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Federal bankruptcy law generally provides that an individual retirement account (IRA) that is exempt from income tax is an exempt bankruptcy asset that cannot be reached by creditors. However, such exemption is not bulletproof, much to the chagrin of Ernest Willis.

Mr. Willis owned a substantial IRA at the time he went into bankruptcy. Since the IRA was sizeable, his creditors did not "roll over" on the exemption issue (apologies for the IRA pun) but instead examined Mr. Willis' prior interactions with his IRA. Based on two sets of transactions that occurred many years in the past, the creditors were able to convince the court that the IRA was no longer exempt from tax due to Mr. Willis having engaged in prohibited transactions with his IRA. Under federal tax law, such prohibited transactions would cost the IRA its income tax exemption, and thus also resulted in the loss of bankruptcy protection. Such loss of IRA income tax exemption was successfully asserted, even though the IRS had never examined the IRA or Mr. Willis on the issue. The purported prohibited transactions related to borrowing from the IRA and improper distributions and contributions.

No analysis was undertaken of Florida's separate bankruptcy exemption for IRA assets.

Thus, the case opens up a possible avenue of challenge for creditors to reaching IRA assets, and a chink in the armor of protection for IRA owners and beneficiaries.

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