Bankruptcy Protection - Sole Proprietor

[ConnieStorer]

Facts:

Single member LLC with no employees other than the single member.

Properly formed pension plan, and properly formed 401k/profit sharing plan.

IRS opinion letters issued with respect to both.

Plan contributions made timely and in allowable amounts.

The Single member LLC has filed for bankruptcy

 

Issue:

The trustee in the bankruptcy case has said that (i) under the US Supreme Court decision of Raymond B. Yates, MD, PC Profit Sharing Plan v. Hendon, a single member LLC having no employees other than the member cannot have a plan that is ERISA qualified, and (ii) if the plan is not ERISA qualified, then the plan cannot be tax-exempt under IRC sections 401 and 501 (and as a result cannot be claimed as exempt in bankruptcy).

 

Question:

I agree that a qualified plan that does not cover any employees (just the owner) is not subject to ERISA.  However I think the logic is flawed that if they are not covered by ERISA then they cannot be tax-exempt under IRC 401.

   

Does anyone have an opinion on this? 

[ErnieG]

They are covered by ERISA, however not by Title I of ERISA.  Title I deals primarily with the rights of participants under a plan and includes requirements for: reporting and disclosure, fiduciary responsibility, vesting, minimum standards for participation, and minimum funding standards. [Reg. 2510.3-3(b)]

 

[Luke Bailey]

22 hours ago, ErnieG said:

They are covered by ERISA, however not by Title I of ERISA.  Title I deals primarily with the rights of participants under a plan and includes requirements for: reporting and disclosure, fiduciary responsibility, vesting, minimum standards for participation, and minimum funding standards. [Reg. 2510.3-3(b)]

 

ErnieG, if the plan only covers the owner, it is not a "plan" for purposes of ERISA, therefore not covered at all. See 29 CFR 2510.3-3(b).

On ‎8‎/‎13‎/‎2019 at 8:50 AM, ConnieStorer said:

Question:

I agree that a qualified plan that does not cover any employees (just the owner) is not subject to ERISA.  However I think the logic is flawed that if they are not covered by ERISA then they cannot be tax-exempt under IRC 401.

ConnieStorer, sure it can be qualified under 401(a), but whether it is depends on the plan document and its operation through time. Note that under Section 547(b) of the Bankruptcy Act after the BRA of 2005, protection from creditors is based on IRC qualification, not ERISA coverage.

[Peter Gulia]

Is the debtor opposing the bankruptcy trustee's position?

 

[RatherBeGolfing]

16 minutes ago, Luke Bailey said:

Note that under Section 547(b) of the Bankruptcy Act after the BRA of 2005, protection from creditors is based on IRC qualification, not ERISA coverage.

Which is why the "not covered by ERISA, therefore not qualified" was an amusingly lazy argument (for those of us who don't have to deal with this particular case...)

[ConnieStorer]

Thanks all for the response.  The Plan has always operated in accordance with standard regulations.  Current Plan Documents, Annual Valuation Reports for the Defined Benefit Plan, Contributions made in accordance with deduction limits and annual Form 5500-EZ filings.

The debtor wants to exclude the assets in his defined benefit and 401k Plan.  The bankruptcy trustee seems to think these should be included since this Plan is not covered by ERISA.

[Mike Preston]

The bankruptcy trustee is correct. 

[RatherBeGolfing]

33 minutes ago, Mike Preston said:

The bankruptcy trustee is correct. 

Which trustee argument is correct?

That  the plans are not covered by ERISA?  That the plans are not qualified because they are not covered by ERISA?  That assets in a one participant plan are fair game in a bankruptcy simply because it not covered by ERISA?

Im not expert when it comes to bankruptcy but my understanding was as long as the plan was otherwise qualified, the assets were still protected.

[Peter Gulia]

If the debtor doubts the bankruptcy trustee's position, it's time (or, more likely, past time) for the debtor to lawyer-up.

 

[Mike Preston]

5 hours ago, RatherBeGolfing said:

 That assets in a one participant plan are fair game in a bankruptcy simply because it not covered by ERISA?

That one. 

[Belgarath]

As far as my limited understanding goes, I agree with Mike that it is not excluded from the bankruptcy estate. But then there is an exemption under Section 522 of the Bankruptcy code. I defer to the attorney/actuary experts as to the practical difference, but I believe it has to do with the fact that under an exclusion, the bankruptcy Trustee has no jurisdiction. Under an exemption, I'm not sure what, if any, authority the bankruptcy Trustee might have, and if any authority, under what circumstances. Way out of my sphere...

[RatherBeGolfing]

11 hours ago, Mike Preston said:

That one. 

Would you mind expanding on that?

I agree the assets are not excludable under ERISA since it is not an employee benefit plan under ERISA.  But are there not still protections as long as the plan is qualified,  both federal (at least I thought so) and state.  Most states have language to offer protection as long as the plan is qualified. 

The argument here is that the plan is not covered by ERISA, and because it is not covered by ERISA it cannot be qualified, therefore the assets have to be included in the bankruptcy.

[Luke Bailey]

On ‎8‎/‎14‎/‎2019 at 2:09 PM, Luke Bailey said:

ErnieG, if the plan only covers the owner, it is not a "plan" for purposes of ERISA, therefore not covered at all. See 29 CFR 2510.3-3(b).

ConnieStorer, sure it can be qualified under 401(a), but whether it is depends on the plan document and its operation through time. Note that under Section 547(b) of the Bankruptcy Act after the BRA of 2005, protection from creditors is based on IRC qualification, not ERISA coverage.

547(b) in my earlier post was the wrong reference. Apologies.

If the plan interest is not covered by ERISA, it may be in the debtor's bankruptcy estate, as Mike Preston states. Section 541 of the Bankruptcy Code, which provides for what is included in the estate. Actually, even if the plan is covered by ERISA, I don't see an exemption in 541 for a debtor's interest in a plan, only for an contributions made to the plan.

But the 2005 Bankruptcy Reform Act modified prior law and provides an exemption (so, not excluded from the state, but exempt from the debtor's creditors if the debtor is using the federal, not state, exemption list) as set forth below. The gist of it is that the bankruptcy exemption for retirement assets after 2005 is very strong and is keyed to tax qualification under 401(a), 403, 408, etc., not ERISA coverage. I believe most states now have similar exemptions:

-----------------------------------------------

Section 522

....

(b)

(1) Notwithstanding section 541 of this title, an individual debtor may exempt from property of the estate the property listed in either paragraph (2) or, in the alternative, paragraph (3) of this subsection....

(2) Property listed in this paragraph is property that is specified under subsection (d), unless the State law that is applicable to the debtor under paragraph (3)(A) specifically does not so authorize.

(3) Property listed in this paragraph is—

....

(C) 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 1986.

 

(4) For purposes of paragraph (3)(C) and subsection (d)(12), the following shall apply:

(A) If the retirement funds are in a retirement fund that has received a favorable determination under section 7805 of the Internal Revenue Code of 1986, and that determination is in effect as of the date of the filing of the petition in a case under this title, those funds shall be presumed to be exempt from the estate.

(B) If the retirement funds are in a retirement fund that has not received a favorable determination under such section 7805, those funds are exempt from the estate if the debtor demonstrates that—

(i) no prior determination to the contrary has been made by a court or the Internal Revenue Service; and

(ii)(I) the retirement fund is in substantial compliance with the applicable requirements of the Internal Revenue Code of 1986; or

(II) the retirement fund fails to be in substantial compliance with the applicable requirements of the Internal Revenue Code of 1986 and the debtor is not materially responsible for that failure.

(C) A direct transfer of retirement funds from 1 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 1986, under section 401(a)(31) of the Internal Revenue Code of 1986, or otherwise, shall not cease to qualify for exemption under paragraph (3)(C) or subsection (d)(12) by reason of such direct transfer.

(D)(i) Any distribution that qualifies as an eligible rollover distribution within the meaning of section 402(c) of the Internal Revenue Code of 1986 or that is described in clause (ii) shall not cease to qualify for exemption under paragraph (3)(C) or subsection (d)(12) by reason of such distribution.

(ii) A distribution described in this clause is an amount that—

(I) has been distributed from 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 1986; and

(II) to the extent allowed by law, is deposited in such a fund or account not later than 60 days after the distribution of such amount.

....

(d) The following property may be exempted under subsection (b)(2) of this section:

....

(12) 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 1986.