                  T.C. Summary Opinion 2004-143



                     UNITED STATES TAX COURT



         SIOANA U. AND S. MOLI NGATUVAI, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 10820-03S.              Filed October 18, 2004.


     Sioana U. and S. Moli Ngatuvai, pro se.

     Mark Howard, for respondent.



     PANUTHOS, Chief 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, and all Rule

references are to the Tax Court Rules of Practice and Procedure.
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     Respondent determined that petitioners are liable for a

deficiency in Federal income tax of $5,185 and an accuracy-

related penalty under section 6662 of $1,037 for the 2001 taxable

year.    After concessions,1 the issue for decision is whether

petitioners’ gross income for 2001 includes $30,714, the portion

of a loan discharged by the United States Department of

Agriculture during that taxable year.

Background

     Some of the facts have been stipulated, and they are so

found.    An oral stipulation of facts and the exhibits are

incorporated herein by this reference.    At the time of filing of

their petition, petitioners resided in Provo, Utah.

     In 1991, petitioners received a $50,000 loan from the United

States Department of Agriculture (USDA).    At the time,

petitioners were farmers in Hawaii who leased 20 acres of land

for a farming operation.    The loan, which was secured by the

farm,2 was to be used to make lease payments.   It is unclear from

the record whether the lease payments were ever made.




     1
        Respondent concedes that petitioners   are not liable for
the accuracy-related penalty under sec. 6662   of $1,037 for the
2001 taxable year. Petitioners concede that    they are not
entitled to an IRA deduction of $300 for the   2001 taxable year.
     2
        Petitioners assert that they owned the farm that was used
to secure the loan by the USDA. The circumstances surrounding
the ownership of this farm are unclear.
                                - 3 -

     In 1992, petitioners discontinued the farming operation and

moved to Utah.   Petitioners did not make any payments on the

loan.   On February 13, 1997, petitioners brought suit against the

USDA and other parties, claiming civil rights violations.      On

August 19, 1997, the United States District Court for the Central

District of Utah dismissed petitioners’ case against the USDA.

     On October 4, 1999, the USDA brought a foreclosure action

against petitioners.   Petitioners’ farm was sold at a public

auction during February 2001, and the sale proceeds were applied

against the outstanding balance of the loan from the USDA.        The

proceeds nevertheless were insufficient to extinguish the loan.

During the 2001 taxable year, the USDA issued Forms 1099-C,

Cancellation of Debt, regarding the remaining balance of the

loan.   Petitioners did not receive the Forms 1099-C.

     Petitioners own a home that they purchased in 1995 with a

$43,000 mortgage and that they estimate to be worth $60,000

during the 2001 taxable year.   Petitioners also own a truck which

they purchased for $300; respondent concedes that this truck had

negligible value in 2001.   During the 2001 taxable year,

petitioners owned stock that they purchased with a $15,000 loan.

Petitioners received a distribution of $3,930.14 from Wells Fargo

& Company during the 2001 taxable year.

     Petitioners filed a Form 1040, U.S. Individual Income Tax

Return, for the 2001 taxable year.      They did not report any
                               - 4 -

income from the discharge of the loan.   The 2001 tax return

listed petitioner Sioana U. Ngatuvai’s occupation as a “cook” and

petitioner S. Moli Ngatuvai’s occupation as a “carpenter”.

Petitioners reported wages of $42,861,3 of which $9,054.97 was

withheld for Federal income tax, Social Security tax, Medicare

tax, and State income tax.

Discussion

     As a general rule, the Internal Revenue Code imposes a tax

on the taxable income of every individual.   See sec. 1.   Section

61(a) defines gross income for purposes of calculating taxable

income as “all income from whatever source derived” and further

specifies that “Income from discharge of indebtedness” is

included within this broad definition.   Sec. 61(a)(12).   The

underlying rationale for such inclusion is that to the extent a

taxpayer is released from indebtedness, he or she realizes an

accession to income due to the freeing of assets previously

offset by the liability.   See United States v. Kirby Lumber Co.,

284 U.S. 1, 3 (1931).

     Statutory exceptions to the above rule are set forth in

section 108.   Section 108(a) excludes from the operation of

section 61(a) indebtedness (1) which is discharged in a title 11

case, (2) which is discharged when the taxpayer is insolvent, (3)


     3
        The Forms W-2, Wage and Tax Statement, indicate that
petitioners received wages of $42,638.20.
                               - 5 -

which consists of qualified farm indebtedness, or (4) which

consists of qualified real property business indebtedness.    Sec.

108(a)(1).

     With respect to the exclusion based upon a discharge when

the taxpayer is insolvent, the term “insolvent” is defined as the

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

108(d)(3).   Insolvency is determined on the basis of the

taxpayer’s assets and liabilities immediately before the

discharge.   See id.; Traci v. Commissioner, T.C. Memo. 1992-708.

Liabilities include excess nonrecourse debt, the amount by which

a nonrecourse debt exceeds the fair market value of the property

securing the debt, but only to the extent that the excess

nonrecourse debt is discharged.

     With respect to the exclusion based upon a discharge of

qualified farm indebtedness, indebtedness of a taxpayer is

treated as qualified farm indebtedness if two conditions are

satisfied.   First, such indebtedness must be incurred directly in

connection with the operation by the taxpayer of the trade or

business of farming.   Sec. 108(g)(2)(A).   Second, 50 percent or

more of the aggregate gross receipts of the taxpayer for the 3

taxable years preceding the taxable year in which the discharge

of such indebtedness occurs is attributable to the trade or

business of farming.   Sec. 108(g)(2)(B).
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     In general, taxpayers bear the burden of proof with respect

to whether they are entitled to an exclusion.   See Rule 142(a);

Welch v. Helvering, 290 U.S. 111, 115 (1933).   Exclusions from

gross income should be construed narrowly, and taxpayers must

bring themselves within the clear scope of the exclusion.   See

Dobra v. Commissioner, 111 T.C. 339, 349 n.16 (1998).    The burden

may shift to the Commissioner if the taxpayer introduces credible

evidence and satisfies the requirements under section 7491(a)(2)

to substantiate items, maintain required records, and fully

cooperate with the Commissioner’s reasonable requests.   Sec.

7491(a).

     In the present case, the burden of proof remains on

petitioners, since they have neither taken a position as to

whether the burden of proof should be placed on respondent nor

established that they have complied with the requirements of

section 7491(a).   As such, petitioners have failed to meet their

burden that they are entitled to any of the exclusions under

section 108(a)(1).   There is no evidence in the record that

discharge of the USDA loan occurred as part of a bankruptcy

proceeding or that the USDA loan constitutes a qualified real

property business indebtedness.   The record does not support a

conclusion that the USDA loan is a qualified farm indebtedness.

Petitioners were no longer in the trade or business of farming 3

years prior to the discharge of said loan in 2001, as required
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under section 108(g)(2)(B).   While the record is not clear as to

the exact date of discharge and can be characterized as

incomplete, we are convinced that the preceding facts found by us

are sufficient for us to conclude that petitioners were solvent

at the time the USDA loan was discharged.   Their assets in 2001

included stock of approximately $15,000, a home estimated to be

worth $60,000, a truck of negligible value, and moneys from wages

and distributions in excess of $30,000.   In comparison, their

liabilities in 2001 included the outstanding debt from their

mortgage of $43,000, the excess nonrecourse debt of $30,714 from

the USDA loan, and the $15,000 loan used to buy stock.    We

sustain respondent’s determination that petitioners must include

$30,714 in their gross income for 2001, such amount representing

the portion of the loan discharged by the USDA.4

     Reviewed and adopted as the report of the Small Tax Case

Division.




     4
        “The moment it becomes clear that a debt will never have
to be paid, such debt must be viewed as having been discharged.”
Cozzi v. Commissioner, 88 T.C. 435, 445 (1987); see also Rinehart
v. Commissioner, T.C. Memo. 2002-71. The fact that a taxpayer
did not receive a Form 1099 does not convert taxable income into
nontaxable income. Vaughn v. Commissioner, T.C. Memo. 1992-317,
affd. without published opinion 15 F.3d 1095 (9th Cir. 1993).
                            - 8 -

To reflect the foregoing,

                                          Decision will be entered

                                    for respondent with respect to

                                    the deficiency and for

                                    petitioners with respect to

                                    the accuracy-related penalty

                                    under section 6662.
