Winning a lawsuit is only half the battle. Sometimes the most difficult part of a lawsuit is recovering the judgment. Often, a debtor will make recovery of a judgment very difficult, if not impossible, by declaring bankruptcy or attempting to hide their assets. In those cases, you may need to gain access to the debtor’s financial information to determine what assets they have.
One of the most important financial documents to obtain from debtors is their tax return, because tax returns allow a judgment holder to see what assets and income a debtor has. In addition, the Court of Appeals recently held in KBD & Associates, Inc. v Great Lakes Foam Technologies and Roger Lyons, that declarations in tax returns can be used to determine whether funds to the debtor are subject to garnishment.
In KBD & Associates, the Plaintiff/Garnisher moved to garnish funds declared in Defendant/Debtor’s tax returns. The issue in the case came down to whether the funds declared were a loan from Defendant/Debtor’s corporation or whether the funds were a shareholder distribution form Defendant/Debtor’s corporation. If classified as a loan, the funds would be subject to garnishment, but not taxable. If classified as a shareholder distribution, the funds would not be subject to garnishment, but would be taxable.
In arguing that the funds are subject to garnishment, Plaintiff/Garnisher pointed to Defendant/Debtor’s tax returns, which declared the funds to be a loan. In response, Defendant/Debtor argued that he only declared the funds to be a loan so that the funds would not be taxed. Defendant/Debtor then amended his return to show the funds as a shareholder distribution, rather than a loan.
The Court of Appeals disapproved of Defendant/Debtor’s actions and held that the funds were a loan subject to garnishment, stating:
[Defendant/Debtor] cannot ask the IRS to treat the withdrawal as a loan to give him favorable tax treatment, but then ask the court of Michigan to, several years later, treat it as a distribution to avoid garnishment.
The holding of the Court of Appeals demonstrates the importance of correctly characterizing transactions on tax returns and being prepared to accept the consequences of such characterizations.
This article was written primarily by law clerk, Laura Barrera.
