allowed under paragraph (a) of this Q&A-10), then the amount of the deemed distribution equals the entire outstanding balance of the loan (including accrued interest) at the time of such failure.
The term “plan” implies a permanent as distinguished from a temporary program. Thus, although the employer may reserve the right to change or terminate the plan, and to discontinue contributions thereunder, the abandonment of the plan for any reason other than business necessity within a few years after it has taken effect will be evidence that the plan from its inception was not a bona fide program for the exclusive benefit of employees in general. Especially will this be true if, for example, a pension plan is abandoned soon after pensions have been fully funded for persons in favor of whom discrimination is prohibited under section 401(a). The permanency of the plan will be indicated by all of the surrounding facts and circumstances, including the likelihood of the employer‘s ability to continue contributions as provided under the plan. In the case of a profit-sharing plan, other than a profit-sharing plan which covers employees and owner-employees (see section 401(d)(2)(B)), it is not necessary that the employer contribute every year or that he contribute the same amount or contribute in accordance with the same ratio every year. However, merely making a single or occasional contribution out of profits for employees does not establish a plan of profit-sharing. To be a profit-sharing plan, there must be recurring and substantial contributions out of profits for the employees. In the event a plan is abandoned, the employer should promptly notify the district director, stating the circumstances which led to the discontinuance of the plan.