-5-
Throughout the administrative proceeding, petitioners
maintained that they did not receive income from the cancellation
of the $228,000 note. They stated that the revenue agent erred
when he determined that the cancellation of petitioner's note to
Elite on April 2, 1990, was connected to Elite's redemption of its
stock from H. Enterprises on April 19, 1990. Petitioners
contended that the cancellation of petitioner's debt to Elite was,
in essence, a reduction of the $300,000 purchase price for Elite's
stock to reflect Elite's correct value pursuant to section
108(e)(5)2 or as a setoff for damages because of misrepresentations
1(...continued)
face value. United States v. Kirby Lumber Co., 284 U.S. 1
(1931). A reduction in debt without a corresponding reduction in
assets causes an economic gain and income to the debtor because
assets are no longer encumbered. Generally, a cancellation of
indebtedness produces income to the debtor in an amount equal to
the difference between the amount due on the obligation and the
amount paid for the discharge. If no consideration is paid for
the discharge, then the entire amount of the debt is in most
circumstances considered the amount of income that the debtor
must include in income. Sec. 61(a)(12); Babin v. Commissioner,
23 F.3d 1032, 1034 (6th Cir. 1994), affg. T.C. Memo. 1992-673.
2 Sec. 108(e)(5) provides:
SEC. 108. INCOME FROM DISCHARGE OF INDEBTEDNESS.
* * * * * * *
(e) General Rules for Discharge of Indebtedness (Including
Discharges Not in Title 11 Cases or Insolvency).--For
purposes of this title--
* * * * * * *
(5) Purchase-money debt reduction for solvent debtor
(continued...)
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