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U.S. high court to chart fate of inherited IRAs in bankruptcy

By Nick Brown

(Reuters) - The U.S. Supreme Court will hear a dispute in the bankruptcy of a small-town pizza shop owner, taking on a case that could dictate how inherited individual retirement accounts are treated in bankruptcy.

The nation's highest court on Tuesday said it would hear arguments in Clark v. Rameker in a fight over whether Heidi Heffron-Clark and her husband, Brandon Clark, can keep creditors from going after $300,000 in an IRA inherited from Heffron-Clark's late mother.

The hearing should clear up a split among lower courts that have issued divergent rulings on the issue, and could impact retirement and end-of-life planning.

The Clarks declared bankruptcy in 2010 after the pizza shop they opened in their home town of Soughton, Wisconsin, fell victim to economic hardship, the couple's lawyer, Michael Murphy, told Reuters on Tuesday.

"Like a lot of smaller entrepreneurs, over four or five years they weren't able to make a go of it, and the bankruptcy was driven by that closure," said Murphy, of law firm DeWitt Ross & Stevens.

The Clarks owed about $700,000 to their landlord, mortgage lenders, trade creditors and others, Murphy said. That means the roughly $300,000 in the IRA could make a big difference in overall creditor recoveries.

William Rameker, the trustee in charge of administering the couple's bankruptcy estate, took the position that the IRA was fair game for creditors, but the Clarks argued it was exempt under bankruptcy laws, which generally protect retirement funds.

After an initial victory for Rameker was reversed by a district court, the matter went before a three-judge panel in the 7th Circuit U.S. Court of Appeals. In an April opinion written by Chief Judge Frank Easterbrook, who is an economic scholar, the panel sided with Rameker, saying creditors could access the inherited IRA.

Easterbrook held that while bankruptcy laws exempt retirement funds from creditor claims, IRAs cease to be "retirement funds" when inherited from a deceased owner.

Under existing law, distributions under an inherited IRA must begin within a year of the prior owner's death and finish within five years.

Easterbrook wrote that inherited IRAs are "not a place to hold wealth for use after the new owner's retirement," and "are not savings reserved for use after their owners stop working."

The ruling clashes with decisions in both the 5th and 8th Circuits, where judges have held that IRAs do not cease to be retirement funds when they change hands.

In a 2010 ruling in the bankruptcy of Nancy Nessa, an 8th Circuit appeals panel found that bankruptcy laws specify exemptions for "retirement funds" but do not require those funds to belong to the debtor.

Two years later, a 5th Circuit appeals panel presiding over a similar dispute in the bankruptcy of Robert Gregg Chilton ruled that any asset that was at any time "set apart" for retirement is exempt.

While the dispute over inherited IRAs has not arisen often, it may crop up more in the future, said Stephen Morgan, a lawyer for Rameker.

"I've got to believe that with the baby boomers passing on and leaving their IRAs for inheritances," the issue is one that "investment advisers will be discussing with their clients," Morgan said.

Denis Bartell, a fellow DeWitt lawyer who works with Murphy in representing the Clarks, said a ruling for Rameker could lead to more people leaving their IRAs to a trust, rather than directly to offspring.

The Clarks will be represented at the Supreme Court by lawyers from Williams & Connolly, while Rameker will be represented by attorneys at WilmerHale.

Initial court briefs are due on January 10, and the sides anticipate arguments sometime in March, Bartell said.

The case is Clark et ux. V. Rameker et al., U.S. Supreme Court, No. 13-299.

(Reporting by Nick Brown; Editing by Leslie Adler)

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