internal_revenue_service national_office technical_advice_memorandum date number release date cc dom it a b6 third party contact index uil no case mis no appeals taxpayer's name taxpayer's address taxpayer's identification no years involved date of conference legend taxpayer tam-109572-99 x y z d year case issue does sec_461 of the internal_revenue_code prevent taxpayer from deducting the amount of a judgment entered against him prior to its payment conclusion sec_461 of the code prevents taxpayer from deducting the amount of a judgment entered against him prior to its payment facts taxpayer has engaged in the oil_and_gas business and used the accrual_method of accounting to report his income from such business in this case he claims a deduction in year in the amount of a judgment entered against him in that year the appeals officer has tentatively determined that the economic_performance requirement found in sec_461 of the code bars deduction of the judgment prior to its payment as explained below resolution of this issue requires us to determine the nature of taxpayer’s liability according to the court’s findings_of_fact and conclusion of law a binding contract was reached for the sale of certain royalty interests in an oil lease plaintiffs were the owners of the interests and were represented by x another party acting as agent y represented the buyer as explained below the identity of the buyer or buyers is not entirely clear from the court’s findings portions of the findings suggest taxpayer was a buyer while other portions indicate that taxpayer employed a corporate entity z to enter into the contract in any event the court found that the buyer had failed to perform its obligations under the sale contract and that as a result plaintiffs had suffered damages in the amount of d dollars the amount by which the fair_market_value of the royalty interests had declined between the date of the contract and the time the buyer failed to perform the court further found that taxpayer never intended to perform or cause to be performed the buyer’s obligation under the contract unless he was able to resell the royalty interests for a profit because taxpayer was unable to resell the interests for a profit the default occurred the court found taxpayer guilty of fraud both actual and constructive the court entered a separate final judgment in the amount of d dollars the record in this case indicates that taxpayer has not paid any portion of the judgment law and analysis sec_1_461-1 of the income_tax regulations provides that under an accrual_method of accounting a liability is incurred and generally is taken into account for federal_income_tax purposes in the taxable_year in which all the events have occurred that establish the fact of the liability the amount of the liability can be determined with reasonable accuracy and economic_performance has occurred with respect to the liability sec_461 of the code provides that if the liability of the taxpayer requires a payment to another person and arises under any worker’s compensation act or arises out of any tort economic_performance occurs as the payments to such person are made the legislative_history of code sec_461 suggests that congress imposed the economic_performance requirement because of a concern that permitting taxpayers to deduct otherwise incurred liabilities that are to be paid in the future results in an overstatement of deductions given the time_value_of_money allowing a taxpayer to take deductions currently for an amount to be paid in the future overstates the true cost of the expense to the extent the time_value_of_money is not taken into account the deduction is overstated by the amount the face value exceeds the present_value of the expense staff of the joint_committee on taxation 98th cong 2d sess general explanation of the revenue provisions of the deficit_reduction_act_of_1984 it also appears that congress viewed worker’s compensation and tort liabilities as presenting special problems due to the lapse of time between accrual and payment reference is made to case law permitting deductions of amounts to be paid at uncertain future dates t he ninth circuit held that the fact of the liability under workmen’s compensation laws is determined in uncontested cases in the year in which injury occurs even though medical services may be rendered and disability may occur at a future time id pincite in drafting regulations interpreting the economic_performance requirement treasury extended the payment requirement to certain liabilities arising from the breach of contract the preamble to the regulations indicates a concern that drawing a distinction between tort and other liabilities may prove difficult in some cases the payment rule was chosen because of the nature of the liabilities and the difficulty in applying the statutory rules to these liabilities for example in the case of liabilities arising out of the breach of contract or violation of law it is often difficult to distinguish among actions based on breach of contract violation of law and tort because many such actions are brought on alternative grounds and settled without any objective determination of the prevailing theory t d 1992_1_cb_158 this regulatory extension of the payment requirement has no bearing on this case however because it applies only to liabilities otherwise incurred in taxable years beginning after date sec_1_461-4 thus the economic_performance rules prohibit taxpayer from deducting the amount of the judgment prior to its payment if the judgment represents a liability arising out of a tort we conclude that it does the court’s findings_of_fact and conclusion of law refute taxpayer’s assertion that the liability is based on a simple breach of contract taken as a whole the document indicates that taxpayer was not a party to the contract and that taxpayer’s personal liability is premised on his fraud true the court did state that taxpayer was a principal or buyer as well as an agent but the court also stated that the corporate fiction if any of z was used as a sham by taxpayer to perpetrate a fraud by taxpayer and should be disregarded if taxpayer were a party to the contract and his liability were based on simple breach of that contract there would be no need to disregard the corporate entity correspondence referenced by the court in its findings also indicates that z not taxpayer was the contracting party y indicates in an offer letter to x that it will purchase the royalty interests for the account of z another letter one from y to taxpayer confirms the existence of a sale agreement between the sellers and z it also contains a signature line for z that appears to be signed by taxpayer in a representative capacity as an officer of the corporation moreover the final judgment of the court emphasizes taxpayer’s fraud not any breach of contract in finding taxpayer liable taxpayer was guilty of such false pretenses or false representations as to be liable to plaintiffs in this transaction taxpayer points out that the amount of the judgment represents the difference between the contract_price of the royalty interests and the fair_market_value of the interests upon default and that these are the type of benefit of the bargain damages that are traditionally awarded in contract cases but benefit of the bargain damages are also awarded in fraudulent inducement cases so this point is not conclusive case caveat s a copy of this technical_advice_memorandum is to be given to the taxpayer sec_6110 of the code provides that it may not be used or cited as precedent


t c summary opinion united_states tax_court gerard eugene stevens petitioner v commissioner of internal revenue respondent docket no 13218-06s filed date gerard eugene stevens pro_se julie jebe for respondent goldberg special_trial_judge this case was heard pursuant to the provisions of sec_7463 of the internal_revenue_code in effect at the time the petition was filed pursuant to sec_7463 the decision to be entered is not reviewable by any other court and this opinion shall not be treated as precedent for any other case unless otherwise indicated subsequent section references are to the internal_revenue_code hereafter code in effect for the year in issue and all rule references are to the tax_court rules_of_practice and procedure respondent determined a dollar_figure deficiency in petitioner’s federal_income_tax for and a dollar_figure accuracy-related_penalty under sec_6662 the issues for decision are whether petitioner failed to include in income for income_from_discharge_of_indebtedness and whether petitioner is liable for the accuracy-related_penalty under sec_6662 background some of the facts have been stipulated and are so found the stipulation of facts and the attached exhibits are incorporated herein by this reference petitioner resided in illinois when he filed his petition sometime in either january or date petitioner and his former spouse sharon stevens the stevenses purchased real_property located pincite south wabash avenue chicago illinois the property purchased was a two-story residence in need of rehabilitation the stevenses purchased the property for investment purposes and intended to rehabilitate the dwelling and either rent the property or sell it thereafter petitioner and sharon stevens ms stevens were married at the time the real_property was purchased and they resided in evergreen park illinois the purchase_price of the property was approximately dollar_figure the stevenses financed the purchase by borrowing money from homecomings financial the stevenses executed a note and deed_of_trust mortgage with homecomings financial and held title to the property as joint_tenants the record does not contain the note and deed_of_trust mortgage sometime later in the stevenses found themselves unable to make the mortgage payments on the property in order to avoid a foreclosure which would have adversely affected their credit rating they decided to sell the property in a short sale1 with the approval of homecomings financial on date the stevenses sellers entered into a purchase agreement with jemal king buyer to sell the property for dollar_figure at that time the unpaid balance of the mortgage was greater than the selling_price on date the stevens separated petitioner moved from the marital residence in evergreen park illinois to chicago illinois the short_sale occurred on or about date the property was conveyed to jemal king by warranty deed executed by the stevenses and recorded with the cook county recorder of deeds on date a short_sale in real_estate occurs when the outstanding loans against a property are greater than what the property is worth and the lender agrees to accept less than it is owed to permit a sale of the property that secures its note homecomings financial approved the short_sale subject_to the following terms and conditions homecomings financial was to receive no less than dollar_figure for satisfaction of the debt certified payoff funds were to be received no later than date homecomings financial was to receive a certified copy of the final hud settlement statement showing all taxes as paid the stevenses were to receive no sale proceeds in the transaction and any excess funds were to be forwarded to homecomings financial the sale price was to be dollar_figure real_estate commissions were not to exceed dollar_figure and closing costs including taxes and repairs were not to exceed dollar_figure these terms and conditions extended only to the short_sale of the property to jemal king by the purchase agreement dated date additionally if the foregoing conditions were not met homecomings financial reserved the right to return the payoff funds and require payment in full in accordance with the original terms of the note and deed_of_trust mortgage homecomings financial also noted that it might report the amount of the discount to the internal_revenue_service homecomings financial subsequently mailed a form 1099-c cancellation of debt to petitioner at his previous address in evergreen park illinois the form 1099-c stated that the mortgage loan debt of dollar_figure was canceled by homecomings financial on date a duplicate form 1099-c was mailed to ms stevens also at the evergreen park illinois address reporting the same information as on the form 1099-c mailed to petitioner on date petitioner resided at the chicago address and ms stevens resided at the evergreen park address ms stevens received both copies of the form 1099-c and notified petitioner that she was in receipt of his copy neither petitioner nor ms stevens included the dollar_figure resulting from the cancellation of mortgage loan debt in income for when they filed their respective federal_income_tax returns further neither petitioner nor ms stevens reported the sale of the property on their respective income_tax returns discussion in general the commissioner’s determination as set forth in a notice_of_deficiency is presumed correct and the burden_of_proof is on the taxpayer to prove otherwise rule a 290_us_111 however under certain circumstances the burden shifts where a taxpayer introduces credible_evidence with respect to any factual issue relevant to ascertaining the income_tax_liability of the taxpayer sec_7491 the resolution of whether petitioner had cancellation_of_indebtedness_income does not depend on which party has the burden_of_proof for the reasons discussed infra we conclude that petitioner has failed to prove that he did not receive income from the relief of indebtedness furthermore sec_6201 as pertinent here provides that in any court_proceeding if a taxpayer asserts a reasonable dispute with respect to any item_of_income reported on an information_return such as a form_1099 filed by a third party and the taxpayer has fully cooperated with the internal_revenue_service the commissioner has the burden of producing reasonable and probative information concerning the deficiency in addition to information on the return itself petitioner does not dispute the information contained on the form 1099-c filed by homecomings financial therefore there is no burden of production on respondent generally a taxpayer must include income from the discharge_of_indebtedness see sec_61 sec_1_61-12 income_tax regs however there are exceptions to this general_rule sec_108 provides that a taxpayer may exclude income from the discharge_of_indebtedness if the discharge occurs in a bankruptcy case or when the taxpayer is insolvent or if the indebtedness is qualified farm or business real_estate debt although the real_estate property was held by the stevenses as investment_property for the production_of_income we cannot for lack of sufficient facts determine whether the exclusion for qualified_real_property indebtedness under sec_108 might apply likewise the record is devoid of sufficient facts upon which we may determine whether the exclusion for insolvency under sec_108 might apply the record is similarly devoid of evidence suggesting that homecomings financial intended to make a gift to the stevenses and to petitioner specifically where property subject_to recourse_debt is disposed of in satisfaction of the debt the debt is deemed discharged the disposition by the mortgagor of the property for a release of liability is treated as a sale_or_exchange upon which gain_or_loss is realized 111_tc_243 the amount of gain realized is the excess of the amount_realized over the taxpayer’s adjusted_basis in the property and correspondingly the amount of loss realized is the excess of the adjusted_basis over the amount_realized sec_1001 the amount_realized is defined by sec_1001 as the sum of any money received plus the fair_market_value of the property received petitioner’s gain_or_loss on the short_sale of the south wabash avenue property is computed pursuant to sec_1001 as a general_rule the amount_realized includes the full amount of the remaining debt if the debt is nonrecourse sec_1 a income_tax regs sec_1_1001-2 income_tax regs however provides the amount_realized on a sale_or_other_disposition of property that secures a recourse_liability does not include amounts that are or would be if realized and recognized income from the discharge_of_indebtedness under sec_61 this regulation actually bifurcates a transaction such as the present one into a taxable sale of property and a taxable discharge_of_indebtedness cf 87_tc_1412 accordingly under this regulation each part should be treated as a separate transaction for tax purposes id while the stevenses’ amount_realized for the south wabash avenue property would be dollar_figure the application of sec_1_1001-2 income_tax regs reduces that sum by the amount of income received from discharge_of_indebtedness although the note and deed_of_trust mortgage is not in evidence on the basis of the record we feel confident that the note was a recourse_liability therefore the stevenses’ amount_realized for the property was dollar_figure accordingly the stevenses realized no capital_loss on the sale of the south wabash avenue property see sec_1001 the stevenses realized dollar_figure of ordinary_income from discharge_of_indebtedness see sec_61 sec_1_61-12 income_tax regs since petitioner has not proven this amount represents the sum of dollar_figure the net amount to be received at closing and accepted by homecomings financial on the short_sale and dollar_figure the amount characterized as income from cancellation of debt on the form 1099-c that homecomings financial issued to the stevenses that any of the aforementioned exceptions under sec_108 applies to his case we hold that petitioner’s income for includes the dollar_figure from the discharge_of_indebtedness that was not reported on his return sec_6662 accuracy-related_penalty in the notice_of_deficiency respondent determined that petitioner was liable for the accuracy-related_penalty under sec_6662 for underpayment_of_tax sec_6662 imposes a 20-percent penalty with respect to any portion of an underpayment_of_tax required to be shown on a return this penalty applies to underpayments attributable to any substantial_understatement_of_income_tax sec_6662 and b an understatement of income_tax is defined as the excess of the tax required to be shown on the return over the tax actually shown on the return sec_6662 an understatement is substantial if it exceeds the greater of percent of the tax required to be shown on the return or dollar_figure sec_6662 under the applicable illinois statute as joint_tenants the stevenses are jointly and severally liable for all debts and obligations arising from their ownership of the south wabash avenue property ill comp stat ann west accordingly and in light of our decision petitioner might look to a civil remedy against ms stevens either under illinois law or pursuant to sec_6015 for contribution as to the amount of tax due as a result of the income from cancellation of indebtedness for sec_6664 provides a defense to the accuracy-related_penalty if a taxpayer establishes that there was reasonable_cause for any portion of the underpayment and that he or she acted in good_faith with respect to that portion sec_6664 sec_1_6664-4 income_tax regs although not defined in the code reasonable_cause is determined under the regulations on a case- by-case basis taking into account all the pertinent facts and circumstances sec_1_6664-4 income_tax regs the taxpayer’s education experience and knowledge are considered in determining reasonable_cause and good_faith id and generally the most important factor is the extent of the taxpayer’s effort to assess his or her proper tax_liability id respondent determined an accuracy-related_penalty under sec_6662 to be applicable because petitioner understated his income_tax by dollar_figure on his return because petitioner’s understatement_of_tax was greater than percent of the tax required to be shown on the return or dollar_figure the understatement was a substantial_understatement_of_income_tax pursuant to sec_6662 petitioner argues that he should not be held liable for the penalty because of his reliance on ms stevens to report all of the form 1099-c income from the cancellation of indebtedness on her income_tax return since both forms 1099-c were mailed to her address respondent carries the burden of production under sec_7491 with respect to the accuracy-related_penalty under sec_6662 to meet that burden respondent must come forward with sufficient evidence indicating that it is appropriate to impose the penalty the burden_of_proof to establish reasonable_cause remains with petitioner see 116_tc_438 we conclude that petitioner has failed to show that his reliance on ms stevens’s reporting the full amount of income and paying the requisite tax on that income was reasonable petitioner admitted that he knew ms stevens had received both forms 1099-c and that the amount at issue dollar_figure should have been reported--either in full or in part--on one of or both of the stevenses’ returns for that year the record is silent as to any facts that would have led to a reasonable assumption on the part of petitioner that he was not responsible for reporting the amount contained on the form 1099-c in income petitioner has therefore failed to carry his burden of showing any reasonable_cause for the underpayment_of_tax for see sec_6664 on the entire record before us we hold that petitioner has failed to carry his burden of proving that he is not liable for an accuracy-related_penalty for under sec_6662 we accordingly sustain respondent’s determination with respect to that issue decision will be entered for respondent