Dudley B. and La Donna K. Merkel - Page 17

          liabilities for the purpose of determining whether the debtor's             
          net worth turns positive (assets exceed liabilities), i.e.,                 
          whether assets are freed, as a result of the debtor's being                 
          discharged of indebtedness.7                                                
                    3.  The Freeing-of-Assets Theory and the Statutory                
                    Insolvency Calculation                                            
               From our examination of the statutory language, the                    
          legislative history, and the relevant cases cited in the                    
          committee reports, we conclude that the analytical framework of             
          the insolvency exclusion and its related provisions is based on             
          the freeing-of-assets theory.  That theory establishes the                  
          foundation for understanding the nature of the examination to be            
          afforded to obligations claimed to be liabilities for purposes of           
          the statutory insolvency calculation.                                       

          7    It should be noted that the net assets test requires an                
          examination of the debtor's net worth after he is discharged of             
          the indebtedness, whereas the statutory insolvency calculation              
          requires an examination immediately before the discharge.  That             
          distinction, however, does not produce disparate results and is             
          simply the product of the manner in which the insolvency                    
          exclusion and its limitation operate.  For purposes of                      
          illustration, assume the following facts:  (1) a debtor has                 
          indebtedness of $100 owed to C, assets of $130, and another                 
          liability of $100 and (2) C discharges the debtor of the                    
          indebtedness for payment of $20.  The net assets test would find            
          that, after the discharge, the debtor has assets of $110 ($130 -            
          $20) and liabilities of $100 ($200 - $100), and, therefore, the             
          debtor realizes income to the extent his assets exceed his                  
          liabilities, $10 ($110 - $100).  The statutory insolvency                   
          calculation would provide that the debtor is insolvent by $70               
          ($200 - $130) and the amount of the exclusion under sec.                    
          108(a)(1)(B) would be limited to that amount pursuant to sec.               
          108(a)(3); the debtor under sec. 61(a)(12) realizes $80 ($100 -             
          $20) of income and excludes $70 of that amount under sec.                   
          108(a)(1)(B), for net income recognition of $10 (same as the net            
          assets test).                                                               

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