I expect clients to conflate themselves and their wholly owned business corporation; I didn’t expect the new bankruptcy lawyer to treat the corporation as if it didn’t exist.
Yet as I reviewed a B-22 for a rookie bankruptcy lawyer, I found all of the corporation’s gross income included in the means test for the individual shareholder. When questioned, the young lawyer replied that it was a sub Chapter S corporation and therefore he had included it in the debtor’s current monthly income. Not in my book…
My approach to businesses conducted by corporations is based on these principles:
- Legal entities are separate legal persons from their owners.
- Tax treatment is just that, tax treatment. Sub S status doesn’t defeat separateness.
- Only the money drawn out of the corporation, as salary or draw, is includible on B-22.
Sole proprietorships are just the reverse. They are indistinguishable from the owner. The business income is propertly treated as the debtor’s income.
Here in the 9th Circuit we have a BAP decision, Wiegand, 386 B.R. 238, that says the B-22 is wrong where it deducts business expenses “above the line” for determining median income. According to the BAP, the debtor’s gross income is reported on line 4 , and the business operating expenses deducted below. You need to see if Wiegand is followed in your circuit.
So, in the case of the struggling small corporation, regardless of the gross income of the entity, if none of that money is distributed to the owner, there is no business income reportable on b-22. This can make a huge difference for the debtor, and it is consistent with the argument for the shareholder being separate from the corporation.
Why do you believe that Distributions are included on B22? According to IRS, distributions (vis á vis Draws) are not income at all (not just NON-TAXABLE income).
Cathy Moran says
My accountant certainly treats my draws from my corporation as my income; draws aren’t wages, but they can be income.
The broader point is that tax rules don’t necessarily control in the means test. The Bankruptcy Code’s definition of “current monthly income” expressly states that it is income “without regard to whether such income is taxable.”
You might reach a different result if the debtor’s corporation is repaying the debtor for a loan made to the corporation. That probably isn’t “income” but rather “return of capital”.
So if a Chapter 7 debtor owns 100% of the shares of an S-Corp, and takes payroll, only the payroll draws get included in B22A? No P&L info on line 4? Or maybe I am not understanding the post well. Thanks for all you do!
I think that only the payroll is income for means test purposes. If there is cash accumulated in the S Corp, that goes to the value of the asset, but not, in my view, to the shareholder’s income.
Put another way, look at the debtor’s personal cash flow, and ignore the taxation issues.
Now maybe if the corporation is making more money than it is disbursing, the debtor needs to provide for the anticipated taxes (a deduction on the means test) but it’s not CMI.
Great to know – I’ll research the issue more for my district. As an aside, how do you examine profits and loss statements prior to filing? Full reconciliation with bank statements? Seems burdensome/impossible unless charging more than I would typically for a 7..