The Monthly Tax and Asset Protection
Newsletter of Klueger & Stein, LLP

December 2008

More Bad News for Madoff Investors?

Investors who recently learned that their investments with Bernard Madoff are all but worthless may soon find that this is only the beginning. They may soon learn that they will be asked to return any distributions they received from Madoff in prior months or years. Whether some of these investors will be required to pony up may depend on where they live or what their assets are.

If, as is likely, Bernard L. Madoff Investment Securities winds up in bankruptcy court, the bankruptcy trustee – person appointed by the bankruptcy court to oversee the bankruptcy – may determine that any past distribution to any investor from Madoff was part of a scheme to defraud future investors. Technically, the distribution may have been a "fraudulent conveyance," which would give the trustee the power to recover the "early" distributions. Once those "early" distributions are recovered, the trustee would add them to whatever is left in the bankruptcy "estate" for equal distribution to all Madoff investors, regardless of whether the investors got out early or came in late.

That, at least, is the theory. But whether the trustee will be able to get at an investor's assets will depend on a number of factors, including where an investor lives. Many of Madoff's investors reside in Florida, a state that has an unlimited "homestead" exemption, which means that a creditor cannot reach the debtor's residence, regardless of its size or value. But many people who live in Florida are not Florida "residents"; they don't vote in Florida or register their cars in Florida. These "snowbirds" may find that when their creditors come calling, the Florida unlimited homestead exemption may give them no protection at all.

For investors who do not live in Florida, the ability to protect a residence may depend not only on where they live but whether they are single or married, and if married whether one or both of the spouses invested with Madoff. Many state laws provide for "tenancy by the entirety" for the marital residence. If a residence is titled as such, and only one of two spouses is the debtor, a creditor of that spouse cannot seize the residence as long as the marriage persists. Some states provide for tenancy by the entirety for investment real estate as well as residences, and a few states allow tenancy by the entirety for personal property as well. But tenancy by the entirety is not automatic: Madoff investors who live in states permitting tenancy by the entirety should check the deeds to their real estate. The deeds must specify that the property is held in tenancy by the entirety.

The bankruptcy trustee will not be able to touch certain assets, regardless of an investor's culpability with Madoff. Federally-regulated retirement plans – including most pension plans and 401(k) plans – are off-limits. But IRA's and Roth IRA's are available to the bankruptcy trustee, unless the investor lives in a state – such as California – that provides a special exemption for IRA's (albeit with limited application) and "private" retirement plans.

Every Madoff investor, regardless of where the investor resides, has one huge advantage over the trustee: The trustee will need to worry about thousands of debtors. Each debtor will need to worry about – and plan for – only one. But the investors will need to plan early and well to be able to avoid the long reach of the bankruptcy trustee.