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realized income on account of the discharge of indebtedness. On
their 1991 U.S. Individual Income Tax Returns (Forms 1040; filing
status of married filing joint return), the Merkels and the
Hepburns each (couple) disclosed their distributive share of that
income, $359,721, but excluded such amount from gross income on
the ground that each was insolvent immediately before that income
was realized by the partnership.
The SLC Indebtedness
Systems Leasing Corp. (SLC) is an Arizona corporation
organized in 1979 by petitioners Dudley Merkel and David Hepburn
to engage in the computer leasing business. SLC is owned “50/50”
by Dudley Merkel and David Hepburn. Dudley Merkel and David
Hepburn were officers of SLC during its fiscal years ended
February 29, 1992, and February 28, 1993, and received officer
compensation for those years as follows:
FYE 2/29/92 FYE 2/28/93
Dudley Merkel $183,202 $191,150
David Hepburn 182,824 191,151
In 1986, SLC incurred an indebtedness to Security Pacific
Bank (the indebtedness and the bank, respectively), evidenced by
a note (the SLC note). The SLC note was personally guaranteed by
each petitioner (collectively, petitioners’ guarantees). As of
April 16, 1991, the unpaid balance of the SLC note was in excess
of $3,100,000, and SLC was in default of its obligations under
the SLC note.
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