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Do You Get The Bankruptcy Grubstake Exemption?

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How bankruptcy grubstake exemption works

The word grubstake never appears in the Bankruptcy Code or the California Code of Civil Procedure where the exemptions available in bankruptcy cases filed in California are found.

Yet every bankruptcy lawyer uses the phrase; and seemingly, every bankruptcy debtor struggles to understand it.

What’s a bankruptcy grubstake

Here’s the standard English definition of grubstake.

1.provisions, gear, etc., furnished to a prospector on condition of participating in the profits of any discoveries.
2.money or other assistance furnished at a time of need or of starting an enterprise.
The miner’s grubstake allowed him to buy food and feed his burro while prospecting.  The bankruptcy grubstake does the same:  it furnishes the wherewithal for a fresh start.

The grubstake exemption is sometimes called the wildcard exemption. The exemption is expressed as a dollar amount. 

In a California case, that amount is currently $30,825.  That’s the total of the amounts provided in sections  Code of Civil Procedure 703.140(b)(1) and (b)(5).  Here’s the Judicial Council list of exemption amounts.

While other exemptions in the California bankruptcy exemption statute are limited to particular kinds of property ($1425 for jewelry, $4800 for equity in a car, etc.) the grubstake can be applied to any kind of property.

More importantly, it can be divided among different kinds of assets.

For example, a person filing Chapter 7 or Chapter 13  can use part of the grubstake to protect extra value in a car; part for the balance in a bank account, or stocks held for investment; or part for a timeshare or business interest.

Any kind of asset is fair game, so long as the total grubstake claims doesn’t exceed  $30,825.

Contrast with state exemptions

The exemptions found in CCP 703.140 are available only in a California bankruptcy.  They aren’t available to protect assets from collection of a money judgment outside of bankruptcy.

The standard California exemption system is found in CCP 704.  Those exemptions do apply in state law proceedings and are an alternative choice for a Californian filing bankruptcy.

The debtor in a case under Title 11  must choose either the 703 or the 704 system of exemptions as a whole.  You cannot combine the two systems or choose one exemption from this system and another exemption from the other system.

The California state exemptions include the generous homestead exemption that protects a specified amount of equity in property used as the debtor’s home.  The grubstake in the California bankruptcy exemptions is a much smaller sop to the family that doesn’t have equity in a home.

Making use of the grubstake

One of the most important services a bankruptcy attorney provides is choosing the exemption system and allocating  the grubstake among the client’s assets so as to protect as much property as possible.  It’s not usually possible to select exemptions until the client has provided a list of what they own, any debt secured by that asset, and an estimate of the present sale value of the property.

More

Getting your bankruptcy papers right

Secret exemptions

Pay creditors or file bankruptcy

Image courtesy of scrambldmeggs

Updated November, 2020

How Filing Bankruptcy Can Benefits Your Heirs

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Elders in California enjoy enhanced state exemptions that protect them from debt collectors.

Those protections often make it unnecessary for a debt-laden senior to file bankruptcy.

But no one talks about one consequence of relying on exemption law to fend off creditors.

California exemption laws that  fully protect the assets of seniors provide no protection to the heirs.

The elder who elects to rely on state law exemptions during his lifetime may be leaving his estate , in effect, to his creditors.

Probate pays creditors

Probate is a proceeding to assure that the property of the decedent (the person who has passed away) goes to the correct parties.

Payment of the decedent’s debts comes before payment to heirs.

In probate, creditors have a short period to file their claims.

Once the allowed claims are paid, the heirs have no liability to the decedent’s creditors, even those who didn’t file a claim.

Exemptions in probate

Probate law provides for a homestead exemption, giving the surviving spouse and any minor children a place to live.  Cal. Probate C. 6520 and following.

The protection of the probate homestead lasts only as long as the probate administration and the property remains liable for the debts of the debtor.  Probate C. 6526.

The probate court can likewise set aside other assets for payment of a family allowance for a surviving spouse, minor children and adult children who are incapacitated and dependent on the decedent.

The family allowance also ends with the final order in the probate.

Revocable trusts expose heirs

The revocable trust, or living trust, is a popular way around the expense and delay of probate.  But it comes with a little discussed exposure to creditors.

When the trustor (the person who creates the trust) dies, the assets of the trust are distributed by the successor trustee as the document provides.  No probate is required for trust assets.

But, unless the successor trustee opens a court proceeding to administer the trust estate and gives notice to creditors, any gift to heirs from the trust comes with personal liability for the debts of the decedent.  Probate C. 19400.  That liability is capped by the amount of the gift.

Creditors have one year from the death of the trustor to file suit against the heirs to collect the debt.  Cal. C. Civ. Pro. 366.2.

Ouch!

Bankruptcy eliminates the debts

If the senior elects to file a bankruptcy case,  he can use the generous bankruptcy exemptions available to Californians to protect the assets he has, including up to $175,000 in equity in his residence.

California homestead exemption increases January 1, 2021 to a minimum of $300,000 for all homeowners.

Most unsecured debts are wiped out for all time.  Any accumulations after bankruptcy are free from the claims of the pre bankruptcy creditors.

And, at the senior’s passing, discharged creditors  have no claim against the estate or the trust heirs.  Whatever assets the senior has flow to those of his choosing, rather than the creditors eliminated in bankruptcy.

That point, alone, might tip the scales in favor of a bankruptcy filing even for the collection-proof senior.

More

Exemptions at work

More about homesteads

Going to court in your bankruptcy case.

California’s New Exemptions For Money In The Bank

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california exemptions


California has finally created a state law exemption for cash in the bank.

Californians filing bankruptcy no longer face loss of all the funds in their bank accounts when they choose California’s generous homestead, thanks to changes in exemption law.

Two exemption statutes , new in 2020 , provide protection for cash in the bank from levy under state law or turnover to a bankruptcy trustee.

The absence of protection for cash other than current wages was a gaping hole in California’s standard exemptions. State exemptions protected significant equity in a home, but next to nothing for the cash necessary to make the next mortgage payment.

That has changed, with the creation of Code of Civil Procedure 704.220 and 704.225, both newly effective in 2020.

Money for basic needs

CCP 704.220 creates an exemption in sum of money equal to a month’s living expenses calculated under a state welfare formula. Currently, that amount is $1788.

The statute reads:

(a) Money in the judgment debtor’s deposit account in an amount equal to or less than the minimum basic standard of adequate care for a family of four for Region 1, established by Section 11452 of the Welfare and Institutions Code and as annually adjusted by the State Department of Social Services pursuant to Section 11453 of the Welfare and Institutions Code, is exempt without making a claim. ….

The exemption has exceptions. In state law, it doesn’t apply to a levy to collect the following:

  • wages owed to another
  • child support or spousal support
  • debts to the state for taxes, unemployment, etc.

We’ll have to see how those exceptions apply in bankruptcy.

Amounts needed for support

The second of the new exemptions , CCP 704.225, appears on its face far broader.

CCP 704.225 Money in a judgment debtor’s deposit account that is not otherwise exempt under this chapter is exempt to the extent necessary for the support of the judgment debtor and the spouse and dependents of the judgment debtor.

This exemption promises the possibility of protecting a sum considerably larger than the formula used to calculate CCP 704.220. But it also opens up opportunities for litigation over support for how long, and at what level of comfort.

Both protect deposit accounts

So, what’s a “deposit account”? This becomes one of the all-too-common treasure hunts through the law, each statute referring you on to another.

CCP 481.081 says “Deposit account” means “deposit account” as defined in paragraph (29) of subdivision (a) of Section 9102 of the Commercial Code.

And the Commercial Code , in subsection 29, provides:

“Deposit account” means a demand, time, savings, passbook, or similar account maintained with a bank. The term does not include investment property or accounts evidenced by an instrument.”

You can take it to the bank

So, in creating a California cash exemption, the legislature has finally recognized, and acted on the idea, that it takes both a roof over your head and some money in the bank to have genuine protection from creditors.

More

California homestead gets a major update to reflect the real cost of housing.

Title Isn’t Everything: Watch Out For The Assets In Your Spouse’s Name

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community property surprise

But it’s titled to my spouse, sputtered the hapless debtor at the bankruptcy hearing. She hasn’t filed bankruptcy.

Not so, says the bankruptcy trustee.  It was purchased during marriage, wasn’t it?

And so, the trouble begins for those who don’t understand community property.

Turns out the debtor left out of his schedules the bank account in his wife’s name.  Ooops!

Which motivates a trustee to keep digging for what else was left out of the bankruptcy papers.  Not where you want to be.

Property character, community or separate, makes a difference because it determines what assets creditors of the spouses can reach.  And, it determines what property falls under the control of a bankruptcy trustee.

All of the community property of a marriage becomes property of the estate when one spouse files bankruptcy.

So the community or separate distinction matters not just in divorce, but it matters to those Californians who owe debts they can’t pay.

Property title doesn’t control

In a nutshell, if you are a married Californian, it doesn’t matter whose name is on the title.

  • Buy a car.
  • Buy a house.
  • Take out an insurance policy

No matter whose name is on the paper work, chances are it’s still community property of you and your spouse.

Because “stuff” acquired during marriage is presumed to be community property under California law.

A presumption in law means  legal inference that must be made in light of certain facts.  Most presumptions are rebuttable, meaning that they are rejected if proven to be false or at least thrown into sufficient doubt by the evidence.  

The legal inference that acquisitions during marriage are community can be rebutted with sufficient and convincing evidence.  But absent such evidence, the presumption of community stands.

So, the house bought during marriage whose title reads Jane Spouse is community property, not Jane’s separate property.  That means that Jim Spouse’s creditors can reach it to pay Jim’s debts.

Magic words make a difference

The words in the title documents can themselves be evidence of an asset’s character.

If you want an asset acquired during marriage to be the separate property of one spouse, the first step in overcoming the presumption of community is to take title like this:

Jane Spouse, a married woman as her sole and separate property

But courts have made it more difficult, because what if Jane buys something using community property and takes title as her separate property.  Maybe she’s trying to cheat her spouse out of his share of the community that was used to buy the asset.  If she bought it, how does a creditor or a bankruptcy trustee know that Jim Spouse agrees that it’s hers alone?

Changing the character of an asset is called transmutation.  California law requires transmutation to be accomplished in a writing, signed by both spouses.  Then others know that the deviation from the usual is OK with Jim.

Prenuptial agreement beats community property

An agreement between the spouses made before marriage (a “prenuptial” agreement) defeats the presumption.

A prenuptial agreement often says “we won’t have community property”.  The agreement lays out who is the owner of each kind of asset.  It may reject the legal cases that give the community an interest in property that either spouse brings to the marriage.

Because a properly drafted prenuptial agreement is in writing and signed by the spouses, it passes muster to rebut the presumption of community property.

Then, title plus the prenuptial beats the community property presumption.

More

What you need to know about community property

Image courtesy of Flickr  & Nathan Pilkington 

Bankruptcy Means Test: New Numbers, Little Impact For Bay Area

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The bankruptcy means test line in California is up, so higher incomes still escape the means test.

The median income in your state is the starting point for bankruptcy’s means test.

Below median, and it’s a given you qualify for the bankruptcy chapter of your choice. Above median, more calculation is required to see whether you can opt for Chapter 7, if that’s your choice.

So, we have new numbers for bankruptcy cases filed on or after November 1, 2020.

The new median income numbers won’t create the same stir as the Powerball jackpot, but they are the starting place for people in need of relief from bills they can’t pay.

The means test divides debtors (the people who need debt relief) into two groups.

  • Those below the median state income get to file bankruptcy, no questions asked.
  • Those above the median income have to jump through another hoop, the means test, to determine if a government watchdog will claim their filing is “abusive”.

People above the median still get to file bankruptcy. The means test just influences which chapters are available and what the debtor has to pay if they elect Chapter 13.

In our experience, a high percentage of people over the median income still qualify for Chapter 7 after they calculate their living expenses.

Bay Area median income

The means test looks at the median income by family size.  The median for families in San Mateo, Santa Clara, Alameda, and Santa Cruz counties is

  • $62,171 for a family of one
  • $82,413  for a family of two
  • $91,605 for a family of three
  • $105,232 for a family of four

For families larger than four, the median is increased by $9000 for each member above four.

While the median income figures are the same for all Bay Area counties, the deduction allowed for housing varies from county to county.  This table shows county by county how much a California debtor can deduct from their income for the cost of housing a family of their size.

If you are above median

Lots of people above the median income pass the second part of the means test with flying colors.

Why it’s a mistake to do the means test yourself

The means test is just another form to fill out.  As I explained in another means test post,  the high cost of housing in the Bay Area makes it relatively easy to pass the test.

All Congress managed to do by imposing a means test on bankruptcy is to drive up the cost to debtors for filling out a tedious form.

More

How the means test works

Cheat sheet for passing the means test

Figuring what you pay in Chapter 13

New California Homestead In Action

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california homestead

The California homestead just increased, a change for the better. But how will the change impact the balance of homestead law? Time, or further legislation, will tell.

The newly enacted version of California Code of Civil Procedure 704.730 replaces the previous homestead system that pegged the amount of the homestead to family relationships, including marriage, to age, or to health.

All of that was eliminated in favor of a system that simply provides that everyone with a principal residence gets a homestead in the amount of $300,000. And in counties where the median sale price of homes is more than $300,000, an exemption equals the median price of a home, not to exceed $600,000.

The new homestead provision in CCP 704.7430 reads:

704.730.  (a) The amount of the homestead exemption isthe greater of the following:

(1) The countywide median sale price for a single-family home in the calendar year prior to the calendar year in which the judgment debtor claims the exemption, not to exceed six hundred thousand dollars ($600,000).

2) Three hundred thousand dollars ($300,000).

b) The amounts specified in this section shall adjust annually for inflation, beginning on January 1, 2022, based on the change in the annual California Consumer Price Index for All Urban Consumers for the prior fiscal year, published by the Department of Industrial Relations.

Who qualifies for a homestead?

The economic interest of anyone in a principal dwelling is protected, so long as that person, or the person’s spouse lives there, regardless of who else lives there as well.

As part of the old system, the definitional section of the California homestead law contains a definition of a “family unit” that allowed an unmarried homeowner to a homestead equal to that of a married couple, if that person was part of a family unit.

That appears to be surplusage as the new exemption doesn’t use the composition of the household residing in the homestead to determine how much value is protected.

The definition of a homestead is unchanged: it is the principal dwelling of a judgment debtor, or the judgment debtor’s spouse. So, homestead protection for the home in which only one spouse lives is preserved.

Also unchanged is the exclusion from the definition of “spouse” of a married person following entry of a judgment of legal separation.

Creditors with pre-increase claims

How about the rights of creditors whose claim arose under the old law?

Do they have a fixed right to limit the homestead to the amount protected when the debt was incurred?

The short, broad answer is no. Unsecured creditors have no vested right to the benefit of a law that’s been superseded. San Diego White Truck Co. v. Swift, 96 Cal.App.3d 88 (Cal. Ct. App. 1979)

The exception is the creditor who has a recorded judgment lien which has attached to a declared homestead as defined in CCP 704.910. The homestead increase is not effective against a creditor with a lien recorded before the effective date of an amendment to CCP 704.730. See CCP 704.965. See In re Morgan, 157 B.R. 467 (Bankr. C.D. Cal. 1993)

Reinvestment requirement remains

Unfortunately, the requirement that homestead proceeds be reinvested in a principal residence within 6 months of receipt remains.

For the automatic homestead, available without recording a declared homestead, that requirement is found in CCP 704.720.

For the declared homestead, see CCP 704.960.

As a practical matter, the increase in the amount of the homestead should make it more feasible for a homeowner to actually acquire a new home within six months, assuming they have significant exempt proceeds.

However, a homeowner who has had to invoke the homestead to protect proceeds of a sale may still find reinvestment difficult if the proceeds are smaller.

More

How exemptions work

The homestead is a super hero

When judgment liens interfere with homesteads

Free Tax Preparation Offered In Bay Area

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Households with an annual income of $54,000 or less can have their tax returns prepared for free through the Bay Area United Way’s Earn It, Keep It, Save It program.

Earned Income Tax Credit

The Earn It, Keep It, Save It campaign is particularly focused on enabling qualifying individuals and families to access this tax credit that stands to put real money in the pockets of working families.

Too many families miss claiming the EITC.  Something like 20% of the families that are eligible fail to take advantage of this support for low and moderate income folks.

Even if you owe no taxes, you can claim the tax credit and receive a check.

Generally, the lower your income and the more children you have, the larger the payment you’re entitled to.

Low income families need tax help

Too many Californians – far too many here in the Bay Area – work hard yet find themselves unable to meet their most basic needs. Furthermore, tax season can be stressful time for many people, as they round up tax documents and receipts, and make sense of confusing tax forms. Those of us who can afford it may pay for tax software that walks us through the process, or we may pay a tax preparer to file on our behalf. But the cost for paid preparers can be costly, and tax software varies widely in price. For low-income families who may not be able to afford these services, tax time can be a significant source of stress, and securing a full refund is not assured. Additionally, many of these families face additional challenges in doing their own taxes –English may not be their primary language or they may have limited computer skills. This is why EKS is so important in our community.

Get help with your taxes.

California puts money in pockets, too

California has a state version of the Earned Income Tax Credit.  The California rules are set out in this fact sheet from the Franchise Tax Board.

How Much Cash Can You Keep In Bankruptcy?

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coins in a stack

How much money can you keep when you file bankruptcy?

It’s not as though you won’t have living expenses after you file bankruptcy.

You need to know how you’ll manage and what you’ll have to manage with.

Funding that fresh start is what exemptions are all about.

We are talking here about California because exemptions, the laws that govern what you can keep for your fresh start., are unique to each state.

Exemptions are the one part of bankruptcy that is explicitly different from state to state.  So, recognize that the rules we’re talking about here apply in California.

California exemption systems

California has two distinct exemption schemes that you can choose from.  And you have to choose one scheme or the other.

You can’t take one exemption from one set and another exemption from the other set.

The exemptions originally enacted in California were big on protecting homes, so we have generous homestead exemption (which gets bigger January 1, 2021) under generally applicable state law.  That system is found in California Code of Civil Procedure 704 and the statutes that follow it.

All about the California homestead

California also has a second system of exemptions available only for its residents who file bankruptcy.  These are found in CCP 703.140.

We’re going to look closely at the California bankruptcy exemptions (CCP 703.140)  on the question of how much cash you can protect.  Here’s an online summary of these exemptions.

Cash to start over

The big money for exemptions is found in the grubstake provision:  §703.140(b)(5).

If you haven’t elected to protect equity in real property, you can combine the dollar amount of the homestead  in subsection (1) with the “wild card” amount in subsection (5) for  total of $28,225..

That’s a pretty good nest egg.

Money traceable to exempt source

You may be holding money that comes from an exempt source.  If the money you hold is traceable to its source, it may be exempt in addition to money claimed exempt as a grubstake.

Personal injury  Funds that you can trace to a personal injury recovery can be claimed exempt.  CCP 703.140(b)(11)(D) limits the exempt portion to damages for bodily injury (not property damage).

The money needs to be traceable to its source.  And it has to be still in the form of money.  If you spend the exempt money on a car, the car isn’t exempt as the proceeds of a personal injury recovery.

This exemption currently protects up to $26,800.

Insurance proceeds or wrongful death award  If someone on whom you were dependent dies or was killed, any award you receive as a result is exempt to the extent necessary for your support.

It gets a little messier, since a judge may have to decide what’s “necessary” for your support.  But for an elderly or disabled individual, that amount could be considerable.

Public benefits    Social Security, unemployment, workers compensation, and veterans benefits are protected from creditors.  Though the words of the statute protect your “right to receive” these benefits, case law in the 9th Circuit protects any sums paid out that are traceable to the exempt source.

Retirement or profit sharing payments  Payments on account of old age, length of service or disability under a contract are exempt, again, to the extent necessary for your support.  The precise amount you can protect is unstated but the protection is whatever is “necessary” for support.

IRA’s

The only good thing to come out of bankruptcy “reform” in 2005, in my opinion, was a universal bankruptcy exemption for IRA’s.  The cap started at 1 million dollars, and is adjusted every three years.

If you are lucky or hard working enough to have a substantial IRA, neither your creditors nor a bankruptcy trustee can reach it by reason of 11 USC 522(n).

Trusts

Trusts that have a specific provision that makes them non transferable are not even property of the bankruptcy estate.  The provision is sometimes called an anti-alienation provision or a spendthrift provision.

It’s this kind of provision that takes most pension plans and 401(k) arrangements out of the reach of creditors.

A trust you create for your own benefit or a revocable living trust doesn’t fall within this provision.  But a spendthrift trust created by a parent or grandparent with you as the beneficiary might qualify.

When something isn’t “property of the estate”, an exemption isn’t necessary to protect it in bankruptcy.

Once you move beyond the grubstake, or wild card exemption we looked at first, application of the exemption laws gets a little more complex.   If one of these other exemptions for cash might apply to you, get help from an experienced bankruptcy attorney.

The single biggest mistake that people representing themselves in a bankruptcy case make involves botching claims of exemption.

More

New California exemption for cash

Interviewing a bankruptcy lawyer

Secret exemptions

What you keep in Chapter 13

California bankruptcy law

Image courtesy of Flickr and Bookis

California Gets New Homestead

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California homestead

The California Legislature enacted a dramatic increase to the state’s homestead law at the very end of the legislative session in August. It becomes effective January 1, 2021.

The dollar amount of the homestead increased to a minimum of $300,000 and a maximum of $600,000. Gone is the link between marital status or dependents. Every homeowner is entitled to the homestead amount.

Recognizing that home values vary widely in the state, the new law establishes a homestead greater than $300,000 where the median price of a home in the county exceeds that floor. Regardless of the median price of homes, no one gets a homestead in excess of $600,000.

Finally, the dollar amount of the homestead will be adjusted by inflation, going forward.

The new statute reads:

704.730.  (a) The amount of the homestead exemption isthe greater of the following:

(1) The countywide median sale price for a single-family home in the calendar year prior to the calendar year in which the judgment debtor claims the exemption, not to exceed six hundred thousand dollars ($600,000).

2) Three hundred thousand dollars ($300,000).

b) The amounts specified in this section shall adjust annually for inflation, beginning on January 1, 2022, based on the change in the annual California Consumer Price Index for All Urban Consumers for the prior fiscal year, published by the Department of Industrial Relations.

Homestead unknowns

The biggest unknown is what information source will serve as the reference point for the median price of a home in each county.

Much of the discussion among legislators and advocates has looked at the California Association of Realtors data base, but the legislation does not specify a source.

Homestead certainties

What we know about the new homestead is that it protects family homes from forced sale in and out of bankruptcy.

In state courts, the homestead acts as a check on the ability of a creditor to force the sale of a home to collect a judgment. That works by requiring that any forced sale pay the homeowner the homestead amount before taking any sales proceeds for himself.

In bankruptcy, the homeowner can claim the homestead and the same restrictions on sale apply to a Chapter 7 trustee. So now, a far larger swathe of homes are protected from sale by the larger homestead floor.

The homestead also plays a part in Chapter 13. While there are no forced sales of homes in 13, the amount of non exempt equity often determines how large the monthly Chapter 13 payments must be. That’s because one of the “rules” in Chapter 13 is that if the debtor gets to keep his assets, creditors must get as much as they would have if the debtor had filed Chapter 7. We’ve nicknamed the “best interests of creditors” test for plan confirmation.

I’ve often seen homeowners who can’t get relief in bankruptcy without putting their home at risk of forced sale or at risk of a Chapter 13 plan payment that is simply too large to manage.

Homestead updated

The original purpose of the homestead was to protect an amount of money that is required to keep a roof over a family’s head.

Prior to this change, the increase in the cost of homes left the homestead outdated. The homestead before this bill only protected about 15% of the value of the typical California home.

We’re now far closer to achieving that goal and preserving home ownership for everyone.

More on homesteads

How the homestead works

Which chapter is best for me

Why I love Chapter 13

The Easiest Business Loan In Town

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Easy loans have consequences

Running a small business is hard work.  

Cash flow is tight; time is in short supply.

When there’s just not enough in the bank to cover payroll, the easiest loan in town is from the Bank of Uncle Sam.

There’s no application, no review, no waiting.

You just give employees their checks, net of the amounts withheld.  You can repay the withheld amounts when cash flow is better, you tell yourself.

Up until now, that maneuver was costly and the financial consequences unavoidable.  Now, in California, it’s also criminal.

California employers exposed

Senate Bill 390, signed into law in October, 2013, makes it a crime for an employer to fail to pay over to taxing authorities money withheld from employees’ paychecks.

As little as $500 unpaid, and the matter is a felony.  The easy “loan” can result in hard time.

Responsibility for payroll taxes

Incorporating a business appears insulate the owners and managers of a business from liability for the debts of the business.

Payroll taxes, or more precisely, trust fund taxes, are an exception.

Trust fund taxes is the label given to the amounts that are withheld from an employees wages.  The withholding includes the employee’s contribution to FICA or Social Security, as well as the employee’s income tax withholding.

The employer holds those funds in trust.  The funds belong to the employee and are entrusted to the employer to transmit to the appropriate state and federal tax authorities.

Failure to remit withheld taxes

Both federal and California law hold corporate management personally responsible if the corporate employer doesn’t pay over the withheld funds.

The tax folks see it as almost theft or embezzlement when the employer diverts that money to the corporation’s purposes.  Even if  management sees the  failure to pay as a matter of survival, there’s little understanding available if you short the taxes.

If the money is withheld from the employee’s paycheck, the tax authorities will give the employee credit for the withheld money.  They see the employee as having done everything expected of him.

The tax authorities then pursue with a vengance every person in corporate management who could have signed the check to remit the funds as expected.

So the liability for the quickie loan spreads over all individuals with decision making power in the business.

Trust fund liability not dischargeable in bankruptcy

Civil liability for unpaid trust fund taxes cannot be wiped out in a bankruptcy filing.

The responsible-person penalty for failing to pay trust fund amounts is collectible for 10 years from assessment.

So, even before it became criminal, handing out net checks and pocketing the difference had consequences.

Now, the consequences include conviction for a crime.

Warning signal

If you are faced with an approaching payroll, and no way to pay all of the taxes and withholding associated with payroll, it’s time to have a serious discussion about the future of the business.

It’s one thing to fail in business;  it’s quite another to become a felon.

Image courtesy of Flickr and Infomatique.

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