Bankruptcy Court Denies Wage Exemption By Self-Employed Business Owner

Exempting wages from garnishment under Florida’s head of household exemption is difficult for self-employed debtors.

Business owners of sub-S corporations typically compensate themselves as employees and as owners. The owner pays himself salary as well as profit distributions. Self-employed business owners limit salary in order to minimize employment taxation, and instead, pay themselves mostly through profit distributions. This compensation arrangement raises issues when the self-employed owner tries to exempt his salary under Florida Statute 222.11 which exempts earnings paid to debtors who are head of household.

Many years ago, in the mid-90s, some bankruptcy courts denied the earnings exemption to self-employed business owners on the grounds that they did not pay themselves in a manner consistent with an employer-employee relationship. The issue just recently was addressed by a bankruptcy court in Florida’s middle district. (In re McDermott, 425 R.R. 848). At issue was an exemption of the debtor’s money in a self-described wage account funded with money received from the debtor’s wholly owned business.

The bankruptcy court denied this debtor an exemption for money in a bank account which the debtor had claimed as exempt wages. The court said the debtor’s compensation history and practice was inconsistent with that of an arms-length employee and employer relationship. The record showed significant variation in the timing and amount of the debtor’s claimed wages. The debtor substantially increased his wages in the months leading up to his bankruptcy in an apparent effort to exempt the money in a wage account. The pre-bankruptcy wages were almost twice the amount he received total in the prior two years. The debtor had complete control over distributions from his business and had no written employment agreement with his corporation.

The court held that, “A debtor who owns and runs his own business, without an arms-lenght employment agreement, and who has almost complete control and discretion over the timing and amount of his own compensation cannot rely on Section 222 (wage exemption statute) to exempt the funds.”

This ruling is consistent with the analysis in the above-mention 1990s cases on the same issue. Self-employed business owners will find it difficult, not impossible, to take advantage of Florida’s head of household earnings exemptions. First, the debtor must pay himself consistent the same salary regardless of variation in business expenses and income. Second, there must be a written employment agreement whose terms are consistent with actual compensation. The owner must pay his wages in the same manner, albeit different amounts, that he pays his unrelated employees. Only then does the business owner have a viable argument that part of his total compensation is exempt wages to a head of household debtor.

About the Author

Jon Alper is an expert in asset protection planning for individuals and small businesses.

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