                        T.C. Memo. 2008-66


                      UNITED STATES TAX COURT



    ANCIL N. PAYNE, JR. AND MARY E. K. PAYNE, Petitioners v.
          COMMISSIONER OF INTERNAL REVENUE, Respondent



     Docket No. 21634-06.             Filed March 18, 2008.



     Ancil N. Payne, pro se.

     Trent D. Usitalo, for respondent.



             MEMORANDUM FINDINGS OF FACT AND OPINION


     HAINES, Judge:   Respondent determined a deficiency of $5,410

in petitioners’ Federal income tax for 2004.1   The sole issue for

decision is whether petitioners should have included $16,678 of



     1
        Unless otherwise indicated, all section references are to
the Internal Revenue Code, as amended, and all Rule references
are to the Tax Court Rules of Practice and Procedure. Amounts
are rounded to the nearest dollar.
                               - 2 -

discharge of indebtedness income on their 2004 Federal income tax

return.   We hold that they should have done so and therefore

sustain respondent’s determination.

                         FINDINGS OF FACT

     Some of the facts have been stipulated and are so found.

The stipulation of facts, together with the attached exhibits, is

incorporated herein by this reference.   At the time they filed

their petition, petitioners resided in Minnesota.

     At the end of 1992 petitioner Ancil N. Payne, Jr. (Mr.

Payne), opened a credit card account with MBNA America Bank.     Mr.

Payne used the credit card to pay hospital bills and receive cash

advances during periods of unemployment.    By April 26, 2004, Mr.

Payne had accumulated $21,407 of credit card debt.   At no time

did Mr. Payne challenge the accuracy of this amount.   Petitioners

were not insolvent in 2004, nor did they file for bankruptcy.

     By October 19, 2004, Mr. Payne and MBNA entered into an

agreement whereby MBNA agreed to accept $4,592 as a full

settlement of the account balance of $21,270, payable in

installments over 4 months.2   Mr. Payne made the necessary

payments, and MBNA issued him a Form 1099-C, Cancellation of

Debt, reporting $16,678 of discharge of indebtedness income.




     2
        Several of these payments had already been made by the
time the agreement was formalized.
                                 - 3 -

     On petitioners’ 2004 Form 1040, U.S. Individual Income Tax

Return, filed jointly in April 2005, petitioners did not report

any discharge of indebtedness income.    Instead, petitioners

attached a statement to their return which disclosed that they

received a Form 1099-C from MBNA that reported discharge of

indebtedness income of $16,678.    The statement also explained

that petitioners believed the amount disclosed on the Form 1099-C

was not subject to income tax.

     Respondent’s determination of a deficiency in petitioners’

Federal income tax for the taxable year 2004 was attributable to

petitioners’ failure to report the discharge of indebtedness

income.3

                              OPINION

     Section 61 generally defines gross income as “all income

from whatever source derived”.    Section 61(a)(12) specifically

provides that gross income includes income from the discharge of

indebtedness.   See also Gitlitz v. Commissioner, 531 U.S. 206,

213 (2001); United States v. Kirby Lumber Co., 284 U.S. 1 (1931).

Respondent determined that MBNA’s agreement with Mr. Payne to

accept $4,592 in full settlement of the undisputed account



     3
        The deficiency is also based on a greater portion of
petitioners’ Social Security income becoming taxable and the
disqualification of petitioners for the earned income credit.
Both of these adjustments stem from the increased gross income
petitioners would have as a result of the discharge of
indebtedness.
                               - 4 -

balance of $21,270 resulted in $16,678 of discharge of

indebtedness income to petitioners.    Petitioners bear the burden

of proving respondent’s determination incorrect.4   See Rule

142(a); Welch v. Helvering, 290 U.S. 111, 115 (1933).

I.   Reduction of Purchase Price

     Petitioners contend that their settlement with MBNA did not

result in the discharge of indebtedness but was rather a

retroactive reduction of the rate of interest charged by MBNA and

thus a reduction of the “purchase price” of the loans under

section 108(e)(5).   Although the record does not indicate that

MBNA agreed to retroactively reduce the rate of interest of its

loans to petitioners, petitioners have nevertheless painstakingly

calculated the various interest rates that applied to their

outstanding balances from October 1994 through October 2004 and

attempt to show that by the time of their settlement they had

paid back all of the principal they had borrowed from MBNA.

     Section 108(e)(5) provides an exception to section 61(a)(12)

where the buyer of property negotiates with the seller/creditor

for a discharge of all or part of the purchase money

indebtedness.   Commonly such a discharge reflects a decline in

the value of the property.   The resulting discharge of


     4
        Petitioners do not argue that the burden of proof shifts
to respondent pursuant to sec. 7491(a) and that the threshold
requirements of sec. 7491(a) have been met. In any event, we
decide the issue on the basis of the preponderance of evidence on
the record.
                                 - 5 -

indebtedness is characterized not as taxable income but in effect

as a retroactive reduction of the purchase price.     Where,

however, the only relationship between the parties is that of

debtor and creditor, “The rule of Kirby Lumber is clearly

applicable”.    OKC Corp. & Subs. v. Commissioner, 82 T.C. 638, 647

(1984).

      Petitioners argue that the lending of money in a generic

credit card transaction constitutes the sale of “property” under

section 108(e)(5).     Petitioners are mistaken.   MBNA effectively

lent petitioners money to be used for health care costs and

general living expenses.5    The only relationship between the

parties was that of debtor and creditor, and thus section

108(e)(5) does not apply.     See OKC Corp. & Subs. v. Commissioner,

supra at 647.

II.   Discharge of Indebtedness for Interest Payments

      Petitioners also allege that no income arises from the

discharge of indebtedness for interest payments.     In support of

this proposition, petitioners reference Earnshaw v. Commissioner,

T.C. Memo. 2002-191.




      5
        Insofar as petitioners used the credit card to buy
merchandise, the Commissioner treats debt forgiveness in third-
party lender cases as a purchase price adjustment only if the
forgiveness is directly related to an aspect of the sale, as
where a seller inflates the purchase price by misrepresentation.
Rev. Rul. 92-99, 1992-2 C.B. 35.
                                 - 6 -

     Generally, when a solvent debtor's fixed obligation is

reduced or canceled, the amount of the reduction or cancellation

constitutes income.   Sec. 61(a)(12); United States v. Kirby

Lumber Co., supra.    In Earnshaw v. Commissioner, supra, we

concluded that there had been a legitimate dispute between the

debtor and creditor regarding the amount of the debtor’s

obligation.   We held that the taxpayer recognized discharge of

indebtedness income from the settlement, but the amount was based

on the account balance that the taxpayer admitted to rather than

the higher amount the Commissioner alleged.        Earnshaw does not

stand for the principle that discharge of indebtedness income

does not include the cancellation of debt attributable to

interest payments.

     As no exclusion applies and the amount of petitioners’

obligation was clearly fixed, petitioners should have included

$16,678 of discharge of indebtedness income in their gross income

on their 2004 tax return.

     In reaching this holding, the Court has considered all

arguments made and, to the extent not mentioned, concludes that

they are moot, irrelevant, or without merit.

     To reflect the foregoing,


                                              Decision will be entered

                                         for respondent.
