Debtor may claim funds were ‘earnings’

Where the debtor previously claimed that money in his personal bank account belonged to his company, the court rejected this argument and ordered the money to be turned over to the trustee, and the debtor then claimed that 75% of the funds were exempt as “earnings” under Virginia Code § 34-29, judicial estoppel did not prevent him from asserting this position.

Background

The debtor is the 100% owner of an LLC known as 4 Star Limousine LLC that leases vehicles and engages independent contractors to drive for Uber. He testified that he occasionally provided driving services for 4 Star when it was understaffed and that he received a regular paycheck from 4 Star for these services.

In December 2021, the debtor applied in the name of 4 Star for an Economic Injury Disaster, or EIDL, loan with the Small Business Administration. 4 Star was granted a loan in the amount of $75,400. The funds were deposited into 4 Star’s bank account. The debtor then caused 4 Star to transfer the funds to his personal bank account at M&T on the same day.

The debtor testified that he transferred the funds to his personal account because he had not been paid in some time. The debtor did not claim the funds as income on his personal tax return for 2021 and, to the court’s knowledge, the debtor has not filed an amended tax return for 2021.

The debtor filed a voluntary petition under Chapter 7 on the day after he transferred the funds to his personal account. After the trustee learned of the EIDL loan and the debtor’s M&T bank account, it filed a motion to turn over the funds. At the hearing on the trustee’s motion, the debtor maintained that he was holding the funds in a constructive trust for 4 Star, and that they were not property of his personal bankruptcy estate. Judge Kindred rejected the debtor’s position and ordered the funds to be turned over to the trustee. Judge Kindred then denied the debtor’s motion to reconsider.

Four days later, the debtor filed an amended schedule in which he claimed that $56,000 of the funds were exempt as “earnings” under Virginia Code § 34-29. The trustee filed an objection, arguing that the debtor’s claim of wage exemption is “an improper after-the-fact characterization of the funds” to avoid the order requiring him to turn over the funds.

Judicial estoppel

The debtor previously argued that the funds were not his property, and that he was holding them in trust for 4 Star. His position now is that the funds are exempt, which implicitly asserts that the funds are his property. His two positions are inconsistent.

Judicial estoppel, however, requires that the court have accepted the litigant’s previous position. In this case, Judge Kindred did not accept the debtor’s position that the funds were not his property. Rather, she held that they were property of the estate, which then prompted the debtor to claim that they are partially exempt. Accordingly judicial estoppel does not apply in this case.

Virginia Code § 34-29

The trustee next objects to the debtor’s characterization of the EIDL loan funds as exempt earnings, maintaining that the funds should be characterized as a distribution of profits. The trustee specifically emphasizes that the debtor’s tax returns did not include the funds.

The court finds that the debtor’s tax returns are not determinative here. The transfer was either compensation to the debtor as earnings (which would be 75% exempt), or a distribution of profits from the business (which would not be exempt). In either event, the payment would cause a taxable event to the debtor as ordinary income or as capital gains. Thus, the debtor’s tax returns, without more, are insufficient to satisfy the trustee’s burden.

The debtor is incorrect in arguing that the EIDL proceeds must be earnings because EIDL loans can only be used to fund wages and salaries. In fact, EIDL loan funds can be used for both operating expenses and payroll expenses. In any event, the transfer of EIDL loan funds in this case would probably not be considered an “operating expense” within the meaning of EIDL; the debtor simply transferred the money to his personal bank account because he had not been paid in some time.

The debtor testified that he transferred the funds to his personal bank account because he had not been paid. There was no evidence that 4 Star was profitable in 2021, or that the transfer was a distribution of profits, much less a distribution of profits after payment of a reasonable salary to the debtor.

Trustee’s objection to the debtor’s claim of exemption overruled.

In re: Raza, No. 21-12075, June 29, 2022. EDVA Bankr. at Alexandria (Kenney). VLW No. 022-4-011. 9 pp.