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Showing posts with label income. Show all posts
Showing posts with label income. Show all posts

Tuesday, March 5, 2024

IRS Gets Called Out In Offer In Compromise Case

 

I am looking at an offer in compromise (OIC) case.

These cases are almost futile for a taxpayer, as the Tax Court extends broad deference to the IRS in its analysis of and determinations on OICs. To win requires one to show that the IRS acted in bad faith.

COMMENT: I have soured on OICs as the years have gone by. Those commercials for “pennies on the dollar” stir unreasonable expectations and do not help. OICs are designed for people who have experienced a reversal of fortune - illness, unemployment, disability, or whatnot – which affect their ability to pay their taxes. It is not meant for someone who is irresponsible or inexplicably unfettered by decency or the responsibilities of the human condition. Not too long ago, for example, one of the clients wanted us to pursue an OIC, as he has racked up impressive tax debt but has no cash. I refused to be involved. Why? Because his cash is going to construct a $2-plus million dollar home. I am very pro-taxpayer, but this is not that. Were it up to me, we would fire him as a client.

Let’s look at the Whittaker case.

Mr. W is a veteran and was a self-employed personal trainer. Mrs. W worked in a local school district and had a side gig as a mall security guard. They were also very close to retirement.

The Ws owed everybody, it seems: a mortgage, student loans, the IRS, the state of Minnesota and so on.

In 2018 the IRS sent a notice of intent to levy.

The Ws requested a collection due process (CDP) hearing.

COMMENT: The Ws were represented by the University of Minnesota tax clinic, giving students a chance to represent clients before the IRS and courts.

The IRS of course wanted numbers: the Form 433 paperwork detailing income, expenses, assets, debt and so forth.

The Ws owed the IRS approximately $33 grand. The clinic calculated their reasonable collection potential as $1,629. They submitted a 20% payment of $325.80, per the rules, along with their OIC.

In the offer, the Ws stressed that their age and difficult financial situation meant that soon they would have to rely on retirement savings as a source of income rather than as a nest egg. Their house was in disrepair and had an unusual mortgage, meaning that it was extremely unlikely it could be refinanced to free up cash.

The IRS has a unit - the Centralized Offer in Compromise unit – that stepped in next. Someone at the unit calculated the Ws’ RCP as $250,000, which is wildly different from $1,629. The unit spoke with representatives at the clinic about the bad news. The clinic in turn emphasized special circumstances that the Ws brought to the table.  

That impasse transferred the OIC file to Appeals.

It was now March 2020.

Remember what happened in March 2020?

COVID.

The two sides finally spoke in September.

Appeals agreed with an RCP of $250 grand. The Settlement Officer (SO) figured that the Ws could draw retirement monies to pay-off the IRS.

Meanwhile Mr. W had retired and Mrs. W was gigging at the mall only two weekends a month.

The SO was not changing her mind. She figured that Mrs. W must have a pension from the school. She also surmised that Mr. W’s military pension must be $2,253 per month rather than $1,394. How did she know all this? Magic, I guess.

The W’s argued that they could not borrow against the house. They had refinanced it under something called the Home Affordability Refinance Program, which helps homeowners owing more than their house is worth. A ballon payment was due in 2034, and refinancing a house that is underwater is nearly impossible.

This did not concern the SO. She saw an assessed value of $243,000 on the internet, subtracted an $85 thousand mortgage, which left plenty of cash. The W’s pointed out that there was deferred maintenance on the house – a LOT of deferred maintenance. Between the impossible mortgage and the deferred maintenance, the house should be valued – they argued – at zero.

Nope, said the SO. The Ws could access their retirement to pay the tax. They did not have to involve the house, so the mortgage and deferred maintenance was a nonfactor. She then cautioned the W’s not to withdraw retirement monies for any reason other than the IRS. If they did so, she would consider the assets as “dissipated.” That is a bad thing.

Off to Tax Court they went. Remember my comment earlier: low chance of success. What choice did the Ws have? At least they were well represented by the tax clinic.

The Court saw three key issues.

Retirement Account

The W’s led off with a great argument:

 

  

This is Internal Revenue Manual 5.8.5.10, which states that a taxpayer within one year of retirement may have his/her retirement account(s) treated as income rather than as an asset. This is critical, as it means the IRS should not force someone to empty their 401(k) to pay off tax debt.

The SO was unmoved. The IRM says that the IRS “may” but does not say “must.”

Yep, that is the warm and fuzzy we expect from the IRS.

The Court acknowledged:

We see no erroneous view of the law and no clearly erroneous assessment of facts.”

But the Court was not pleased with the IRS:

But there may be a problem for the Commissioner – this reasoning didn’t make it into the notice of determination …”

The “notice of determination” comment is the Court saying the files were sloppy. The IRS must do certain things in a certain order, especially with OICs. Sloppy won’t cut it.

Home Equity

The W’s had offered to provide additional information on the loan terms, the deferred repairs to the house, the unwillingness of the banks to refinance.

The IRS worked from assessed values.

It is like the two were talking past each other.

Here is the Court:

The IRS does need to take problems with possible refinancing a home seriously.”

The Whittakers have a point – there’s nothing in the administrative record that states or even suggests that the examiner at the Unit or the settlement officer during the CDP hearing asked for any information in addition to the appraised value.”

There is no evidence in the record of any consideration of the Whittakers’ arguments on this point.”

Oh, oh.

Here is the first slam:

We therefore find that the settlement officer’s conclusion about the Whittaker’s ability to tap the equity in their home was clearly erroneous on this record. This makes her reliance on that equity in her RCP calculations an abuse of discretion.”

COVID

The W’s had alerted the IRS that Mr. W had completely retired and Mrs. W was working only two weekends a month. The SO disregarded the matter, reasoning that the W’s had enough pension income to compensate.

Which pension, you ask? Would that include the pension the SO unilaterally increased from $1,394 to $2,253 monthly?

The Commissioner now concedes that the settlement officer was mistaken, and that Mr. Whittaker had a military pension of only $1,394 per month.”

Oops.

There was the second slam.

The IRS – perhaps embarrassed – went on to note that the Mall of America opened after being COVID-closed for three months. Speaking of COVID, the lockdown had inspired a nationwide surge in demand for fitness equipment. Say …, wasn’t Mr. W a personal fitness trainer?

The Court erupted:

Upholding the rejection of the Whittakers’ offer because Mrs. Whittaker’s mall job may have resumed or Mr. Whittaker might be able to run a training business using potential clients’ possible pandemic purchases is entirely speculative.”

True that.

The settlement officer ‘did not think that the loss of the Whittaker’s wage income or self-employment income … sufficiently mattered to justify reworking the Offer Worksheet.’”

The Court was getting heated.

The settlement officer’s explicit refusal to rework the worksheet despite the very considerable discrepancy in the calculation before and after the pandemic is a clear error and thus an abuse of discretion.”

The Court remanded the matter back to IRS Appeals with clear instructions to get it right. It explicitly told the IRS to consider the material change in the Ws’ circumstances – changes that happened during the CDP hearing itself - and their ability to pay.

We said earlier “almost futile.” We did not say futile. The Ws won and are headed back to IRS Appeals to revisit the OIC.

Our case this time was Whittaker v Commissioner, T.C. Memo 2023-59.

Sunday, January 28, 2024

Using A Fancy Trust Without An Advisor

 

I am a fan of charitable remainder trusts. These are (sometimes) also referred to as split interest trusts.

What is an interest in a trust and how can you split it?

In a generic situation, an interest in a trust is straightforward:

(1) Someone may have a right to or is otherwise permitted to receive an income distribution from a trust. This is what it sounds like: if the trust has income, then someone might receive all, some or none of it – depending on what the trust is designed to do. This person is referred to as an “income” beneficiary.

(2) When there are no more income beneficiaries, the trust will likely terminate. Any assets remaining in the trust will go to the remaining beneficiaries. This person(s) is referred to as a “remainder” beneficiary.

Sounds complicated, but it does not have to be. Let me give you an example.

(1)  I set up a trust.

(2)  My wife has exclusive rights to the income for the rest of her life. My wife is the income beneficiary.

(3)  Upon my wife’s death, the assets remaining in the trust go to our kids. Our kids are the remainder beneficiaries.

(4)  BTW the above set-up is referred to as a “family trust” in the literature.

Back to it: what is a split interest trust?

Easy. Make one of those interests a 501(c)(3) charity.

If the charity is the income beneficiary, we are likely talking a charitable lead trust.

If the charity is the remainder beneficiary, then we are likely talking a charitable remainder trust.

Let’s focus solely on a charity as a remainder interest.

You want to donate to your alma mater – Michigan, let’s say. You are not made of money, so you want to donate when you pass away, just in case you need the money in life. One way is to include the University of Michigan in your will.

Another way would be to form a split interest trust, with Michigan as the charity. You retain all the income for life, and whatever is left over goes to Michigan when you pass away. In truth, I would bet a box of donuts that Michigan would even help you with setting up the trust, as they have a personal stake in the matter.

That’s it. You have a CRT.

Oh, one more thing.

You also have a charitable donation.

Of course, you say. You have a donation when you die, as that is when the remaining trust assets go to Michigan.

No, no. You have a donation when the trust is formed, even though Michigan will not see the money (hopefully) for (many) years.

Why? Because that is the way the tax law is written. Mind you, there is crazy math involved in calculating the charitable deduction.

Let’s look at the Furrer case.

The Furrers were farmers. They formed two CRATs, one in 2015 and another in 2016.

COMMENT: A CRAT is a flavor of CRT. Let’s leave it alone for this discussion.

In 2015 they transferred 100,000 bushels of corn and 10,000 bushels of soybeans to the CRAT. The CRAT bought an annuity from a life insurance company, the distributions from which were in turn used to pay the Fullers their annuity from the CRT.

They did the same thing with the 2016 CRT, but we’ll look only at the 2015 CRT. The tax issue is the same in both trusts.

The CRT is an oddball trust, as it delays - but does not eliminate – taxable income and paying taxes. Instead, the income beneficiary pays taxes as distributions are received.

EXAMPLE: Say the trust is funded with stock, which it then sells at a $500,000 gain. The annual distribution to the income beneficiary is $100,000. The taxes on the $500,000 gain will be spread over 5 years, as the income beneficiary receives $100,000 annually.

Think of a CRT as an installment sale and you get the idea.

OK, we know that the Furrers had income coming their way.

Next question: what was the amount of the charitable contribution?

Look at this tangle of words:

§ 170 Charitable, etc., contributions and gifts.

           (e)  Certain contributions of ordinary income and capital gain property.

(1)  General rule.

The amount of any charitable contribution of property otherwise taken into account under this section shall be reduced by the sum of-

(A)  the amount of gain which would not have been long-term capital gain (determined without regard to section 1221(b)(3)) if the property contributed had been sold by the taxpayer at its fair market value (determined at the time of such contribution),

This incoherence is sometimes referred to as the “reduce to basis” rule.

The Code will generally allow a charitable contribution for the fair market value of donated property. Say you bought Apple stock in 1997. Your cost (that is, your “basis”) in the stock is minimal, whereas the stock is now worth a fortune. Will the Code allow you to deduct what Apple stock is worth, even though your actual cost in the stock is (maybe) a dime on the dollar?

Yep, with some exceptions.

Exceptions like what?

Like the above “amount of gain which would not have been long-term capital gain.”

Not a problem with Apple stock, as that thing is capital gain all day long.

How about crops to a farmer?

Not so much. Crops to a farmer are like yoga pants to Lululemon. That is inventory - ordinary income in nerdspeak - as what a farmer ordinarily does is raise and sell crops. No capital gain there.

Meaning?

The Furrers must reduce their charitable deduction by the amount of income that would not be capital gain.

Well, we just said that none of the crop income would be capital gain.

I see income minus (the same) income = zero.

There is no charitable deduction.

Worst … case … scenario.

I found myself wondering how the tax planning blew up.

In July 2015, after seeing an advertisement in a farming magazine, petitioners formed the Donald & Rita Furrer Charitable Remainder Annuity Trust of 2015 (CRAT I), of which their son was named trustee. The trust instrument designated petitioners as life beneficiaries and three eligible section 501(c)(3) charities as remaindermen.”

The Furrers should have used a tax advisor. A pro may not be necessary for routine circumstances: a couple of W-2s, a little interest income, interest expense and taxes on a mortgage, for example.

This was not that. This was a charitable remainder trust, something that many accountants might not see throughout a career.

Yep, don’t do this.

Our case this time is Furrer v Commissioner, T.C. Memo 2022-100.

Sunday, November 12, 2023

The EV Tax Credit

I was reading an article recently that approximately 40% of Americans have not heard about the EV tax credits.

EVs are battery powered cars. We used to have hybrids, which sometimes used a motor and other times a battery. EVs by contrast are 100% battery powered.

If you are thinking about buying one for personal use, here are a few markers to keep in mind:

(1)   There was an OLD tax credit and now there is a NEW tax credit.

a.     The OLD credit went through April 18, 2023.

b.    The NEW credit of course is after April 18, 2023.

Both credits can get up to $7,500, so what changed was the measuring stick.

Before April 19, the EV had to be assembled in North America.

After April 18, one test became two tests:

·       The battery itself has to be manufactured in North America, and

·       Then critical minerals in the battery (cobalt and lithium, for example) must be extracted or processed in the U.S. or in a country with which the U.S. has a free trade agreement.

Notice that OLD $7,500 credit (assembled in North America) has become two NEW credits of $3,750 each. You can get to $7,500, but along a different route.

It matters. For example, the new Ford Mustang Mach-E only qualifies for one of the credits – only $3,750 – because its battery comes from abroad.

Some – like the Genesis GV70 – used to qualify for the old $7,500 credit but no longer qualify for anything under the new rules.

If you are considering an EV, please double check whether the vehicle qualifies. Here is the Department of Energy’s website:

https://fueleconomy.gov/feg/tax2023.shtml

(2)   Congress included some price caps on qualifying vehicles. These things are expensive, and Congress was trying to exert downward pressure.

To qualify,

·       A van, SUV or pickup truck must cost $80 grand or less.

·       Any other vehicle (a sedan, for example) must cost $55 grand or less.  

(3)   Starting in 2024, you will have the option of using the credit immediately when you purchase the vehicle. It would make for an easy down payment, I suppose.  

The heavy lifting is done behind the scenes, as the dealerships will register on a new website to initiate and receive the credits. If you are curious, that website is: 

https://www.irs.gov/credits-deductions/register-your-dealership-to-enable-credits-for-clean-vehicle-buyers  

(4)   For the first time, used EVs will qualify for a credit. This credit will not be as large as the one for new EVs, but it is not insignificant either. Here are the ropes:

·       The price must be $25 grand or less.

·       The car must be at least two years old.

·       The car qualifies only once in its lifetime.

·       The credit is up to $4 grand, limited to 30% of the price.

·       You can claim the used EV credit once every three years.  

(5)   There are income limits on both the new EV and used EV credits. Make too much money and you will not qualify.  

For example:

New EV

           Married        income < $300,00

                                       Single          income < $150,000

                            Used EV

                                        Married       income < $150,000

                                        Single         income < $75,000  

You can test for income either in the year of purchase or the immediately preceding year. I am thinking – to be safe – that one should generally go with the preceding year. It would be no fun to apply a $7,500 credit against the purchase of an EV and then give it back because you reported too much income on your 2024 tax return.  

(6)   Up to now, we have been talking about buying an EV for personal use. There is a similar credit if you lease rather than buy, but some rules are different.

·       Since the leasing company (and not you) owns the vehicle, the income test does not apply.

·       The credit requires the EV be manufactured by a “qualified manufacturer” rather than the two-step qualification discussed above for a purchased vehicle. This should result in a wider selection.

·       Mind you, the leasing company is not required to pass (all or any of) this credit on to you. Education is important here - and expect negotiation.  

The reason the rules are different is that this second credit is designed for businesses – rather than individuals – buying an EV. By bringing in a leasing company, we flipped from the first to the second credit.  

I am not in the market for a car myself.  If I were, though, I would go in a very different direction.


Monday, August 7, 2023

Can You Have Income From Life Insurance?

 

I was looking at a recent case wondering: why did this even get to court?

Let’s talk about life insurance.

The tax consequences of life insurance are mostly straightforward:

(1) Receiving life insurance proceeds (that is, someone dies) is generally not an income-taxable event.

(2) Permanent insurance accumulates reserves (that is, cash value) inside the policy. The accumulation is generally not an income-taxable event.

(3) Borrowing against the cash value of a (permanent) insurance policy is generally not an income-taxable event.

Did you notice the word “generally?” This is tax, and almost everything has an exception, if not also an exception to the exception.

Let’s talk about an exception having to do with permanent life insurance.

Let’s time travel back to 1980. Believe it or not, the prime interest rate reached 21.5% late that year. It was one of the issues that brought Ronald Reagan into the White House.

Some clever people at life insurance companies thought they found a way to leverage those rates to help them market insurance:

(1)  Peg the accumulation of cash value to that interest rate somehow.

(2)  Hyperdrive the buildup of cash value by overfunding the policy, meaning that one pays in more than needed to cover the actual life insurance risk. The excess would spill over into cash value, which of course would earn that crazy interest rate.

(3)  Remind customers that they could borrow against the cash value. Money makes money, and they could borrow that money tax-free. Sweet.

(4)  Educate customers that – if one were to die with loans against the policy – there generally would be no income tax consequence. There may be a smaller insurance check (because the insurance is diverted to pay off the loan), but the customer had the use of the cash while alive. All in all, not a bad result – except for the dying thing, of course.

You know who also reads these ads?

The IRS.

And Congress.

Neither were amused by this. The insurance whiz kids were using insurance to mimic a tax shelter.

Congress introduced “modified endowment contracts” into the tax Code. The acronym is pronounced “meck.”

The definition of a MEC can be confusing, so let’s try an example:

(1)  You are age 48 and in good health.

(2)  You buy $4,000,000 of permanent life insurance.  

(3)  You anticipate working seven more years.

(4)  You ask the insurance company what your annual premiums would be to pay off the policy over your seven-year window.

(5)  The company gives you that number.

(6)  You put more than that into the policy over the first seven years.

I used seven years intentionally, as a MEC has something called a “7 pay test.” Congress did not want insurance to morph into an investment, which one could do by stuffing extra dollars into the policy. To combat that, Congress introduced a mathematical hurdle, and the number seven is baked into that hurdle.     

If you have a MEC, then the following bad things happen:

(1) Any distributions or loans on the policy will be immediately taxable to the extent of accumulated earnings in the policy.

(2) That taxable amount will also be subject to a 10% penalty if one is younger than age 59 ½.

Congress is not saying you cannot MEC. What it is saying is that you will have to pay income tax when you take monies (distribution, loan, whatever) out of that MEC.

Let’s get back to normal, vanilla life insurance.

Let’s talk about Robert Doggart.

Doggart had two life insurance contracts with Prudential Insurance. He took out loans against the two policies, using their cash value as collateral.

Yep. Happens every day.

In 2017 he stopped paying premiums.

This might work if the earnings on the cash value can cover the premiums, at least for a while. Most of the time that does not happen, and the policy soon burns out.

Doggart’s policies burned out.

But there was a tax problem. Doggart had borrowed against the policies. The insurance company now had loans with no collateral, and those loans were uncollectible.   

You know there is a 1099 form for this.

Doggart did not report these 1099s in his 2017 income. The IRS easily caught this via computer matching.

Doggart argued that he did not have income. He had not received any cash, for example.

The Court reminded him that he received cash when he took out the loans.

Doggart then argued that income – if income there be - should have been reported in the year he took out the loans.

The Court reminded him that loans are not considered income, as one is obligated to repay. Good thing, too, as any other answer would immediately shut down the mortgage industry.  

The Court found that Doggart had income.

The outcome was never in doubt.

But why did Doggart allow the policies to lapse in 2017?

Because Doggart was in prison.

Our case this time was Doggart v Commissioner, T.C. Summary Opinion 2023-25.

Monday, July 31, 2023

An IRS Payment Plan And Tax Evasion

 

Let’s talk today about IRS payment plans. More specifically, let’s talk about common paperwork in requesting a payment plan.

A common one is Form 433-A, and it is used by W-2 workers and self-employeds.

The IRS is trying to figure out how much you earn, own, and owe.

There are questions about whether you (or your spouse) own a business, are a beneficiary of a trust or have gifted property worth more than $10,000 over the last 10 years. Yes, they wanna know stuff.

You will have to list your bank accounts, as well as other investments, real estate and other assets.

You will have to provide an accounting of your monthly income and expenses.

There is also expanded disclosure if you are self-employed (that is, a sole proprietor).

There are other ways to own a business than as a proprietor (for example, a shareholder in a C corporation). The IRS will want to know about that, too.

Part of tax practice is avoiding this series, if possible. For example, if you have personal tax debt of $50,000 or less, you can bypass the 433 series and request a “streamlined” payment plan. You are still entering into a contract with the IRS (you must stay current with your filings, make all payments as required, and so on), but in exchange the IRS lifts some of the paperwork requirements. Sometimes advisors recommend hybrid arrangements (taking out a second mortgage, for example), leaving the IRS debt at $50 grand or less. And sometimes you are simply into the IRS for more than $50 grand, leaving no choice but to run the 433 gauntlet. This can be a rude awakening, as the IRS uses standards for certain expense categories (for example, housing and utilities). You might google that you can request an increase from these standards. You can request; don’t expect to receive, though. Barring significant factors (think care for chronic medical conditions), it is unlikely to happen. Depending on the numbers, you might be forced to downgrade a vehicle or pull the kids from a private school. This is not a friendly loan.  

And you do not want to be … sly … when running the 433 hurdles.

Let’s look at someone who was too clever by half.

Kevin Crandell is a medical doctor. He contracted with two hospitals, one in Mississippi and another in Alabama, for $30 to $40 grand per month.

From 2006 through 2012 he did not file returns or pay taxes.

The IRS started garnishing his wages in 2010.

COMMENT: I find it remarkable that he still did not file or pay even when garnished.

The doctor racked up close to a million dollars in taxes, penalties, and interest.

Somewhere in there he formed a couple of corporations. He used one to receive monies earned as a contractor. The second appeared to serve as asset protection.

He finally hired someone (Blue Tax) to help out with tax returns and attendant debt.

Blue Tax drafted a 433. The first draft showed Crandell’s salary as $17 grand per month (I don’t know where the rest of the money went either). The doctor howled that the number was much too high and should be closer to $12 grand.

Oh, the 433 also left out bank accounts for those two corporations (which he controlled). And a $50,000 gun collection. And the $40 grand he drew from the corporations shortly after submitting a 433 stating that his salary was around $12 grand.

Doc, you have to know when to stop. Lying, and then lying about the lying is called something in tax.

Crandell was indicted for fraud.

That pattern of non-file and non-pay looked bad now. That “creative” 433 also gleamed like a badge of fraud, leaving off income, assets and so on.

Crandell argued that he relied on Blue Tax.

It is a good argument - an excellent argument, in fact - except that he did not fully disclose to Blue Tax. If you want to show reliance on an advisor, you have to … you know … actually rely on the advisor.

Crandell was convicted for tax evasion.

Our case this time was US v Crandell, 2023 PTC 178 (5th Cir. 2023).

Monday, July 17, 2023

Income And Cancellation of Bank Debt

 

There is a basic presumption in the tax Code that any accession to “wealth” is income. It isn’t much of a leap for the tax Code to then say that all income is taxable unless otherwise excluded.

Let’s next look at “wealth.” I propose a working definition as follows:

          Assets (A) = Liabilities (L) + Wealth (W)

A little algebra shows the following:

          A – L = W

Here is spiff on the above: do you have wealth if your liabilities go down?

Let’s look at the Katrina White case.

Katrina started a business in 2015. She took out a business loan for $15,000. She leased space for her business, signing a three-year lease.

The business did not work out. The family lent her $8 grand, but there was no way to save it. She had repaid the bank less than a grand when her remaining debt of $14,433 was discharged. The bank sent her a 1099, of course, as all American life events can apparently be reduced to a 1099.

Katrina never made a payment on the lease. Since rent was late for more than two months, the entire lease became due and payable. That fiasco totaled $21,700.

 She filed her return.

The IRS said she left out income of $14,433.

How?

Let’s go through it.

Katrina said that her wealth (that is, A – L = W) was as follows when the business failed:                 

Real property

28,500

Personal property

3,560

32,060

Student loans

5,294

Utilities

961

Utilities, estimated

2,500

Furniture loan

1,120

Judgements

8,128

Bank loan

14,433

Lease breach

21,700

Family loan

7,800

61,936

Net wealth

(29,876)

The IRS wasn’t buying this. They argued that:

·      The estimated utilities were a no go.

·      The family loan wasn’t really a “loan.”

·      While we are at it, the lease breach wasn’t really a loan, as the landlord had no intention of enforcing the debt.

The IRS math was as follows:

Real property

28,500

Personal property

3,560

32,060

Student loans

5,294

Utilities

961

Furniture loan

1,120

Judgements

8,128

Bank loan

14,433

29,936

Net wealth

2,124

The matter went to Tax Court.

The Court pointed out the obvious: Katrina signed a valid and binding lease contract. Perhaps the landlord decided that there was nothing there to pursue, but it cannot be argued that she had an enforceable debt.

The Court saw the following:

Real property

28,500

Personal property

3,560

32,060

Student loans

5,294

Utilities

961

Furniture loan

1,120

Judgements

8,128

Bank loan

14,433

Lease breach

21,700

51,636

Net wealth

(19,576)

Let’s recap our numbers:

Wealth per Katrina was          ($29,876)

Wealth per the IRS was              $2,124

Wealth per the Court was        ($19,576)

Remember what we said at the beginning, that all income is taxable unless there is an exception?  Well, there is an exception for cancellation of debt. Several, in fact, but today we are concerned with only one: insolvency. The Code says that one does not have income to the extent that one is insolvent.

What is insolvency?

Go back to the formula: A – L = W.

To the extent that “W” is negative, one is insolvent. Another way of saying it is that one has more debts than assets.

So, who showed negative “W”?

Well, Katrina did. So did the Court.

Katrina was insolvent. That was an exception to cancellation of indebtedness income. Katrina did not have taxable income. The IRS lost.

Our case this time was Katrina White v Commissioner, T.C. Memo 2023.-77.