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.

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Tax Court Resolves a "Kind of Conundrum Only Tax Lawyers Love" in Sale of Rental

In the case of Simonsen v. Commissioner, 150 TC No. 8, the Tax Court reaffirmed its previously stated position regarding a short sale when a nonrecourse debt is involved.  As well, for the first time the Court also addressed the reportable gain/loss on a property converted to rental use that was sold for less than its original cost but more than its date of conversion fair market value.

The couple in question had purchased a townhouse in San Jose in 2005 for $695,000.  They lived in that home for five years, during which the real estate crisis hit.  In 2010 they relocated to Southern California and began renting the townhouse.  At the time it was converted to a rental the fair value had declined to $495,000.

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IRS Is Able to Process Returns with Some, But Not All, Benefits Retroactively Restored for 2017

In News Release IR-2018-33 the IRS announced that it was now able to begin accepting returns claiming certain tax benefits retroactively restored for 2017 by the Bipartisan Budget Act of 2018.  The three benefits that the IRS is now ready to accept returns containing are the following:

  • Exclusion from gross income of discharge of qualified principal residence indebtedness (often, foreclosure-related debt forgiveness),
  • Mortgage insurance premiums treated as qualified residence interest, and
  • Deduction for qualified tuition and related expenses.

These provisions had expired at the end of 2016 and Congress had not enacted legislation to extend them for an additional year until the passage of the Bipartisan Budget Act on February 9.

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Value of CalPERS Pension Not Included in Calculation of Insolvency

The general rule is that income from the cancellation of debt is included in a taxpayer’s gross income. [IRC §61(a)(12)]  However, IRC §108 provides various exclusions from income for cancellation of debt if certain requirements are met.  One of those exclusions, found at IRC §108(a)(1)(B), provides for excluding from income cancellation of debt to the extent the taxpayer is insolvent at the time the debt is discharged.

The taxpayers in the case of Schieber v. Commissioner, TC Memo 2017-32 argued that they were insolvent at the time GMAC Mortgage had cancelled debt of $448,671.  The debt was secured by a piece of property (the Stockdale Highway property) that was not the taxpayer’s principal residence. 

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Requirements for Exclusion of Home Mortgage Debt Discharge For PRMP and HAMP Relief in Process at December 31, 2016 Outlined

The special rule for exclusion from income of cancellation of debt income related to the discharge of certain home mortgage debt (IRC §108(a)(1)(E)) was only extended by Congress through December 31, 2016 in the PATH Act.  However, Congress did provide that the relief would apply to discharges after that date if certain events took place before December 31, 2016 that had the effect of entering into an agreement to cancel the debt at some later date.

In Notice 2016-72 the IRS provides guidance about how that “special rule” would apply to the Federal Housing Finance Agency’s (FHFA’s) principal reduction modification program (PRMP) and the Home Affordable Modification Program (HAMP).

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Regulations Hold Bankruptcy or Insolvency of Disregarded Entities and Grantor Trusts Not Relevant in Determination of Taxation of Cancellation of Debts of Such Entities

The IRS finalized regulations (TD 9771) that were issued in proposed form back in 2011(Proposed Reg. §1.108-9, REG-154159-09,  4/13/11) regarding cancellation of debt relief provisions for bankruptcy and insolvency found in IRC §108 as they relate to grantor trusts and disregarded entities (generally single member LLCs).

The IRS had indicated when the proposed regulations were issued that some taxpayers had attempted to interpret the provisions granting relief to taxpayers who had a discharge of indebtedness involving insolvency or bankruptcy as applying at the disregarded entity level rather than at the level of the taxpayer treated as the owner of the disregarded entity.

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Ability of IRS to Adjust Amount to Recapture for Taxpayer with §108(i) Election in Prior Year Considered by Chief Counsel's Office

The issue of what items IRS can and cannot change that arose in “closed” years is the issue discussed in Chief Counsel Advice 201604017.  In this memorandum the question arose regarding whether the IRS can make adjustments to the amounts included in income under the special temporary provision that allowed for deferral of cancellation of indebtedness income under IRC §108(i).

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Nonrecourse Determination for Debt under §752 Does Not Control Treatment for Nature for Determining Cancellation of Debt Rules for §61(a)(12)

In tax law (and, in fact, law in general) confusion may reign because words are often given a specific definition in a particular context—such as when dealing with a particular statute or regulation.  That limited scope may exist even though an identical term is used in a very similar context—such as the same term having different (though somewhat related) meanings for two different provisions of the Internal Revenue Code.

In Chief Counsel Advice 201525010 the IRS looks at the issue of “nonrecourse debt” under the tax law and the fact that the term is used in two very different contexts.

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Failure to Notify Debtor that Accepting Debt Compromise Could Lead to Taxes Not a Deceptive Practice on Part of Collection Agency

A debt collection agency did not mislead debtors by failing to inform them that compromising a debt could have tax consequences according to the Second Circuit Court of Appeals in the case of Altman v. J.C. Christensen & Associates, Inc., 2015 TNT 94-13, CA2, No. 14-2240.  Thus there was no basis for the claim that the collector had violated the Fair Debt Collections Practices Act (FDCPA).

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FEMA Issued Form 1099C Years After Actual Cancellation of Debt, Taxpayer Not Liable for Tax in Year IRS Questioned

Erroneous Forms 1099C continue to plague clients and they often come from sources that an adviser would think should know better.  In the case of Bacon v. Commissioner, TC Summary Opinion 2015-15 the offending issuer was, like in the case of Kleber v. Commissioner, TC Memo 2011-233, an agency of the United States government, though this time it was the Federal Emergency Management Agency (FEMA) rather than the U.S. Navy.

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Late Election Relief Granted Where Partnership Tax Adviser Failed to Follow Through on Providing Guidance to LLC Members on Making Qualified Real Property COD Election

Sometimes events occur during an engagement that can cause an advisor to lose focus and fail to take into account issues the adviser knows about.  That appears to have been the case in a series of private letter rulings, each of which basically duplicates what is found in PLR 201509020.

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