Can the trustee take 100% of the proceeds if the business owner wins the tax lawsuit? 12 Answers as of February 21, 2014

I own a small CPA firm and have the following situation: The owner of a (now virtually defunct) Schedule C business (an LLC) declared bankruptcy in 2012. A lawsuit is in process against a former employee that "stole" the business by ignoring the non-compete and caused the bankruptcy. The lawsuit was initiated prior to bankruptcy. The bankruptcy was discharged in 2012 but the trustee will not close the bankruptcy until the lawsuit is complete. The potential proceeds are far less than amounts due creditors. If the owner wins lawsuit, can the trustee take 100% of the proceeds, and leave the owner (remember, schedule C so in this case proceeds would be subject to self-employment tax, too) with no funds to pay the income and self-employment taxes due on the proceeds? Otherwise, the owner cannot afford the taxes and should drop the lawsuit meaning no money for creditors, either.

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A Fresh Start
A Fresh Start | Dorothy G Bunce
The trustee is entitled to keep a bankruptcy case open virtually forever to collect any nonexempt assets and distribute these assets to creditors. A lawsuit for money damages would be the type of situation which would justify doing just that. When a person fileds bankruptcy, every asset that isn't protected by an exemption under state or federal law belongs to the bankruptcy trustee on behalf of the bankruptcy estate. Your client should be consulting with his/her own attorney for legal advice, and not be asking you to engage in unauthorized practice of law by answering his/her legal questions. After all, you have your own professional license you need to protect.
Answer Applies to: Nevada
Replied: 2/21/2014
The Law Office of Darren Aronow, PC
The Law Office of Darren Aronow, PC | Darren Aronow
Trustee can take 100% to pay towards creditors
Answer Applies to: New York
Replied: 2/21/2014
Resnick & Moss, P.C.
Resnick & Moss, P.C. | Mark Bredow
More information is required. You do not mention which entity filed the bankruptcy, the owner, or the business. If the owner filed a personal bankruptcy, then his interest in the LLC is limited to the value of his ownership shares. If the LLC filed the bankruptcy, then the Trustee would control the business and would be responsible for filing any tax returns and payment of any corporate taxes. The shareholder should be discussing these issues with the Trustee to ensure the taxes are paid, and if necessary, bring the issue before the Court to ensure that the proceeds pay the expenses.
Answer Applies to: Michigan
Replied: 2/21/2014
Kirby G. Moss PC | Kirby G. Moss
The proceeds of the suit would be property of the estate so Trustee would be the party in interest in the claim. If there are tax ramifications from any recovery, Trustee should pay those from the recovery. This should be discussed with the Trustee. Owner can't drop the claim as Trustee now owns it.
Answer Applies to: Indiana
Replied: 2/20/2014
Fluhr & Moore, LLC | Steven S. Fluhr
The trustee is entitled to all proceeds of non-exempt property. However, the trustee will have to file a tax return for the estate and may wish to avoid doing so. You need to have your bankruptcy attorney talk to the trustee so that this matter will be worked out.
Answer Applies to: Missouri
Replied: 2/20/2014
    Stuart P Gelberg
    Stuart P Gelberg | Stuart P Gelberg
    The trustee would have to pay the creditors of the LLC before he gets a commission and can pay the debtor's creditors. Tax obligation would be the trustee's responsibility since the trustee is now the shareholder.
    Answer Applies to: New York
    Replied: 2/20/2014
    Musilli Brennan Associates PLLC
    Musilli Brennan Associates PLLC | John F Brennan
    This should be discussed with the trustee and the bankruptcy attorney.
    Answer Applies to: Michigan
    Replied: 2/20/2014
    Danville Law Group | Scott Jordan
    Since the LLC is the bankrupt party, the trustee can take the monies, after attorney fees and costs are paid, but would be responsible for paying any taxes owed by the LLC, since the Trustee is the owner of the bankruptcy estate. The owner will not see anything from the lawsuit.
    Answer Applies to: California
    Replied: 2/20/2014
    Deborah F Bowinski, Attorney & Counselor at Law | Debby Bowinski
    What state are you located in and what exemptions are you entitled to and were they properly claimed? Was it the owner or the LLC that filed the bankruptcy case? Was the lawsuit listed as an asset? The jurisdiction will control what portion, if any, of the lawsuit proceeds may be exempt from the trustee's claim. Hopefully this business owner retained an attorney to file the bankruptcy case. These questions should be addresses to his lawyer. If he did not hire a lawyer to file, I have a feeling he will wish he had.
    Answer Applies to: Colorado
    Replied: 2/20/2014
    Janet A. Lawson Bankruptcy Attorney
    Janet A. Lawson Bankruptcy Attorney | Janet Lawson
    The lawsuit belongs to the trustee (and the estate would owe taxes). The debtor might get some of the proceeds if they were "exempted". So someone needs to look at the Bankruptcy Schedule B (assets) and Schedule C (exemptions). Who ever is doing the work is entitled to be paid... the trustee can not just freeload. Hopefully the retainer agreement has a security clause.
    Answer Applies to: California
    Replied: 2/20/2014
    Law Offices of Linda Rose Fessler | Linda Fessler
    He can take the proceeds.
    Answer Applies to: California
    Replied: 2/20/2014
    Goldsmith & Guymon
    Goldsmith & Guymon | Marjorie Guymon
    If it was an llc that filed bankruptcy, there is no discharge. The case most likely remained open to see what, if anything, would happen with the lawsuit. If the suit results in payout to the llc then the proceeds belong to the bankruptcy estate. The trustee will take his/her % recovery and disburse the rest to the creditors pro rata. The trustee is required to pay any taxes incurred during the bk case.
    Answer Applies to: Nevada
    Replied: 2/20/2014
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