• Defense of Marriage Act held unconstitutional—The U.S. Supreme Court has issued the long-awaited opinions in Windsor v. United States (2013 U.S. LEXIS 4935, June 26, 2013) and Hollingsworth, et al. v. Perry et al. (Docket No. 12-144, June 26, 2013) regarding the Defense of Marriage Act (DOMA).

In Windsor, Edie Windsor, the New York executor of the estate of her same-sex spouse, Thea Spyer, filed an estate tax return for Thea’s estate, claiming the marital deduction, under Internal Revenue Code Section 2056, for the property passing to her. The Internal Revenue Service denied the marital deduction, citing DOMA, and Edie filed a refund suit for the estate taxes paid. On appeal, the U.S. Court of Appeals for the Second Circuit applied intermediate scrutiny to DOMA and, ultimately, held that DOMA was unconstitutional.

The IRS appealed to the Supreme Court. Edie continued to argue that DOMA discriminates on the basis of sexual orientation, which implicates the same factors as race, sex and national origin; therefore, it should be considered a suspect class subject to heightened scrutiny. The U.S. House of Representatives Bipartisan Legal Advisory Group (BLAG) represented the United States. BLAG argued that sexual orientation isn’t a quasi-suspect class; that the Court should apply rational basis review; and that the federal government has a rational interest in making sure that federal tax burdens and benefits are distributed equally, such that persons residing in different states aren’t eligible for different benefits. Lastly, BLAG argued that marriage is intended to protect and encourage procreation within a stable relationship.

The Supreme Court held for Edie and determined that DOMA violates the basic due process and fundamental equal protection requirements of the Constitution. Justice Anthony Kennedy wrote for the 5-4 majority and described the general historical deference of the federal government to the states in regulating marriage. Justice Kennedy recounted the various ways in which DOMA interfered with states that had allowed same-sex marriage by imposing unequal effects on same-sex married couples as compared to opposite-sex marriages. The majority found that the principal purpose of DOMA was to impose inequality and that such burden imposed on same-sex couples violated the Fifth Amendment.

In a separate case, Perry, the Supreme Court was asked to address the constitutionality of California’s Proposition 8. The California Supreme Court had ruled in a prior case that the California Constitution provided a right to marry to same-sex couples. However, in response to the California Supreme Court’s decision, a voter initiative, known as Proposition 8, sought to add a new provision to the California Constitution to limit marriage to opposite-sex couples. The initiative passed with 52.3 percent of the vote, and the additional provision was added to the California Constitution. In Perry, two same-sex couples filed an action after they weren’t permitted to marry, claiming a violation of the Fourteenth Amendment. The Northern District of California held for the plaintiffs and the U.S. Court of Appeals for the Ninth Circuit affirmed. However, the Supreme Court didn’t rule on the substantive claims regarding the Fourteenth Amendment because it held that the petitioners, as proponents of the voter initiative, didn’t have standing to defend the amendment to the California Constitution. The petitioners had stepped in when California’s governor and state officials refused to defend the law, but the Supreme Court held that, as a third party, the residents supporting the voter initiative didn’t have standing to defend the law. As a result, the decisions of the lower courts were upheld: the amendment to the California Constitution was struck down.

Windsor and Perry mean that states may define marriage as they like; the federal government is prohibited from restricting or classifying marriages at the national level. Therefore, the federal government must respect marital status conferred by the states, as varied as that may be. In addition, since DOMA was declared unconstitutional, it’s void ab initio. As a result, same-sex married couples who paid additional income or estate taxes as a result of DOMA may seek refunds by filing amended returns if the applicable statute of limitations hasn’t run. And, many same-sex couples will now be entitled to other health care, insurance, retirement and social security benefits that were previously restricted to opposite-sex couples. However, striking down DOMA has many consequences and raises many questions.   

For example, even though the definition of marriage no longer inherently excludes same-sex couples, certain federal laws recognize marriage based on the state of domicile, while others recognize marriage based on the state where the couple was married, known as the “state of celebration” (for estate tax purposes, case law has held that the marital status of a decedent is determined according to the state of domicile at the date of death). This means that a same-sex couple that moves from the state where they were married to a state that doesn’t recognize same-sex marriage may face problems in obtaining certain federal benefits.

Another problem is that many same-sex couples drafted their estate plans, used certain estate-planning techniques or drafted other documents, such as divorce property settlements, based on DOMA. Now that DOMA is no longer law, there may be unintended tax and other results.


• QSST beneficiary entitled to deduct interest payments made by QSST—In ILM 201327009 (May 1, 2013), the IRS addressed the question of whether a beneficiary of a qualified subchapter S trust (QSST) was entitled to deduct the interest expense incurred in making required payments on a promissory note. The QSST purchased S corporation stock from a third party in exchange for a note. The QSST made timely payments on the note, including interest payments. The S corporation stock was the only asset held by the QSST.

Generally, a pro rata share of the S corporation’s items of income, loss and deduction and credits flow through to the shareholder, the QSST, under IRC Section 1366. However, interest expense for acquisition indebtedness isn’t an expense that flows through to the shareholder under Section 1366. IRC Section 641 specifically allows a deduction for this type of expense for electing small business trusts, but there was no authority on this issue for QSSTs.

To determine whether the interest expense was deductible, the IRS looked to IRC Section 163 and the tracing rules and confirmed that interest allocated to a trade or business expenditure is fully deductible. Prior IRS Notices 89-35 and 88-37 allocated the interest incurred on a debt used to purchase an interest in a pass-through entity to the assets of the pass-through entity and ruled that such interest, traced to the trade or business expenditure, is deductible.

Under IRC Section 1361(d)(1), the beneficiary of a QSST is treated as the owner of the portion of the trust that consists of the S corporation stock for which the QSST election was made. And, under the grantor trust rules, specifically Treasury Regulations Section 1.671-3(a)(2), if there’s a portion of trust property or a specific property held by the trust treated as owned by the grantor, the tax attributes directly related to that portion or property flow through to the grantor.

Therefore, the ruling held that the interest was traceable to the S corporation stock, allocable to the QSST and flowed through to the beneficiary as the grantor of the QSST. However, the ruling also noted the unique situation presented here. Because the QSST held no other income-producing assets, the cash received from the S corporation was the sole source of the interest payment. As a result, the payment of the interest expense directly reduced the distributions that, otherwise, would have been made to the beneficiary. The ruling hints that a different result (or perhaps a more complicated analysis) would be required if the QSST had other income-producing assets, and the S corporation distributions were commingled with other income before the payment of the interest expense.