What DOMA’s Demise Means For Lawyers and Other Professionals

In a landmark decision, the United States Supreme Court held today that the Defense of Marriage Act (“DOMA”) is unconstitutional because it violates the Due Process Clause of the Fifth Amendment. (U.S. v. Windsor.) DOMA is a 1996 federal statute which provides that only marriages between a man and a woman are recognized under federal law.

The death of DOMA is a game-changer for same-sex couples, attorneys, accountants, real estate professionals, commercial banks, the Internal Revenue Service, the Social Security Administration, state and federal judges, etc. The statute’s repeal by the Supreme Court will have sweeping effects on an enormous patchwork of federal laws, most notably the Internal Revenue Code and the Bankruptcy Code.

Below is a list of the top five adverse effects DOMA had on same-sex couples under tax and bankruptcy law:

1. DOMA prohibited same-sex couples from filing a joint tax return, denying them Alternative Minimum Tax exemption amounts afforded to opposite-sex couples, affecting their eligibility to receive the Earned Income Tax Credit as well as increased standard deduction amounts, and literally hundreds of other tax benefits reserved for joint filers.

2. Same-sex couples were not permitted to transfer property between spouses without incurring tax liability.

3. Same-sex couples could not devise or bequeath assets to their spouse under a will or trust without imposing substantial tax burdens on the surviving spouse.

4. Gay and lesbian couples could not file a joint bankruptcy petition, thereby increasing the costs and complexity of their bankruptcy.

5. A deceased spouse’s ERISSA-qualified retirement account would not roll over to the surviving spouse without first being taxed, often at significant rates.

These legal detriments – and about 995 others – were eliminated today by the Supreme Court’s historic decision.

Discharging Student Loans in Bankruptcy

Student loan debt is quickly becoming the largest source of consumer debt in the United States. As student debt soars, struggling borrowers are increasingly looking for relief from their massive debt obligations. One possible form of relief can be found, albeit in limited circumstances, in the United States Bankruptcy Code.

Section 523(a)(8) of the Bankruptcy Code provides that student loan debt obligations are non-dischargeable unless nondischarge will impose undue hardship on the debtor and the debtor’s dependents. Undue hardship is not defined anywhere in the Bankruptcy Code, which means that its meaning must be judicially defined.

Most jurisdictions have adopted the undue hardship test from the leading case of Brunner v. New York State Higher Education Services Corp., 831 F.2d 395 (CA 2, 1987). Under the so-called “Brunner test” for establishing undue hardship, the debtor must prove:

1. That if the loan is not discharged he or she cannot maintain, based on current income and expenses, a minimal standard of living for the debtor and his or her dependents;

2. That this state of affairs is likely to persist for a significant portion of the loan repayment period; and

3. That he or she has made a good-faith effort to repay the loan.

Although the first prong of the Brunner test requires the debtor to show that he cannot maintain a minimal standard of living for himself and his dependents if the student loan is not discharged, it does not require a showing of absolute poverty or hopelessness. See In re Anelli, 262 B.R. 1 (MA, 2000). As long as the debtor’s recurring expense are deemed by the reviewing bankruptcy court to be necessary and reasonable, and the student loans cannot be repaid with the debtor’s disposable income, the first prong of the Brunner test will be satisfied.

More difficult to satisfy is the second prong of the Brunner test because it generally requires a showing of extraordinary and permanent hardship. In In re Frech, 62 B.R. 235 (MN, 1986), the bankruptcy court stated that a debtor does not establish proof of undue hardship by showing that a continued responsibility to pay student loans would bring about mere unpleasantness or garden-variety hardship. The hardship must be long term and there must be no hope of repayment, not simply a present inability to repay. In In re Ballard, 60 B.R. 673 (WD VA, 1986), the court held that undue hardship is reserved for exceptional cases and requires the presence of extraordinary circumstances which would render it unlikely that the debtor would ever be able to repay the debt. As a practical matter, “extraordinary circumstances” are usually found by a reviewing bankruptcy court only when the debtor has some long-term or permanent physical or mental disability. It must be shown that the debtor’s disability will prevent the debtor from obtaining any type of employment sufficient to support a minimal standard of living during the loan repayment period. See In re Nathon-Marie, 303 B.R. 228 (SD FL, 2003) (57-year-old with advanced glaucoma); In re Ford 269 B.R. 673 (BAP 8, 2001) (62-year-old with arthritis); O’Brien v. Household Bank FSB, 165 B.R. 456 (WD MO, 1994) (chronic fatigue syndrome); In re Alliger, 78 B.R. 96 (ED PA, 1987) (back injury); In re Wilson, 76 B.R. 19 (RI, 1987) (physical disability); In re Wilcox, 57 B.R. 479 (MD GA, 1985) (crippling arthritis); In re Dresser, 33 B.R. 63 (ME, 1983) (post-traumatic stress disorder); In re Dockery, 36 B.R. 41 (ED TN, 1984) (heart attack); and In re Connolly, 29 B.R. 978 (MD FL, 1983) (physical and emotion disorders).

A finding of undue hardship may be denied if the bankruptcy court is not convinced that the debtor’s disability is not permanent and will be cured in the foreseeable future. See In re Bowen, 37 B.R. 171 (MD FL, 1984). In Ford v. Tennessee Student Assistance Corp., 151 B.R. 135 (MD TN, 1993), the court held that the debtor had failed to establish undue hardship where it was shown that the debtor was unemployed, received disability and food stamps, and was unable to pay her bankruptcy filing fee, but it was also shown that her disability was at most 50 percent, the debtor had made little attempt to find employment to maximize income, and the debtor’s student loans represented most of her total unsecured debt. In In re Kelly, 351 B.R. 45 (ED NY, 2006), the court held that the debtor failed to show undue hardship because she did not satisfactorily prove that her depressive disorder and social phobia were likely to continue into the indefinite future.

In sum, student loans are not per se non-dischargeable in bankruptcy, but very few debtors will satisfy the threshold requirements for undue hardship under the judicially-created Brunner test.

Is an “S-Corp” Right For Your Client’s Business?

A Subchapter S Corporation (“S-Corp”) is a corporation organized under state law but receives special tax treatment under the Internal Revenue Code (“IRC”). Under the IRC, an S-Corp is a tax-reporting entity but not a tax-paying entity. This means that when the corporation realizes profits the corporation will incur no tax liability. Only the corporate shareholders will pay taxes on the income generated by the corporation, based upon their proportional share of stock ownership. For example, Shareholders X and Y each own 50% of the stock of Z Corporation, an S-Corp under federal tax law. Z Corporation generates $100,000 of corporate earnings and profits in tax year 2013. X and Y will report $50,000 of income on their respective 2013 tax returns.

Not every small business corporation will be eligible to make an S-Corp election, however. In order to qualify as an S-Corp, the following conditions must be met:

1. The business must be a domestic corporation with no more than 100 shareholders.

2. The shareholders must be individuals, trusts, estates, or tax-exempt organizations; no partnerships, Subchapter C Corporations, or limited liability companies.

3. All shareholders must be U.S. Citizens or legal permanent residents.

4. The corporation is permitted to issue only one class of stock, usually common, non-preferred voting stock.

5. There are significant restrictions on the type of debt instruments the corporation is permitted to issue.

Before making an S-Corp election under the IRC, it’s important to carefully consider whether you will be able to meet the requirements listed above, because the tax consequences of your corporation losing its S status can be severe.