As many of us know from our day-to-day litigation or bankruptcy practices, Colorado Revised Statute § 13-54-104 exempts from collection actions, such as garnishments, 75% of an individual’s   “disposable earnings” as defined in C.R.S. § 13-54-104 (1) (a).  “Earnings” is defined in C.R.S. § 13-54-104(1) (b) to be, among other listed items: “compensation paid for personal services, whether denominated as salary, commission, or bonus.”  The questions of what constitutes ‘earnings’ for a self-employed person or business professional who runs his or her own practice, such as a law practice, is a somewhat murky area of the law, frequently decided on a case by case basis with no bright line test for what constitutes ‘earnings’ and what does not.   Items such as deferred compensation, future earned commissions such as renewal commission, separation and termination payments based upon employment  have all be held to be exempt earnings under C.R.S. § 13-54-104. Certainly professionals like accountants, physicians, dentists, and attorneys who are paid by 1099 draws or K-1 distributions and not W-2 based wages have always assumed that their income was protected from garnishment, at least up to the 75% exemption.

That assumption is not accurate after the Colorado Court of Appeals decision, In  Idaho Pacific Lumber Co. v. Celestial Land Co., Ltd., 2013 WL 5397427, 1 (Colo. App. Sep. 26, 2013), a case of first impression. In Idaho Pacific a panel of Colorado Court of Appeals concluded that money owed to an individual who was an independent contractor could not be exempt as “earnings” under the plain language of Colo. Rev. Stat. § 13-54-101.  Many surmised, perhaps hoped, that the Idaho Pacific decision was an anomaly and that the Colorado Court of Appeals simply relied on an incorrect interpretation of “earnings.”   It turns out the Idaho Pacific court’s interpretation has a solid foundation.

The United States Bankruptcy Court for the District of Indiana decision in In Re Abrams, decided April 28, 2014, 13-12909-RLM-7A  denied the wage exemption claimed by Abrams, an attorney, in his accounts receivable held by him and for which his chapter7 trustee had filed a motion for turnover. Abrams operated as a sole proprietorship and took draws from the firm’s account as funds were available depending, according to the Court, upon whom and when he was paid by his clients, a very typical situation for many professional firms, both big and small.  The Court in Abrams held that the attorney accounts receivable and collections held in his account were not wages paid to him on a periodic basis and thus denied the claimed exemption.  The Court noted the result might be different in Abrams had been incorporated or otherwise paid himself period wages instead of sporadic and varying distributions.

The Abrams Court relied on the United States Supreme Court’s interpretation of “earnings” under the Consumer Credit Protection Act in Kokoszka v. Belford, 417 U.S. 642, 94 S.Ct. 2431 (1974).  The definition of “earnings” in the Consumer Credit Protection Act, after which the Indiana exemption statute in question was patterned, and which is nearly identical to Colorado’s definition of “earnings,” means “…periodic payments of compensation and (do) not pertain to every asset that is traceable in some way to such compensation.”  Kokoszka addressed a debtor’s tax refund and whether it was disposable income under the Consumer Credit Protection Act, which it was held not to be.

Practice Pointer: Since the definition of “earnings” in Colorado’s statute is nearly identical to the definition of “earnings” in the Consumer Credit Protection Act,  the Idaho Pacific court’s interpretation of “earnings” has a solid basis.  Professionals and the self-employed should be justifiably concerned over the vulnerability of any earnings that are not paid as W-2 wages.

Consider the exemption issue one more issue to add to the list of factors to be considered when adopting a business structure or form of operations.  Besides control, tax and personal liability ramifications of the business structure, one must now consider the impact of that structure on the exemption of “earnings” paid out.

Bankruptcy attorneys should also take special note of this issue before advising a self-employed or professional person about the costs and benefits of seeking bankruptcy protection.

Michael J. Guyerson