Uncashed Check from Debtor's 401k Isn't Excludible from Bankruptcy Estate

(Parker Tax Publishing June 2020)

The Bankruptcy Appellate Panel of the First Circuit reversed a bankruptcy court and held that proceeds of a loan from a debtor's retirement account, represented by an unnegotiated check, were not excludible from the debtor's bankruptcy estate. The court concluded that, because the debtor had not rolled over the funds within 60 days of receiving the check, the funds were not exempt property and thus were includible in the estate. Ostrander v. Brown, 2020 PTC 154 (B.A.P. 1st Cir. 2020).

Background

Angilene Brown filed for chapter 7 bankruptcy and David Ostrander was appointed as the bankruptcy trustee (Trustee). On her Schedule A/B, Brown disclosed that she held $50,600 in a Costco 401(k) retirement plan (the "401(k) plan"). On Schedule C, Brown elected the federal exemptions provided in 11 U.S.C. Section 522(d) and listed the 401(k) plan. She further indicated the value of her interest in the plan was $50,600 and claimed as exempt under 11 U.S.C. Section 522(d)(12) 100 percent of the 401(k) plan's fair market value. Brown appeared at the first meeting of creditors on September 25, 2018, and, based on payment advices Brown provided to the Trustee before the meeting, the Trustee questioned her about certain loan repayments to the 401(k) plan. Brown testified that she borrowed $18,000 from the 401(k) plan in July 2018 and admitted that the deductions on her payment advices were to repay that loan. After further questioning, Brown stated that she still possessed the $18,000 check representing the loan proceeds received from the administrator of the 401(k) plan. However, Brown did not list the check in her schedules because, she claimed, it was part of her claimed exemption for the entire amount held in her 401(k) plan.

After learning about the check, the Trustee asked Brown to deliver it to her attorney. Although her attorney confirmed that he had received the check from Brown, he never turned it over to the Trustee. The Trustee subsequently filed a motion with the bankruptcy court to compel Brown to turn over the $18,000 uncashed check to the bankruptcy estate. In support of his motion, he asserted that the sum represented by the check was non-exempt property of the bankruptcy estate. Brown objected to the motion, asserting that the uncashed check was still part of the 401(k) plan and, therefore, exempt.

Trustee's Argument

In his memorandum of law filed in support of the check being turned over, the Trustee argued that the check, and the funds represented thereby, were property of the estate and the fact that Brown had not cashed the check as of the petition date was immaterial. According to the Trustee, the analogy would be as if Brown issued a personal check from her bank account to herself for $18,000 and then argued that the check was not property of the estate because it had not yet been "cashed." Another analogy, the Trustee said, would be if Brown held a winning lottery ticket for a certain sum of money as of the petition date that had not yet been cashed or redeemed. The money represented by that lottery ticket would clearly be property of the estate.

The Trustee cited to Marchand v. Whittick (In re Whittick), 2016 PTC 528 (Bankr. D.N.J. 2016), in which a New Jersey bankruptcy court held that a loan check issued to and received by the debtor from his retirement account one day before his bankruptcy filing was property of the bankruptcy estate even though the check was not cashed until after the bankruptcy filing. Relying on Whittick, the Trustee maintained that the loan proceeds could not be excluded from the bankruptcy estate under 11 U.S.C. Section 541(c)(2) because they had been distributed to Brown and were "within her possession and control" when her bankruptcy case was filed. In addition, the Trustee complained that Brown had not amended her schedules to disclose or exempt the $18,000 represented by the check.

The bankruptcy court rejected the Trustee's motion to turn over the check and adopted Brown's reasoning that the check represented exempt property from her retirement account. In declining to follow the Whittick decision, the bankruptcy court judge stated "I just completely disagree with the judge from New Jersey. . . . I'm surprised that that's the outcome that that judge came to because I just consider the funds as still being in that 401(k) account at the time the bankruptcy case was filed and, therefore, they're exempt funds." The trustee appealed.

Bankruptcy Appellate Panel's Decision

The Bankruptcy Appellate Panel of the First Circuit reversed the bankruptcy court and held that the uncashed check from Brown's 401(k) was property of the bankruptcy estate. While there is no controlling authority in the First Circuit, the court noted that several well-reasoned decisions had held that distributed funds do not retain their exempt character if not placed in another account that is exempt from tax under Code Secs. 401, 403, 408, 408A, 414, 457, or 501(a). The court cited, as an example, the decision in In re Sullivan, 2019 PTC 498 (Bankr. N.D. Tex. 2019), where a Texas bankruptcy court concluded that the distribution of funds from a retirement account caused those funds to lose their exempt status.

The Bankruptcy Appellate Panel said there was no contest that the check, which was in the possession, custody or control of a noncustodial third party, was of the type that the Trustee could use, sell, or lease pursuant to 11 U.S.C Section 363, and had value or benefit to the estate. The question that remained, the court said, was whether the $18,000 check constituted property of the estate. The court noted that Brown never negotiated the $18,000 check; nor did she deposit it in a tax-exempt fund within the 60-day rollover period specified in Code Sec. 408(d)(3)(A). Thus, the court concluded, the $18,000 disbursement from Brown's 401(k) lost its exempt status and was therefore property of the bankruptcy estate.

For a discussion of the treatment of retirement accounts in bankruptcy, see Parker Tax ¶134,580.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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