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Court Looks to Tax Code to Determine LLC Owner's Payments on Defaulted SBA Debt

(Parker Tax Publishing August 2017)

A district court held that, in determining whether a debtor had "disposable earnings" sufficient enough under the definition employed by the Federal Debt Collection Procedures Act of 1990 (FDCPA) to make installment payments on a judgment after defaulting on an SBA loan, allowable deductions were determined under Internal Revenue Code. However, the court concluded that more information was needed from the debtor and the government to determine what "deductions required by law" should be withheld in determining what disposable earnings the debtor had left to pay his debt to the government. U.S. v. Polivka Group, LLC, 2017 PTC 321 (N.D. Ill. 2017).

Andrew Polivka is a commercial real estate agent. He operates a single-member limited liability corporation, the Polivka Group, LLC. Polivka and the LLC defaulted on a loan guaranteed by the Small Business Administration. In 2012, the United States obtained a $65,812 default judgment against both Polivka and the LLC. The government filed suit in an Illinois district court under a provision of the Federal Debt Collection Procedures Act of 1990 (FDCPA), 28 U.S.C. Sec. 3204, for an order requiring Polivka to make installment payments on the judgment.

Under 28 U.S.C. Sec. 3204, a court is authorized to order a judgment debtor to make installment payments when the evidence shows that the judgment debtor: (1) is receiving or will receive substantial nonexempt disposable earnings from self-employment that are not subject to garnishment; or (2) is diverting or concealing substantial earnings from any source, or property received in lieu of earnings. If one or both of those conditions are met, the court must consider the income, resources, and reasonable requirements of the judgment debtor and the judgment debtor's dependents, any other payments to be made in satisfaction of judgments against the judgment debtor, and the amount due on the judgment in favor of the government when fixing the amount of an installment payment. Polivka and the government disagreed about how, if at all, to separate the income and expenses of Polivka and the LLC in order to calculate an appropriate installment payment.

In April 2017, the Illinois district court concluded that it could not determine how to allocate the income and expenses reflected in the record between Polivka and his LLC in order to determine an appropriate installment payment to the government. The court noted that no party had provided separate evidence of Polivka's personal income. Nor had any party explained why the LLC's earnings and expenses should be equated to Polivka's earnings and expenses. In the order, the court also noted that some of the expenses listed in the LLC's profit and loss statement matched expenses Polivka claimed as personal expenses. The profit and loss statement expenses included the amount of the entire cost of rent for the space in which Polivka worked and lived, for instance. The statement also listed the cost of internet access; expenses related to maintenance of a car, including parking and gas; and fees for membership in the multiple listing service and other fees for membership in professional organizations as expenses. On the other hand, other costs claimed by Polivka as personal expenses were not reflected on the profit and loss statement, the court observed, even though some, such as health insurance, are sometimes paid by an employer. The court asked Polivka and the government to file supplemental statements, which they did, clarifying their positions on which income and expenses were attributable to the LLC and which were attributable to Polivka.

Building on the fact that Polivka and the LLC were both judgment debtors, the government argued that treating the LLC's income and expenses as Polivka's income and expenses made practical and legal sense. It also suggested that piercing the corporate veil between Polivka and the LLC was appropriate because the two "are so intertwined that the court should consider them the same." Lastly, the government maintained that the profits of a single-member LLC are generally taxed as the member's gross earnings and cited a bankruptcy case to argue that Polivka should be required to list the LLC's gross, rather than net, income as his income.

Polivka disagreed and urged the court to treat his and the LLC's income and expenses as separate. He submitted cash flow and profit-and-loss statements for the LLC showing that he took approximately $7,000 as his "owner's draw" from the LLC in 2016. The LLC earned approximately $59,000 in gross income during the same period, according to the profit and loss statement in the record.

The district court began its analysis by evaluating whether Polivka was self-employed. The court noted that Polivka controls the LLC, provides all of the professional services for which the LLC is paid, and does not pay himself a regular salary. The court also observed that Polivka determines the amount of income he will draw from LLC and which of his expenses the LLC will pay. Because of these factors and the fact that the LLC pays many of Polivka expenses, including rent, utilities, and most, if not all, of the expenses associated with his car, the court concluded that Polivka is self-employed.

The court then looked at the FDCPA definition of "nonexempt disposable earnings" which is defined as 25 percent of disposable earnings, subject to a provision of the Consumer Credit Protection Act. And "disposable earnings," the court noted, means "that part of earnings remaining after all deductions required by law have been withheld." The term "earnings" is defined as "compensation paid or payable for personal services, whether denominated as wages, salary, commission, bonus, or otherwise, and includes periodic payments pursuant to a pension."

Because the FDCPA's definition of "disposable earnings" required the court to determine what "deductions required by law" should be withheld in determining the disposable earnings Polivka had left to pay his debt to the government, the court looked to the Tax Code for the answer. Citing Code Sec. 1402, Code Sec. 702, and Code Sec. 162, the court observed that a self-employed person may generally deduct business expenses, including ordinary and necessary expenses paid or incurred during the tax year in carrying on any trade or business. The court thus rejected the government's argument that the court should ignore allowable business expenses in calculating Polivka's disposable earnings.

However, the court said that without a detailed analysis of which of Polivka's expenses are deductible as business expenses and which are not, the court could not determine which of Polivka's expenses were deductible from his earnings from self-employment as ordinary and necessary business expenses in order to determine whether Polivka was receiving substantial nonexempt disposable earnings from self-employment. And, the court noted, piercing the corporate veil between Polivka and the LC would leave the court with the same problem.

The court set another hearing so that the parties could prepare the appropriate calculations and analyses to allow the court to determine whether Polivka's nonexempt disposable earnings from self-employment is substantial.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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