Wittman v. Koenig, Another Decision on Annuity Exemptions - But Sometimes You Get What You Need
Last week, our post “You Can’t Always Get What You Want” discussed a Texas bankruptcy court decision rejecting efforts by debtor Sam Wyly to claim as exempt a number of offshore private annuities. In denying the exemptions, the bankruptcy judge rejected the debtor’s arguments that the principle of liberal application of exemptions and the policy of plain language construction required that the Wyly annuities be found exempt.
In a timely counterpoint, the Seventh Circuit issued its ruling last week in Wittman v. Koenig, a case involving the Wisconsin exemption statutes. Under Wisconsin law, an annuity can qualify as exempt if, among other requirements, it “complies with the provisions of the Internal Revenue Code.” However, the statute does not specify which provisions of the Internal Revenue Code (IRC) an annuity must comply with in order to qualify for an exemption.
In Wittman, the trustee challenged the debtors’ claimed exemption of several annuities. The trustee contended that, in order to qualify as exempt, the annuities had to comply with IRC §§ 401-409, dealing with tax-deferred qualified retirement plans. In response, the debtors argued that annuity would qualify as exempt if it met the standards for favorable tax treatment under § 72 of the IRC, which deals with annuities more generally.
The Seventh Circuit’s review began with an analysis of the language of the statute, as well as its structure and purpose, the latter as a means of informing its statutory analysis. The court also noted that, “with suitable caution,” it could consider external sources such as legislative history to deal with ambiguous language.
First, the Seventh Circuit found that for an annuity to “comply with” the IRC, the annuity should be eligible under IRC § 72 to receive the tax deferral applicable to annuities under the tax laws. The court rejected the trustee’s argument that, in order to “comply with” the tax code, an annuity must comply with ALL annuity‑related provisions of the IRC. In support, the court noted that, for example, it would not make sense to require an individual retirement annuity to comply with tax code provisions in IRC §§ 401-409 applicable to employer-sponsored annuities. The court also rejected the trustee’s argument that the exemption was designed to apply only to annuities intended for retirement purposes. The court noted that the statute supports no such limitation.
Second, the court found that the more liberal application of the exemption urged by the debtors would not frustrate the purpose of the Wisconsin and federal bankruptcy statutes. The court noted that “there is nothing unlawful about structuring one’s assets to take advantage of the bankruptcy laws as Congress and the Wisconsin Legislature have seen fit to write them.” Similarly, the court said that “no debtor owes [their] creditors more than the law demands”
Finally, the court examined legislative history argued by both parties in support of their positions. After review, the court found that the legislative history was “not inconsistent with our conclusion based on the statute’s language, structure and purpose.”
So how does one reconcile these two recent decisions on annuity exemptions? Could it not also be said that Sam Wyly was “structuring one’s assets to take advantage of the bankruptcy laws?” Perhaps, as mentioned in our earlier post, the controlling factor in the Wyly decision was the sense that the debtor was attempting to “have his cake and eat it too.” The Wyly bankruptcy court found that the transactions in question did not meet the definition of an “annuity” because the debtor had never relinquished control over the assets allegedly transferred to the offshore entities providing the annuity promises.
In Wittman, the annuities in question were more typical of a traditional annuity: a third‑party investment where cash is exchanged for a promise of future payments. Since the debtors had complied with the requirements to establish an annuity recognized as such by the tax laws, the court was more prepared to give the transaction the legal effect of the annuity exemption. All this would suggest that if one wishes to engage in some “bankruptcy planning,” one should stay carefully within the boundaries of the exemptions that one is seeking to utilize.