United States Court of Appeals,
Fifth Circuit.
No. 93-1403.
In the Matter of William YOUNGBLOOD, Jr., dba Azle Oaks Joint
Venture, dba Boty '79 Co., et al., Debtors,
William Lee YOUNGBLOOD, Jr., a/k/a and d/b/a Boty '79 Co. and
Azle Oaks Joint Venture, and Nellma Jane Youngblood, a/k/a and
d/b/a CSK & W.L. Youngblood and English Creek Estates, Appellants,
v.
FEDERAL DEPOSIT INSURANCE CORPORATION, Appellee.
Aug. 23, 1994.
Appeals from the United States District Court for the Northern
District of Texas.
Before GOLDBERG, DAVIS and DeMOSS, Circuit Judges.
W. EUGENE DAVIS, Circuit Judge:
Mr. and Mrs. Youngblood, the Chapter VII debtors in this case,
claimed an individual retirement account ("IRA") as exempt property
under § 42.0021 of the Texas Property Code. The bankruptcy court
and the district court concluded that the IRA was not exempt
because it accepted a rollover contribution from a pension plan
which the bankruptcy court determined was not "qualified" under the
Internal Revenue Code. We conclude that the courts below erred in
not deferring to the determination of the Internal Revenue Service
("IRS") regarding the qualification of the pension plan. We
therefore reverse and remand for further proceedings.
I.
William Lee Youngblood Jr. was the sole shareholder and
president of Youngblood Builders, Inc. ("YBI"), a Texas corporation
1
engaged in constructing homes for resale. In 1977, YBI created a
defined-benefit pension trust for the benefit of its employees.
In December 1978, the IRS issued a favorable determination
letter, ruling that the YBI Plan was "qualified" under § 401(a) of
the Internal Revenue Code. In June 1987, the IRS issued another
favorable determination letter based on proposed amendments to the
YBI Plan. In December 1987, the plan was terminated and its assets
distributed. As a beneficiary of the plan, Mr. Youngblood arranged
to have his distribution "rolled over" into an IRA.
Near the time of its termination, the YBI Plan was audited by
the IRS, which assessed sanctions in the form of excise taxes based
on two loans made by the plan to employees for amounts greater than
their vested interests. Although the IRS questioned other
transactions, it assessed no additional penalties or taxes and did
not revoke its earlier determination that the YBI Plan was
"qualified" under the Internal Revenue Code.
On March 6, 1989, Mr. and Mrs. Youngblood filed a voluntary
Chapter VII bankruptcy petition.1 In their bankruptcy schedules,
the Youngbloods claimed the rollover IRA as exempt property under
§ 42.0021 of the Texas Property Code. However, one of their
creditors, NCNB Texas National Bank ("NCNB"), objected to the
claimed exemption. NCNB argued that the YBI Plan was not
"qualified" under the Internal Revenue Code, and that when Mr.
Youngblood's distribution from that plan were rolled over into the
IRA, the funds in the IRA were not exempt. In support of their
1
Mr. Youngblood died on August 5, 1989.
2
objection, NCNB presented evidence that the YBI Plan had violated
the "exclusive benefit" rule under § 401(a)(2) of the Internal
Revenue Code.
Despite the IRS determination letters to the contrary, the
bankruptcy court agreed with NCNB that the YBI Plan was not
"qualified":
The YBI Plan was not being used for the exclusive benefit of
the employees or their beneficiaries. The YBI Plan was being
used to: (1) provide working capital for YBI and other
entities owned by Debtor William Youngblood; (2) act as a
mortgage lending [arm] of [YBI] to assist in selling YBI
homes; and (3) act as a purchase money lender to assist
Debtor William Youngblood in selling some of his other
property.
As a result, the bankruptcy court held that the proceeds of the YBI
Plan that were rolled over into the IRA were not exempt property.
The district court affirmed this decision.2
II.
On appeal, Mrs. Youngblood does not challenge the bankruptcy
court's factual finding that the YBI Plan violated the "exclusive
benefit" rule. Rather, she argues that the bankruptcy court was
precluded from finding that the YBI Plan was not "qualified" under
the Internal Revenue Code because the IRS had already made a
contrary determination. We review de novo the bankruptcy court's
legal conclusion that it was not bound by the IRS determination.
See McCarty v. United States, 929 F.2d 1085, 1089 (5th Cir.1991).
Under the Bankruptcy Code, a debtor may claim as exempt any
2
While the appeal was pending in the district court, the
Federal Deposit Insurance Corporation ("FDIC") was substituted
for NCNB as assignee of NCNB's claims.
3
property that is exempt under federal, state, or local law. 11
U.S.C. § 522(b). In this case, the Youngbloods claimed the IRA as
exempt under § 42.0021 of the Texas Property Code. Subsection (a)
of that provision states generally that funds held in a qualified
retirement plan are exempt from seizure. Subsection (b) speaks
directly to the exemption of funds held in an IRA:
Contributions to an individual retirement account or annuity
that exceed the amounts deductible under the applicable
provisions of the Internal Revenue Code of 1986 and any
accrued earnings on such contributions are not exempt under
this section unless otherwise exempt by law. Amounts
qualifying as nontaxable rollover contributions under Section
402(a)(5), 403(a)(4), 403(b)(8), or 408(d)(3) of the Internal
Revenue Code of 1986 are treated as exempt amounts under
Subsection (a). (emphasis added).
Because the funds at issue in this case were rolled over from a
pension plan to an IRA, the proper section for determining the
taxability of the rollover contribution is § 402(a)(5).3
At the time of the rollover in this case, § 402(a)(5)(A)
provided that:
If—
(i) any portion of the balance to the credit of an
employee in a qualified trust is paid to him,
(ii) the employee transfers any portion of the
property he receives in such distribution to an eligible
retirement plan, and
3
The bankruptcy court and the district court both found that
the IRA was not exempt because it did not qualify under §
408(d)(3) of the Internal Revenue Code. We do not believe that §
408(d) is relevant here because it relates to the tax treatment
of "any amount paid or distributed out of an individual
retirement plan." This case, however, involves a distribution
out of a pension plan. In any event, the question under §
42.0021(b) remains the same: whether the rollover of the funds
from the YBI Plan to the IRA was nontaxable. If it was, then the
IRA should be considered exempt property.
4
(iii) in the case of a distribution of property
other than money, the amount so transferred consists of
the property distributed,
then such distribution (to the extent so transferred) shall
not be includible in gross income for the taxable year in
which paid. (emphasis added).
Thus, under this section, a distribution from a pension plan is
taxable as gross income unless it is rolled over into an eligible
retirement plan, such as an IRA. In addition, if the pension plan
is not "qualified" under the Internal Revenue Code at the time of
the distribution, the distribution is taxable.
Because § 42.0021(b) provides that "[a]mounts qualifying as
nontaxable rollover contributions ... are treated as exempt
amounts," the tax treatment of Mr. Youngblood's rollover from the
YBI Plan to the IRA is the key to determining whether the IRA is
exempt property in the present bankruptcy proceeding. The answer
to that question depends on whether the YBI Plan was "qualified"
when Mr. Youngblood's distribution from that plan was rolled over
into the IRA. Mrs. Youngblood argues that because the IRS
determined that the YBI Plan was qualified and did not tax Mr.
Youngblood's distribution from the YBI Plan, the bankruptcy court
should have deferred to that decision and granted the exemption.
The FDIC, on the other hand, argues that the bankruptcy court has
the authority to make its own determination as to whether the YBI
Plan was qualified under the Internal Revenue Code. Thus, the
resolution of this case turns on whether the bankruptcy court is
required to defer to the IRS determination regarding the
qualification of the YBI Plan, or whether the bankruptcy court has
5
the authority to decide this question independently. We believe
that the answer to this question ultimately depends on the intent
of the Texas legislature in enacting § 42.0021.
In analyzing the legislative intent, we first state the
obvious: Texas has no statutory or administrative rules relating
to federal taxation. As a practical matter, therefore, the
legislature had to know that, in applying § 42.0021, its own state
courts would be required to look to federal tax law to determine
whether a plan was qualified under the Internal Revenue Code. The
IRS, which has been entrusted with the task of implementing the
Internal Revenue Code, has adopted extensive rules and regulations
governing income tax in general, and the taxability of pension
plans in particular. The IRS also has a wealth of experience in
the practical application of the tax laws. With particular
relevance to this case, the IRS has adopted guidelines for
distinguishing between violations of § 401(a) justifying monetary
sanctions and violations calling for disqualification.4 The
4
For example, the current version of the Internal Revenue
Manual provides that certain operational violations of § 401(a)
will not result in the disqualification of a plan. For a
violation to be considered nondisqualifying, the following
criteria must be satisfied: (1) "The operational violation must
be an isolated insignificant instance." (2) "The plan must have
either (i) a history of compliance with section 401(a), both in
form and operation, or (ii) if the plan does not have a history
of compliance, the violation was corrected before examination,
and there is no evidence of noncompliance in other areas." (3)
"The plan sponsor or plan administrator must have established
practices and procedures to ensure compliance with section
401(a), including procedures involving the area in which the
violation occurred." (4) "Established procedures must have been
followed, but through an oversight or mistake in applying those
procedures, an operational violation occurred." (5) "Where
dollar amounts are involved, the amounts are insubstantial in
6
question in this case therefore narrows to whether the Texas
legislature contemplated that its courts would independently decide
whether particular violations were sufficiently serious to merit
the ultimate sanction of disqualification especially when the IRS
has made a contrary determination.
We answer this question in the negative. We are persuaded
that the legislature intended for its own state courts (or
bankruptcy courts applying Texas law) to defer to the IRS in
determining whether a retirement plan is "qualified" under the
Internal Revenue Code. We see no reason that the legislature would
want its courts, which are inexperienced in federal tax matters, to
second-guess the IRS in such a complex, specialized area. We find
it much more reasonable to assume that the legislature contemplated
creating an exemption from seizure for a debtor's retirement funds
that could be simply and readily determined by referring to the
federal tax treatment of those funds. Moreover, we do not believe
that the legislature wanted to adopt a scheme that invites
frequent, unseemly, conflicting decisions between the state court
or bankruptcy court, and the IRS, such as occurred in this case.
III.
For the reasons stated above, we conclude that the courts
view of the total facts of the case." (6) "The taxpayer must
have made an immediate and complete correction to cure the
violation once it was discovered so that no participant or
beneficiary suffered substantial detriment." Internal Revenue
Manual § 7(10)54, subsection 660(3); see generally Federal Tax
Coordinator 2d ¶ T-10590 (1994) ("IRS has established programs
... designed to correct past defects, to ensure that plans are
properly operated in the future, and to impose sanctions less
severe than outright disqualification.").
7
below erred in not deferring to the IRS's determination that the
YBI Plan was qualified and that the rollover distribution was
nontaxable.
REVERSED and REMANDED.
8