The US Tax Court held that the assessee is not liable for tax on cancellation of indebtedness income but is liable for tax rental income.
The court remarked that the business income at issue is not in dispute, so we do not discuss it further. The only disputed income is from cancellation of indebtedness, totaling $322,459 in 2011 and 2012. Gross income generally includes income from the discharge of indebtedness. The rationale of this principle is that the cancellation of indebtedness provides the debtor with an economic benefit that is equivalent to income. However, a cancellation of indebtedness may be excluded from income if, and to the extent to which, a taxpayer is insolvent. A taxpayer is insolvent if he has an “excess of liabilities over the fair market value of assets.
The court noted that income from the cancellation of indebtedness in 2011 and 2012 was not included in the cancellation of indebtedness issue pleaded in the Commissioner’s answer but was raised for the first time in a pretrial memorandum.
Facts
During 2011 through 2014, the years at issue, P and W owned and operated several businesses that provided tax and financial services to clients. P’s primary source of income was P’s business SBP, a bill pay service that allowed clients of P to use credit cards to pay expenses that otherwise required cash or check payments. P and W did not keep records, and they intermingled their personal and business expenditures. P failed to file tax returns for tax years 2011 through 2014. For those years, R conducted a bank deposit analysis and determined deficiencies in tax totaling over $1.7 million as well as additions to tax for failure to file, fraudulent failure to file, and failure to pay estimated income tax. R issued Notices of Deficiency (“NODs”) to P and W. In 2018 P filed a timely petition disputing the NODs, but W failed to timely file a petition. In 2019 P and W submitted late returns for 2011 through 2014. In this case R accepted the income as reported on the late returns; R denied many of the deductions claimed on the returns but allowed some; and R newly asserted income from cancellation of indebtedness.
Also Read: US Tax Court Dismisses Case On Failure Of Dept. Prove Deficiency Notice Properly Mailed To Assessee
Conclusion
The court observed that P is not liable for cancellation of indebtedness income, because that issue was “new matter” as to which R bore the burden of proof under Rule 142(a)(1), but R failed to prove that P was not insolvent at the time the debt was canceled.
The court opined that P substantiated and is entitled to deduct business expenses in amounts slightly larger than those conceded by R; but P failed to substantiate most of the expenses in dispute. R did not prove by clear and convincing evidence that P’s failure to file returns was fraudulent for purposes of the I.R.C. § 6651(f) addition to tax for fraudulent failure to file, so P is not liable for that addition to tax. P is liable for additions to tax under I.R.C. §§ 6651(a)(1) (for non-fraudulent failure to timely file), 6651(a)(2) (for failure to pay tax), and 6654 (for failure to pay estimated tax).
Also Read: Failure Of Assessee To Prove Business Activity, Tax Deduction Not Allowable: US Tax Court
Case Details
Case name: Lawrence Leroy Henry V/S Commissioner Of Internal Revenue
Citation: T.C. Memo. 2024-79
Court: United States Tax Court
Decision Date: 22/08/2024
Coram: Gustafson Judge
