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thus, gross income is realized from the discharge. In essence,
the net assets test is simply an examination of the debtor's net
worth after he is discharged of indebtedness--an increase in net
worth gives rise to income, but a decrease in negative net worth
does not.
2. Codification of the Net Assets Test
The net assets test has been criticized, particularly for
employing an improper criterion in the definition of income.6
Congress, however, codified the net assets test in section
108(a)(1)(B), (a)(3), and (d)(3) as a means of determining an
exclusion from gross income of an item of income derived from the
discharge of indebtedness. Aside from the parallel descriptions
in the committee reports of the preexisting law and of the
proposed insolvency exclusion, see supra sec. II.B.2., that
codification is apparent from the statutory insolvency
calculation coupled with the insolvency exclusion limitation
provided in section 108(a)(3), which together share the same
underlying analytical framework as the net assets test. That
framework requires an examination of the debtor's assets and
6 See, e.g., Eustice, “Cancellation of Indebtedness and the
Federal Income Tax: A Problem of Creeping Confusion”, 14 Tax L.
Rev. 225, 246-247 (1959); see also Estate of Newman v.
Commissioner, 934 F.2d 426, 427 (2d Cir. 1991) (“confusion as to
the theoretical basis for taxing discharges of indebtedness has
spawned an illogical, judge-made `insolvency exception'”), revg.
T.C. Memo. 1990-230. The net assets test and other judicially
created insolvency exceptions have been described as “an
emotional response by the courts to the plight of financially
embarrassed debtors rather than * * * any strict application of
judicial logic.” Eustice, supra at 246.
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