                  T.C. Summary Opinion 2007-19



                      UNITED STATES TAX COURT



     STUART RAYMOND QUARTEMONT AND VELVET FENNER QUARTEMONT,
                          Petitioners v.
           COMMISSIONER OF INTERNAL REVENUE, Respondent



    Docket No. 3584-06S.               Filed February 6, 2007.


    Stuart R. Quartemont, pro se.

    David Cao, for respondent.



     JACOBS, 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.   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
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Tax Court Rules of Practice and Procedure.    The decision to be

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

should not be cited as authority.

     Respondent determined a $27,326 deficiency in petitioners’

2003 Federal income tax, as well as a penalty of $5,465 under

section 6662(d).   Respondent subsequently conceded that the

section 6662(d) penalty was not applicable.    Consequently, the

only issue remaining for decision is whether petitioners may

exclude the value of their residence, which is exempt property

for State bankruptcy law purposes, in determining whether they

were insolvent for purposes of section 108(a)(1)(B), pertaining

to exclusion from discharge of indebtedness income.

                            Background

     This case was submitted fully stipulated, and the stipulated

facts are so found.   The stipulation of facts and the attached

exhibits are incorporated herein by this reference.    At the time

petitioners filed the petition, they resided in College Station,

Texas.

     Beginning in 2001, petitioners encountered financial

difficulty stemming from an unrelated party’s default on an

unsecured loan of $100,000 made by petitioners in 2000.    In

connection with such loan, petitioners incurred substantial

amounts of credit card debt, believing that they would be able to

repay their debts to the credit card companies when their debtor
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repaid the loan owed to them.   By the time petitioners realized,

in 2001, that the loan they had made in 2000 would never be

repaid, petitioners had incurred more than $100,000 in credit

card debt.

     Petitioners considered filing for bankruptcy, but decided

instead to negotiate with the credit card companies to extinguish

their debts by paying a lesser sum than was owed.    Petitioners

succeeded in making these arrangements in 2002 and in 2003.      The

amount by which their credit card debt exceeded their actual

payment (i.e., the amount of relief from indebtedness) was

$77,265 in 2003, the tax year in issue.1   Petitioners did not

include this amount in income for 2003.    Respondent determined

that such discharge of indebtedness should have been included in

income and accordingly determined a deficiency in petitioners’

2003 Federal income tax.

                           Discussion

     As a general rule, the Commissioner’s determinations in the

notice of deficiency are presumed correct, and the burden of

proving an error is on the taxpayer.    Rule 142(a); Welch v.

Helvering, 290 U.S. 111, 115 (1933).




     1
      The cancellation of indebtedness occurred on two occasions:
Feb. 3, 2003, in the amount of $62,040 and May 12, 2003, in the
amount of $15,225.
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    Gross income is defined in section 61(a) as all income from

whatever source derived, and income from discharge of

indebtedness is specifically included in the definition of gross

income.   Sec. 61(a)(12).

    The Supreme Court long ago articulated the principle that

increases in net worth from forgiveness or cancellation of

indebtedness give rise to gross income, United States v. Kirby

Lumber Co., 284 U.S. 1 (1931), but there are recognized

exceptions to this general principle.    The Court of Appeals for

the Fifth Circuit, to which this case would be appealable if it

had not been heard pursuant to section 7463, was among the first

Courts of Appeals to develop an “insolvency exception”, in Dallas

Transfer & Terminal Warehouse Co. v. Commissioner, 70 F.2d 95

(5th Cir. 1934), revg. 27 B.T.A. 651 (1933).

    In Dallas Transfer & Terminal Warehouse Co. v. Commissioner,

supra at 96, the taxpayer’s relief from indebtedness did not

result in gross income where he was insolvent both before and

after the debt was discharged.    The court stated:

     This [relief from indebtedness] does not result in the
     debtor acquiring something of exchangeable value in addition
     to what he had before. There is a reduction or
     extinguishment of liabilities without any increase of
     assets. There is an absence of such a gain or profit as is
     required to come within the accepted definition of income.
     Eisner v. Macomber, 252 U.S. 189, 40 S.Ct. 189, 64 L.Ed.
     521, 9 A.L.R. 1570; Merchants’ L. & T. Co. v. Smietanka, 255
     U.S. 509, 519, 41 S.Ct. 386, 65 L.Ed. 751, 15 A.L.R. 1305.
     It hardly would be contended that a discharged insolvent or
     bankrupt receives taxable income in the amount by which his
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     provable debts exceed the value of his surrendered assets.
     The income tax statute does not purport to treat as income
     what did not come within the meaning of that word before the
     statute was enacted. * * * [Id.]

     Section 108, Income from Discharge of Indebtedness, codifies

the result reached in Dallas Transfer, and identifies in

subsection (a), Exclusions From Gross Income, four occasions in

which discharge of indebtedness is not included in gross income.

The instant case involves the exception found in section

108(a)(1)(B), which provides:

          (1) In general.--Gross income does not include any
     amount which (but for this subsection) would be includible
     in gross income by reason of the discharge (in whole or in
     part) or indebtedness of the taxpayer if --

                 *    *    *    *    *    *    *

            (B) the discharge occurs when the debtor is insolvent
     * * *

     The parties in this case do not agree on whether petitioners

were insolvent at the time the discharge of indebtedness

occurred.    Resolution of the parties’ disagreement turns on the

calculation, for purposes of section 108(d)(3), of the value of

petitioners’ assets prior to the discharge of their debt to the

credit companies.

     Insolvency is defined in section 108(d)(3) as “the excess of

liabilities over the fair market value of assets.”    Petitioners

contend that property that would be exempt from creditors’ claims

under State law in bankruptcy proceedings is not taken into

account in determining the value of one’s “assets” for purposes
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of section 108(d)(3).    The only such exempt property in this case

is petitioners’ house.   The fair market value of petitioners’

house immediately before any discharge of indebtedness was

$335,110.   Petitioners’ house was encumbered by a mortgage in the

amount of $189,354.

    If petitioners’ house is included as an asset (and the

encumbering debt is included as a liability) in the insolvency

calculation, then petitioners were not insolvent either before or

after the forgiveness of debt,2 and such discharge of indebtedness

is includable in their gross income.    If, on the other hand, the

house is not included as an asset (and any debt thereon is not

included as a liability), then petitioners were insolvent both

before and after the forgiveness of debt (on both the February

and May occasions), and the discharge of indebtedness is not

includable in their gross income.

    In Carlson v. Commissioner, 116 T.C. 87 (2001), after a

thorough examination of the statutory history of section 108,

this Court found that Congress chose not to define insolvent to

exclude exempt assets.   We held that the word “assets” as used in

section 108(d)(3) includes assets exempt from the claims of

creditors under applicable State law.   Petitioners argue that our




     2
      This would be the case whether the February or May occasion
is considered.
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holding in Carlson produces an anomalous result, in the light of

other provisions of section 108.

     Section 108(a)(1)(A) provides that gross income does not

include “any amount which * * * would be includable in gross

income by reason of the discharge * * * of indebtedness * * * if

the discharge occurs in a title 11 case”.   Therefore, petitioners

point out, under the Carlson rationale, a taxpayer who declares

bankruptcy would not be required to include discharge of

indebtedness in gross income, whereas a taxpayer seeking to pay

his debts and avoid bankruptcy would potentially find himself

burdened with additional tax as a consequence.   Petitioners are

correct in this description of the statutory regime as determined

under Carlson.   However, consistent with congressional purpose in

according a debtor coming out of bankruptcy a “fresh start” and

leaving him unburdened with an immediate tax liability, Carlson

v. Commissioner, supra at 95, we see nothing anomalous in a

statutory framework that simultaneously requires solvent

taxpayers, like petitioners, to pay taxes according to the usual

formula.3   Furthermore, not following our precedent in Carlson

would produce anomalous results.


     3
      We note that sec. 108(a)(3) limits the amount of discharged
indebtedness that is excludable from gross income under the
insolvency provision to the amount by which the taxpayer is
insolvent. No such limitation applies when discharge occurs in a
title 11 case, such being another example of the statutory
framework that distinguishes between bankrupt and nonbankrupt
taxpayers.
                               - 8 -

     In Hunt v. Commissioner, T.C. Memo. 1989-335, decided with

respect to a taxable year prior to the effective date of section

108(a)(1)(B) and (d)(3), we held, as petitioners wish us to hold

today, that assets exempt from the claims of creditors by State

law were excluded from the definition of assets for purposes of

determining whether a nonbankrupt debtor was insolvent.   This

entailed our holding that exempt assets included assets that, in

the event of bankruptcy, would be protected from the reach of

creditors under State exemptions, and not Federal exemptions,

even though (1) State law permitted debtors to elect either State

exemptions or Federal exemptions, and (2) Federal exemptions

would be more beneficial.   In furtherance of this holding, we

noted:

     While this conclusion may lead to different results for
     taxpayers who actually file for bankruptcy and those who do
     not, we note that different answers also result from those
     debtors who file for bankruptcy and reside in different
     states. The reason for the lack of consistency is twofold.
     First, the Federal exemptions must be elected. Second, many
     states do not allow their residents to choose Federal
     exemptions over those offered by the state. Therefore, no
     matter what path we choose today [in deciding whether state
     exemptions or Federal exemptions are to be used], we still
     cannot guarantee nationwide uniformity in determining which
     assets are exempt from the claims of creditors when making a
     determination of solvency. [Fn. ref. omitted.]

     Excluding assets exempt under State bankruptcy law from the

section 108 definition of assets would result in inconsistencies

among taxpayers in different States that have different exemption

categories or amounts, another anomaly.   In any event, section
                                 - 9 -

108 was amended by the Bankruptcy Tax Act of 1980, Pub. L. 96-

589, section 2(a), 94 Stat. 3389, to include a definition of

insolvency in section 108(d)(3).    That section does not exclude

exempt assets from the definition of insolvent for purposes of

section 108.   The amendments also added section 108(e)(1), which

provides that “Except as otherwise provided in this section,

there shall be no insolvency exception from the general rule that

gross income includes income from the discharge of indebtedness.”

In interpreting the amended statute, we noted in Carlson that

Hunt was inapplicable because it was decided before the effective

date of the amendments, and that section 108 as amended required

the opposite result from Hunt.     Carlson v. Commissioner, supra at

99 n.7.

     Concluding, we find that petitioners were not insolvent

within the meaning of section 108, either before or after their

debt was discharged.   Consequently, we hold that the discharge of

indebtedness income, as determined by respondent, is includable

in petitioners’ gross income for 2003.

     To reflect respondent’s concession with respect to the

section 6662(d) penalty,
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          Decision will be entered

     for respondent as to the

     deficiency and for petitioners

     as to the accuracy-related

     penalty.
