Dudley B. and La Donna K. Merkel - Page 14

               not applicable to the facts of the instant case, as the                
               cancellation of the respondent's past due debt to its                  
               lessor did not have the effect of making the                           
               respondent's assets greater than they were before that                 
               transaction occurred.  * * *  [Dallas Transfer &                       
               Terminal Warehouse Co. v. Commissioner, supra at 96.]                  
               In Lakeland Grocery Co. v. Commissioner, 36 B.T.A. 289                 
          (1937), the taxpayer, pursuant to a “composition settlement”,               
          paid to its creditors $15,473 in consideration of being relieved            
          of the taxpayer's indebtedness to those creditors of $104,710.              
          Prior to the composition settlement, the taxpayer was insolvent;            
          after that settlement, the taxpayer had net assets of $39,597.              
          The Board of Tax Appeals (the Board) agreed with the Commissioner           
               that the rationale of United States v. Kirby Lumber                    
               Co., 284 U.S. 1, should apply and that gain is realized                
               to the extent of the value of the assets freed from the                
               claims of creditors * * * The petitioner's net assets                  
               were increased from zero to $39,596.93 as a result of                  
               the cancellation of indebtedness by its creditors, and                 
               to that extent it had assets which ceased to be offset                 
               by any liability.  * * *  [Id. at 292.]                                
               C.  Discussion                                                         
                    1.  Origin of the Net Assets Test                                 
               The Board's approach to a taxpayer in financial distress               
          being discharged of an indebtedness, which approach was                     
          crystallized in Lakeland Grocery Co. v. Commissioner, supra, has            
          been called, among other things, the “net assets” test.4  That              

          4    See Surrey, “The Revenue Act of 1939 and the Income Tax                
          Treatment of Cancellation of Indebtedness”, 49 Yale L. J. 1153,             
          1164 (1940); Warren & Sugarman, “Cancellation of Indebtedness and           
          Its Tax Consequences: I”, 40 Colum. L. Rev. 1326, 1352 & n.108              
          (1940) (“The `net assets' test was first intimated in Porte F.              
          Quinn, 31 B.T.A. 142, 145 (1934).”); see also Bittker & Thompson,           

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