Taxation of Discharge of Indebtedness

I.R.C. Section 108(a)(1)(B), insolvency exception

In Vincent C. Hamilton and Stephanie Hamilton v. Comm’r, T.C. Memo 2018-62, filed May 8, 2018, the Tax Court explores a common exception to inclusion of discharge of indebtedness in gross income. Gross income generally includes discharge of indebtedness – I.R.C. section 61(a)(12). Section 108(a)(1)(B) excludes income from the discharge of indebtedness from gross income if the discharge occurs when the taxpayer is insolvent. Insolvency is measured by comparing the excess of the taxpayer’s liabilities over the fair market value of the taxpayer’s assets immediately before discharge. Taxpayers borrowed money in order to finance their son’s education. The husband ultimately injured his back and became permanently disabled. The student loan provider discharged over $158,000 in student loan debt. Husband then exhibited poor money management skills and his wife took over their finances. To protect their assets, she transferred $323,000 into their son’s savings account. She had the password and permission from her son to transfer money. She did this regularly during the year at issue to pay bills from her joint account with her husband. When filing the return, their accountant advised they were insolvent and claimed as much on the return. He had not included the value of the savings account in the son’s name. In this case, the sole issue is whether or not a bank account of taxpayers’ son should be included in their asset calculation. In this case, the taxpayers failed to prove that their son was not their nominee because they continued to enjoy the benefits of the funds they transferred to their son’s savings account. There was no evidence that the son paid any consideration for the funds transferred to his savings account by the taxpayers. As such, the funds were included as assets of the taxpayers, and the taxpayers were no longer insolvent.