Academic journal article Journal of Accountancy

Canceled Debt Is Partially Excludable: A Married Couple's Interest in Their Retirement Plan Was Not an Asset for Purposes of the COD Insolvency Test

Academic journal article Journal of Accountancy

Canceled Debt Is Partially Excludable: A Married Couple's Interest in Their Retirement Plan Was Not an Asset for Purposes of the COD Insolvency Test

Article excerpt

The Tax Court held that a married couple's interest in their retirement account was not considered an asset for purposes of the cancellation-of-debt (COD) insolvency test, and thus the taxpayers could exclude a portion of the income from the debt forgiveness. According to the court, the retirement account could not be used to immediately pay any income tax due to the discharged debt and therefore was not an asset for purposes of the test.

Facts: On June 30,2009, GMAC Mortgage canceled $448,671 of David and Janet Schieber's debt ($418,596 of principal and $30,076 of interest) secured by real property that was not their principal residence. On that date, their liabilities were $1,218,227, and the fair market value (FMV) of the Schiebers' assets was $924,919. In addition to those assets, David Schieber was a retiree receiving lifetime monthly payments from a defined benefit pension plan. The pension payments would continue to Janet Schieber after his death, but the couple could not borrow from or against the plan, sell their interest in it, assign it, or receive a lump-sum cash payment in exchange for their interest in it.

The Schiebers had never deducted the canceled interest of $30,076 on previous tax returns; therefore, under Sec. 108(e)(2), they excluded it from income on their 2009 return. Claiming insolvency, the couple also excluded $346,418 of the canceled principal from income and reported the remaining $72,178 as income. The IRS issued a notice of deficiency for tax year 2009 on the basis that the entire $418,596 of canceled principal was income because the Schiebers were solvent at the date of the debt cancellation. The taxpayers petitioned the Tax Court for relief.

Issues: Generally, cancellation of debt results in taxable income. However, Sec. 108 excludes certain debt forgiveness from income including the cancellation of (1) qualified principal residence indebtedness; (2) any debt that, if paid, would have resulted in a tax deduction; and (3) debt forgiven when, and to the extent that, the taxpayer was insolvent. …

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