Taxpayers not insolvent for purposes of Sec. 108 exclusion.

• Author: Beavers, James A.

The Tax Court held that a married couple had failed to prove the fair market value (FMV) of their two homes and the husband's pension and thus were not entitled to exclude discharge of indebtedness income from their gross income under the Sec. 108(a)(1)(B) insolvency exclusion because they could not prove they were in solvent.

[ILLUSTRATION OMITTED]

Background

In November 2007, Capital One Bank (Capital One) referred Bernard and Desiree Shepherd's delinquent credit card account to an outside collection agency. The principal loan balance due on the couple's Capital One account at the time of the referral was $9,962.06. The Shepherds entered into a settlement agreement with the outside collection agency, agreeing to settle the Capital One loan balance for $5,550. The petitioners made payments totaling $5,550 from March 28 to July 30, 2008. Capital One coded the account as "Settled in Full" and discharged the remaining liability on Sept. 3, 2008.

In January 2009, Capital One issued Mr. Shepherd a Form 1099-C, Cancellation of Debt, showing that $4,412 of indebtedness had been canceled on Sept. 3, 2008. The Shepherds did not report the $4,412 as income on their 2008 joint federal income tax return because they believed that the income was excludable under the insolvency exception of Sec. 108 (a) (1) (B), which allows an insolvent taxpayer to exclude discharge of indebtedness income from gross income to the extent the taxpayer is insolvent.

The IRS determined that the Shepherds' liabilities were not greater than the FMV of their assets immediately before the discharge, and thus the couple were not insolvent for purposes of the exception. Therefore, the Shepherds were not entitled to exclude the income under the exception, and the IRS assessed a deficiency against them. The IRS contended that in calculating insolvency, the Shepherds had not properly valued their principal residence, a beach house they owned, and Mr. Shepherd's pension in the New Jersey Public Employees Retirement System. The Shepherds challenged the IRS's deficiency determination in Tax Court.

The Tax Court's Decision

The Tax Court held that the Shepherds could not exclude the discharge of indebtedness income from their gross income. According to the Tax Court, to prevail, the Shepherds had the burden of proving that they were actually insolvent. The court found that the Shepherds had not proven their claimed values for the disputed assets. Because they could not prove the total...