By Ed Boltz, The Law Offices of John T. Orcutt, P.C. (Durham, NC) and Sarah Beth Withers, Inner Banks Legal Services (Washington, NC)
DISCLAIMER: This article is not meant to provide specific advice about the formation of a 501(c)(3) non-profit corporation or the tax or other consequences of such. At most, this is intended to encourage Chapter 13 trustees and their staff to investigate this option.
Whenever staff attorneys or other staff members for Chapter 13 trustees learn about the (moderately) affordable Income Driven Repayment (“IDR”) plans for student loans; being normal, self-interested human beings, the first thing they ask is whether their job qualifies for Public Service Loan Forgiveness (“PSLF”). See: https://studentaid.gov/manage-loans/forgiveness-cancellation/public-service. Leaving aside questions of its implementation, effectiveness and continuation under the U.S. Department of Education (“USED”), the PSLF program allows the forgiveness of student loan balances after ten years of payments under an IDR. See: https://www.ed.gov/content/8-common-public-service-loan-forgiveness-mist.... This is a complete forgiveness of the student loan debt, regardless of the amount paid or the outstanding balance owed. This contrasts with being saddled with the debt for the twenty or twenty-five years of payments otherwise required, and also avoids any tax consequences.
Unfortunately, while the position often has a salary comparable to that of a legal aid or government attorney, it generally does not have the same public service loan forgiveness benefit. There are many ways to qualify for PSLF and its eventual forgiveness of student loan debt, but the only way for a Chapter 13 trustee employee is to be employed by a 501(c)(3) non-profit corporation. So why don’t positions within the offices of the Chapter 13 trustees qualify?
Corporate Status for Trustees?
One of the first hurdles to the trustee qualifying for public service loan forgiveness is incorporation. 11 U.S.C. § 701 (a)(1) allows the appointment of a Chapter 7 trustee that is “one disinterested person”, with “person” being defined under § 101(41) to include individuals, partnerships, corporations, but not, except in some narrow circumstances, government entities. Similarly, 11 U.S.C. § 1104(b)(1) also permits the appointment of “one disinterested person” as a Chapter 11 trustee. Despite the language of the code, it has been the long-standing practice to appoint an individual as Chapter 7 and 11 trustees.
In contrast, 11 U.S.C. § 1302(a), as well as 28 U.S.C. § 586(b), expressly refer to the appointment of individuals as Chapter 13 trustees (11 U.S.C. § 1202 largely mirrors this for Chapter 12 trustees.) Further, according to the Executive Office for United States Trustees (“EOUST”) Handbook for Standing Chapter 13 Trustees, an individual must be appointed to serve as the standing trustee. Handbook for Chapter 13 Standing Trustees, at 2-1 (October 1, 2012). The EOUST has also expressed that as “[a]ll chapter 13 trustees were appointed in their individual capacity and a change in that status would seem to be tantamount to a resignation by the individual as trustee.” This would largely preclude a Chapter 13 trustee him or herself from obtaining the benefits of incorporation. Accordingly, Chapter 13 trustees cannot operate and, as far as the authors are aware, none do operate as incorporated entities, but instead as sole proprietorships. But that is neither a complete picture of how trustees actually operate nor is it the end of the question. Operating as an individual is generally not a risk for a trustee in regards to the bankruptcy estate, as the Barton doctrine bars claims against the trustee and his staff without prior judicial approval. See Lankford v. Wagner, 853 F.3d 1119 (10th Cir. 2017) (arguing that the Barton doctrine both “precludes suits against a bankruptcy trustee for claims based on alleged misconduct”, but also “extend[s] to the trustee’s counsel”) (citing Satterfield v. Malloy, 700 F.3d 1231, 1234-35 (10th Cir. 2012) (See, e.g., McDaniel v. Blust, 668 F.3d 153, 156-57 (4th Cir. 2012); Lawrence v. Goldberg, 573 F.3d 1265, 1269-70 (11th Cir. 2009); Allard v. Weitzman (In re DeLorean Motor Co.), 991 F.2d 1236, 1241 (6th Cir. 1993)). The trustee is also covered by a bond obtained by the trustee as an individual pursuant to 11 U.S.C. § 322(a).
However, even with the protections of the Barton doctrine and a trustee bond, as a sole proprietor the trustee would be personally liable should there be operational claims such as employer/employee disputes, tax issues, breach of contract, failure to pay business debts, etc. A slip and fall at the trustee’s office could result in a judgment lien attaching to the trustee’s home and, heaven forbid, potentially a bankruptcy to deal with such claims. The general benefit of incorporation is the limitation of such liability, which would further protect the individual trustee from potential operational liabilities that fall outside of the trustee’s official duties. And all Chapter 13 trustees, it can be assumed, contract to have their various operational needs met, whether it be for banking, computer systems, or even janitorial services, usually with entities that are incorporated. It would greatly benefit the trustees to contract the services of a separate incorporated entity that employs the staff attorneys and other staff needed by the trustee to manage all of the Chapter 13 cases. This separate entity could claim limited liability, protecting the trustee from many potential operational liabilities that fall outside of the trustee’s official duties. Let’s call that entity “Trustee Employee Services, Inc.” or “TESI”
If the trustees were to contract for the employment of their staff through TESI, such an incorporation would be only the first step in allowing those employees to qualify for PSLF. The incorporated entity also needs to further apply for 501(c)(3) non-profit status in order to offer PSLF to its employees. It is also worth drawing attention to the myriad of additional benefits, beyond the PSLF, that a 501(c)(3) status provides. These include:
- Federal Tax Exemption: While the non-profit would still be responsible for filing annual tax returns, it would receive federal income tax exemption, along with unique treatment for federal unemployment taxes.
See: https://www.irs.gov/charities-non-profits/charitable-organizations/exemption-requirements-501c3-organizations; and https://www.irs.gov/charities-non-profits/annual-filing-and-forms.
- State Tax Exemption: Depending on the state of incorporation, it is possible for the entity to additionally receive exemption from state income, employment, and/or unemployment taxes, as well as state sales and/or state/county property taxes. This decrease in tax liability would decrease the overhead of the trustee, as it is a cost neither the trustee nor TESI would be required to pay.
- Cost Savings: Many stores and business (e.g. Walmart, Staples, Office Depot, Microsoft, Adobe, and QuickBooks) give discounts and/or donations on office supplies, technology, and IT to 501(c)(3) organizations. These perks, coupled with states that provide sales tax exemption or sales tax refunds, mean major cost savings that drive down the overhead of the business. See: https://good360.org; and https://www.techsoup.org.
- Reduced Postal Rates / Postage Savings: Potential discounts on postage for bulk mail, with more than 200 identical mailings. See: https://pe.usps.com/text/pub417/welcome.htm.
- Grant Funding: The non-profit can apply for various grants. E.g. grants that could be used by the trustee and/or collaboration with outside attorneys to publish on topics of interest. See: https://www.abi.org/endowment/research-grants; and https://alwd.org/resources/grants.
- Tax Exempt Donations/Tax Deductible Contributions: Donors can make a tax exempt donation to the organization. Donated funds could be used to set up pro-bono representation projects, or fund other areas of need within the local bankruptcy district.
- Tax-Exempt Financing.
Even though disbursements by the Chapter 13 operation are not subject to taxation, the minimization of other taxes for employees of a TESI would benefit not only those employees, but would reduce expenses for the trustee, lowering the commission and saving money for both debtors and unsecured creditors. The savings from reduced postage on all of the service of motions and other pleading alone would be tremendous!
Pursuant to IRS Form 1023 and Instructions, in order for a TESI to be tax-exempt under section 501(c)(3) of the Internal Revenue Code, none of its earnings may inure to any private shareholder or individual. This obviously excludes amounts paid to the employees of a TESI and would clearly apply to such an entity, since that is the case for Chapter 13 trustees and their staff already.
The next criteria to qualify as a 501(c)(3) would be that a TESI must be organized and operated exclusively for exempt purposes, which include charitable, religious, educational, scientific, literary, testing for public safety, fostering national or international amateur sports competition, and preventing cruelty to children or animals. The term charitable is used in its generally accepted legal sense and includes, among other things:
- Relief of the poor, the distressed, or the underprivileged;
- Defending civil rights secured by law;
- Combating community deterioration; or
- Lessening the burdens of government.
While it would not be difficult to argue that a Chapter 13 trustee assists in providing relief for the poor and financially distressed by defending debtors’ civil rights to bankruptcy and consequently combats community deterioration, focusing on the last of this abridged list of charitable purposes is the most apt.
The standard for lessening the burdens of government is a determination based on the specific facts and circumstances that a governmental burden exists (as evidenced by the government), and that the organization’s activity actually lessens that burden. To determine whether an activity is a burden of government, the question to be answered is whether there is an objective manifestation by the government that it considers such activity to be part of its burden. See: Instrumentalities-Lessening the Burdens of Government, 1984 EO CPE and Update on Instrumentalities and Lessening the Burdens of Government, 1987 EO CPE. That the duties and obligations of Chapter 13 trustees are enumerated in the federal Bankruptcy Code and that Chapter 13 bankruptcies require, both by law and logistics, a trustee with an experienced staff, clearly indicate that a governmental burden exists, namely to administer estates under the Bankruptcy Code, and that a TESI, by providing the necessary support for a Chapter 13 trustee, actually lessens those burdens. A large consideration of whether the entity lessens the burdens of government is given to whether the governmental unit considers the activities to be its burden. It would be rare to find a bankruptcy court to find that a Chapter 13 trustee and staff do not provide such service. For further examples of the application of this criteria, See: Lessening the Burdens of Government, 1993 EO CPE.
Despite all of the benefits a non-profit status may have to the trustee, there are some down sides. First, a non-profit must have a board of directors, which holds regular board meetings. Each state has its own requirements for how many directors must be on the board, but it is generally frowned upon to have a single director. This means that a TESI would need to invite other people to the table to share control and direction of the non-profit. Depending on the state, the board of directors may not be compensated (it is frowned upon even in states that allow it), meaning the board would need to be made up of volunteers that are not employees of the TESI. If the trustee and board are open to applying for grant funding, then the board should be a mix of both attorneys and non-attorneys. Other burdens include:
Open to Public Scrutiny: A non-profit is dedicated to public interest, so the public may obtain copies of the non-profit’s state and federal filings to learn about salaries and expenditures.
No Lobbying: A non-profit is restricted in how much political and legislative activities they may conduct.
Business Assets are Not Personal Property: Upon dissolution, all assets and remaining proceeds must be distributed to another charitable organization.
While the Code and the EOUST Handbook for Standing Chapter 13 Trustees states that an individual must be appointed to serve as the standing trustee, it is possible to maintain the appointment of an individual as trustee, and for the trustee to benefit from incorporation; the two are not mutually exclusive. Upon the appointment of an individual as the trustee, the trustee could enter into a contract with the organizational board of directors of a TESI (potentially with a similar makeup as a local rules committee) to contract for his/her operational needs and staff. Then the incorporated entity is not the trustee, but the trustee is simply contracting for services, as is currently standard practice for specific operational needs. With the added protections of limited liability, reduction in taxes, operational cost savings, and PSLF, the trusteeships across the nation could be greatly benefited by contracting their staff through incorporated non-profit entities. This is a possibility that Chapter 13 trustees and NACTT as a whole, should investigate more fully.
Edward C. Boltz is a member of the Law Offices of John T. Orcutt, P.C., where he has managed the firm’s office in Durham, North Carolina since 1998, representing clients in not only Chapter 13 and Chapter 7 bankruptcies, but also in related consumer rights litigation, including fighting abusive mortgage practices. Mr. Boltz received his B.A. from Washington University in St. Louis in 1993 and his J.D. from George Washington University in 1996. He is a member of the North Carolina State Bar, where he has been certified as a specialist in consumer bankruptcy law. He is admitted to practice before the Districts Courts in both the Eastern and Middle Districts of North Carolina. Mr. Boltz is the current President of the National Association of Consumer Bankruptcy Attorneys (NACBA). Previously, he has served as the Secretary of NACBA, and has jointly responsible for directing the NACBA State Chair program, Mr. Boltz has also served on the Bankruptcy Council for the North Carolina Bar Association and previously served as the Bankruptcy Chair for the North Carolina Association of Trial Lawyers.
Sarah Beth Withers worked as a bankruptcy paralegal practicing both debtor and creditor rights prior to becoming an attorney. While attending law school, she served as a Judicial Extern for The Late Honorable Randy D. Doub, Chief Judge of the United States Bankruptcy Court for the Eastern District of North Carolina, and was a recipient of the Judge Thomas M. Moore scholarship. Sarah Beth graduated from Florida Coastal School of Law in 2013. After graduation, she worked for three years as a staff attorney for Richard M. Stearns, retired Chapter 13 Bankruptcy Trustee for the Eastern District of North Carolina. After her time as a staff attorney, Sarah Beth founded Inner Banks Legal Services, Inc., a 501(c)(3) non-profit law firm dedicated to serving the justice gap in Eastern North Carolina.