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Tax Court upholds tax on debt forgiveness for two Eastern Iowans

June 09, 2009

It's easy to dig a financial hole by running up consumer debt. The tax law works to keep you down there, as two eastern Iowans found out yesterday in separate Tax Court cases.

Washington County Debt Wipeout

Timothy Fuller of Washington County in Southeast Iowa bought a used Pontiac Grand Am with his wife. They broke up, the wife didn't keep up her payments, and the car got repossessed. Eventually the finance company forgave the remaining debt and issued a 1099-C.

Mr. Fuller claimed that the debt forgiveness was excludible under the "insolvency" exception of Section 108. Under that section, debt forgiveness is excludible to the extent the fair market value of your assets before the forgiveness is less than your debts. Mr. Fuller argued his own case in Tax Court, and, unfortunately, it appears that he didn't put together good evidence of his insolvency (I have emphasized what I see as the key word):

We turn now to petitioner's argument that he was insolvent at the time of the discharge of the outstanding debt to Triad. In support of that argument, petitioner relies on his conclusory and uncorroborated testimony regarding certain assets that he owned at that time. We are not required to, and we shall not, rely on petitioner's testimony to establish the nature and the fair market value of each of his assets and the nature and the outstanding amount of each of his liabilities immediately before the discharge of the outstanding debt

Insolvent in Ossian?

Joseph Hakim is an entrepreneur in Ossian, near Decorah, where he runs a D.J. service and Mr. Computers USA. He ran up a credit card bill buying items for Mr. Computers USA and apparently had trouble keeping up with the payments. He worked out a deal with the bank, which forgave $7,239 of his balance. As is normal practice, they issued a 1099-C to Mr. Hakim.

Like Mr. Fuller, Mr. Hakim represented himself in Tax Court, and also like Mr. Fuller, he failed to produce evidence of insolvency strong enough to convince the Tax Court Judge:

We turn now to the documentary evidence on which petitioner relies. That evidence consists of (1) a list that he prepared shortly before the trial in this case of the assets and liabilities that he contends he had immediately before Advanta Bank discharged petitioner's debt (petitioner's list of assets and liabilities) and (2) certain Kelley Blue Book Web site printouts (Kelley Blue Book printouts) for certain models of certain vehicles. Petitioner's list of assets and liabilities is nothing more than a self-serving, conclusory, and uncorroborated list of the claimed fair market values of the assets and the claimed amounts of the liabilities that petitioner contends he had immediately before Advanta Bank's discharge of petitioner's debt. The Kelley Blue Book printouts show that book's values as of February 2, 2009, the date of the trial in this case, of certain models of certain vehicles that petitioner contends he owned immediately before that discharge. We are not required to, and we shall not, rely on petitioner's list of assets and liabilities and the Kelley Blue Book printouts to establish that petitioner was insolvent at the time of Advanta Bank's discharge of petitioner's debt.

Many taxpayers represent themselves in Tax Court, and sometimes they win. If you can't afford to pay your credit cards, it's likely that you don't want to incur lawyer costs. But if you are going to argue insolvency in Tax Court without a lawyer to help you get organized, you should be ready to spend a lot of time documenting the case.

You should start with a complete financial statement. It should list all of your bank accounts and debts at the time of the discharge, and each number should be supported by an account statement or confirmation from the lender (note the word "uncorroborated" in the Judge's rejection of the taxpayer's evidence). You should list all of your assets, including cars, with a statement of condition, photos, and a well-documented value. You should list your real property, with its assessed value and with recent comparable sales. You should list any other personal assets and liabilities. Finally, you should make sure all of the values you use tie out to your supporting documentation, and that the financial statements don't have math errors.

The Moral: it isn't easy to convince the Tax Court that you are insolvent. If you are going to try, you need to have your homework done before you show up in court.

Cites:

Fuller, T.C. Summ. Op. 2009-91
Hakim, T.C. Summ. Op. 2009-92

Tags: debt forgiveness.Judge Chiechi.tax court.