Savings Account Held by Son as Nominee, Must Be Counted in Calculation of Solvency for Debt Discharge Exclusion

In the case of Hamilton v. Commissioner, TC Memo 2018-62, the taxpayer had excluded from income cancellation of indebtedness of $158,511.  The taxpayers claimed they qualified for the insolvency exclusion under IRC §108(a)(1)(B), with liabilities in excess of assets at the time of the discharge of $165,871.  But the IRS objected that they had omitted from their calculation of insolvency a significant asset—a savings account held by their son that had been funded by the taxpayers and which the taxpayers regularly used to pay personal expenses.

Under IRC §61(a)(12), a discharge of indebtedness is specifically called out as a type of gross income subject to tax.  However, IRC §108 provides that, in a number of specific circumstances, a taxpayer is able to exclude from income some or all of the discharge.

The provision in question here, IRC §108(a)(1)(B) allows for the exclusion from income a discharge that occurs “when the taxpayer is insolvent.”  The fact that an asset may be impervious to the claims of creditors does not exclude it from consideration (see Carlson v. Commissioner, 116 TC 87 (2001)).

The Court begins the description of the fact in this case by describing how the debts in question came to arise and the situation that caused the discharge:

Petitioners have an adult son, Andrew Hamilton (Andrew). Petitioner husband (Mr. Hamilton) obtained student loans to finance Andrew’s education. In 2008 Mr. Hamilton injured his back, was diagnosed with degenerative disc disease, and became permanently disabled as a result of his injuries. In June 2010 he sought to have the loans discharged because of his disability. In 2011 (year in issue) Nelnet and the Missouri Higher Education Loan Authority (MOHELA) discharged $157,199 and $1,312, respectively, of Mr. Hamilton's debt. Also in 2011 Mr. Hamilton received a $308,105 nontaxable cash distribution relating to his 14.4% interest in a limited liability company.

Around the same time, Mr. Hamilton began engaging in what the opinion described as “erratic” spending behavior, at which point Mrs. Hamilton took over managing the finances.  Presumably to “wall off” Mr. Hamilton’s ability to access funds to continue his erratic spending behavior, the taxpayers took the following actions:

On April 1, 2011, petitioners transferred $323,000 to Andrew's Chase bank savings account. Andrew gave Mrs. Hamilton his electronic banking username and password and gave her permission to transfer funds from his savings account. Throughout 2011 Mrs. Hamilton regularly transferred money from Andrew's savings account to the petitioners' joint account, from which she paid a majority of the household bills.

In the calculation of the taxpayers’ solvency status, their CPA did not include this savings account (which was owned by their son) but did include all other assets and liabilities of the taxpayers.  The IRS did not dispute any of the values of the assets or liabilities included in that calculation. 

The parties stipulated that if, in fact, the Chase savings account of their son was an asset of the taxpayers they would be solvent (and thus all discharge income would be taxable).  As well, if that account was not properly includable in the calculation of solvency, the taxpayers were insolvent and would qualify for a full exclusion of the discharge income.

The IRS contention is simple—Andrew was holding the savings account, nominally in his name, solely as a nominee for his parents.

Ownership of assets is a state law question, as states control the definition of property rights generally in the United States.  In this case the state in question is Utah.  The Tax Court, citing the case of United States v. Wade (No. 2:15CV00883 DS, 2017 U.S. Dist. LEXIS 163345, at *20-*21 (D. Utah Oct. 2, 2017), found that under Utah law there are six factors that must be considered to determine if a nominee relationship exists:

  • The taxpayer exercises dominion and control over the property while the property is in the nominee's name;
  • The nominee paid little or no consideration for the property;
  • The taxpayer placed the property in the nominee's name in anticipation of a liability or lawsuit;
  • A close relationship exists between the taxpayer and the nominee;
  • The taxpayer continues to enjoy the benefits of the property while it is in the nominee's name; and
  • The conveyance to the nominee is not recorded.

In this case, the Court found that Andrew did hold this account as nominee for his parents, stating:

The parties’ stipulations reflect that although the transferred funds were placed in Andrew’s savings account, Mrs. Hamilton was able to freely transfer funds to petitioners' joint account to pay household bills (i.e., she exercised dominion and control). There is no evidence that Andrew paid any consideration for the funds transferred to his savings account, or that the funds were transferred in anticipation of a lawsuit or a liability. There is, however, sufficient evidence to establish that a close relationship existed between petitioners and their son Andrew, and that petitioners continued to enjoy the benefits of the funds they transferred to Andrew’s savings account. In short, petitioners have failed to establish that Andrew was not their nominee. See Rule 142(a). We accordingly find that during the year in issue petitioners’ assets exceeded their liabilities by at least $60,002, and thus their $158,511 of canceled debt should be included in income. See secs. 61(a)(12), 108(d)(3).

A key issue to note about this case is that it involved both the tax law and issues that were governed by law outside the tax law.  Those who are not licensed members of the Bar need to be aware of the limits of their expertise and licensing in such matters—the only real dispute turned on an interpretation of Utah property law, not the Internal Revenue Code.  For such issues, consideration needs to be given to consultation with competent counsel with expertise in the appropriate areas.