T.C. Summary Opinion 2001-67

UNITED STATES TAX COURT

EDWARD D. AND DONNA L. JOHNS, Petitioners v.

COMMISSIONER OF INTERNAL REVENUE, Respondent

Docket No. 13763-99S. Filed May 9, 2001.

Edward D. Johns, pro se.

Brandi B. Darwin (specially recognized) and Stephen R.

Takeuchi, for respondent.

PAJAK, Special Trial Judge: This case was heard pursuant to

the provisions of section 7463 of the Internal Revenue Code in

effect at the time the petition was filed. The decision to be

entered is not reviewable by any other court, and this opinion

should not be cited as authority. Unless otherwise indicated,

subsequent section references are to the Internal Revenue Code in

effect for the year in issue.
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Respondent determined a deficiency of $4,538 and an addition

to tax under section 6651(a)(1) of $680 for 1996. Petitioners

concede that they should have included an additional $4 of

interest income in their gross income and that they are liable

for the failure to file addition to tax under section 6651(a)(1). 

This Court must decide whether $13,938 of discharge of

indebtedness income is includable in petitioners' 1996 gross

income. 

Some of the facts in this case have been stipulated and are

so found. Petitioners resided in Ft. Myers, Florida, at the time

they filed their petition.

In 1996, the job of petitioner Edward Johns (petitioner) was

terminated. Petitioner knew he and his wife were overextended on

credit card debt and that they would be faced with financial

problems. Petitioners were headed for bankruptcy. Some of the

creditors offered petitioners a settlement for less than the full

amount of debt due. Petitioners paid a portion of the debts to

these creditors and in return the remainder of the debts were

discharged. Petitioners withdrew $17,511 from their retirement

account, and paid the early withdrawal penalty on this amount, in

order to use part of the amount to satisfy their debts.
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In 1996, on the dates set forth below, petitioners made the

following payments and the following portions of their credit

card loans were forgiven by the lenders.

 Date Payments Discharge Total

MBNA Aug. 27 $1,300 $3,254 $4,554 

MBNA Aug. 27 2,000 4,507 6,507

Barnett Bank N.A. Sept. 30 2,500 1,535 4,035

Nationsbank of

 Delaware N.A. Oct. 29 3,605 4,642 8,247

Total of debts discharged $13,938

None of the aforementioned amounts included interest which

would have been deductible if paid. All of the debts that were

discharged were valid debts. Petitioners did not file for

bankruptcy in 1996. Petitioners did not include the $13,938 of

discharged debt in their gross income on their 1996 Federal

income tax return. Respondent determined that the income from

the discharge of petitioners' debts must be included in their

gross income because petitioners' creditors forgave the debts.

Based on the testimony and the exhibits presented at trial,

we find that petitioners had the following liabilities prior to

the discharge of the loans on August 27, 1996:

Fleet Mortgage $54,311

 Nationsbank 8,247

 MBNA America 4,554

 MBNA America 6,507

 Barnett Bank 4,035

 Chemical Bank 9,238
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 Bank of New York 7,574

 G.E. Capital Credit 4,559

 Florida Power and Light Credit Union 6,746

 First North American National Bank 2,500

 First Union Bank 15,253

 $123,524

On August 27, 1996, petitioners had the following assets:

 House, assessed value $55,490

 FPL thrift plan 35,371

 Thrift plan withdrawal 17,511

 MetLife annuity 20,840

 Van 5,000

 Furniture, etc. 6,000

 Automobile 3,000

 Sedan 2,500

 Cash and bank accounts 2,000

 Trailer 100

 $147,812

In addition, petitioners had potential interests in the FPL

pension plan and the Florida Retirement System, which we find

unnecessary to address in this case, as explained below.

On August 27, 1996, when the MBNA loans were discharged,

petitioners had assets of $147,812 and liabilities of $123,524.

On September 30, 1996, when the Barnett Bank N.A. loan was

discharged, petitioners had assets of $144,512 ($147,812 less the

payments to MBNA of $1,300 and $2,000) and liabilities of

$112,463 ($123,524 less the MBNA debts of $4,554 and $6,507).

On October 29, 1996, when the Nations Bank loan was

discharged, petitioners had assets of $142,012 ($144,512 less the

payment to Barnett Bank of $2,500) and liabilities of $108,428

($112,463 less the Barnett Bank debt of $4,035).
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Petitioner stated: "If I have to pay income tax on the

portion the [companies] cancelled I will have learned one thing. 

It does not pay to try and do the right [and] moral thing, just

file bankruptcy [and] clear your debts." Petitioners contend

that they should not have to include the $13,938 of discharged

debt in their income because they were insolvent in 1996. 

Respondent contends that petitioners were not insolvent in 1996

because all of petitioners' property should be included in the

calculation of the fair market value of their "assets" under

section 108(d)(3), regardless of whether some property is exempt

from creditors' claims under State law.

Under section 61(a)(12), gross income includes "all income

from whatever source derived, including * * * income from

discharge of indebtedness". Under certain circumstances, a

taxpayer may exclude from gross income the income from discharge

of indebtedness if the discharge occurs when the taxpayer is

insolvent. Sec. 108(a)(1)(B). The exclusion cannot exceed the

amount by which the taxpayer is insolvent. Sec. 108(a)(3). For

purposes of this section, "insolvent" is defined as "the excess

of liabilities over the fair market value of assets." Sec.

108(d)(3). Such a determination is to be made on the basis of

the taxpayer's assets and liabilities immediately before the

discharge. Sec. 108(d)(3). 
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Under the Florida Constitution, Florida residents are

provided with a homestead exemption. Fla. Const. art. 10, sec. 4

(West 1965). Under this exemption, in general, the debtor's

residence and the debtor's personal property to the value of

$1,000 are exempt from creditors. Id. The Florida Statutes also

provide exemptions for annuities and certain pension, retirement,

and profit-sharing plans. Fla. Stat. Ann. secs. 222.14, 222.21

(West 1998). A debtor's interest, not to exceed $1,000 in value,

in a single motor vehicle is also exempt from creditors. Fla.

Stat. Ann. sec. 222.25 (West 1998). Therefore, under Florida

law, petitioners' creditors would not be able to attach

petitioners' home, $1,000 of the automobile, $1,000 of personal

property, the interests in the FPL Thrift Plan and the MetLife

annuity, and the potential interests in the FPL pension and the

Florida Retirement System.

Even so, for purposes of section 108(a)(1)(B) and (d)(3),

petitioners cannot exclude from their assets the property exempt

under Florida law. This Court recently held that property exempt

from creditors under State law may not be excluded from "assets"

when making an insolvency determination under section

108(a)(1)(B) and (d)(3). Carlson v. Commissioner, 116 T.C. 87

(2001). 

As set forth above, on each of the three dates on which

petitioners’ debts were discharged, petitioners’ assets exceeded
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their liabilities. We understand that petitioners considered

themselves insolvent in 1996, but at all relevant times

petitioners were solvent at the time their debts were discharged

within the meaning of section 108(a).

Because petitioners were solvent, we need not address

whether the potential benefits under the FPL pension plan and the

Florida Retirement System, which petitioners had no access to in

1996, should be included in "assets". Nor do we need to decide

whether the fair market value of the home was greater than the

assessed value of the home.

On this record, we hold that petitioners must include the

$13,938 of discharged debt in their 1996 gross income, pursuant

to section 108(a)(1)(B). 

To the extent we have not addressed any of the parties'

arguments, we have considered them and find them to be without

merit. 

Reviewed and adopted as the report of the Small Tax Case

Division.

Decision will be entered

for respondent.