- 16 -
E. Should Petitioners’ Income From Discharge of
Indebtedness Be Treated as Ordinary Income?
Petitioners argue that respondent erred in treating the
entire amount of discharge of indebtedness income as ordinary
income rather than as capital gain. Petitioners cite section
316, which generally defines a dividend as a distribution out of
a corporation’s earnings and profits. Petitioners argue that
Bonnevista and Castle Towers had no earnings and profits, and
therefore any distribution to petitioner could not have been a
dividend. Respondent’s answering brief, citing section 1368,
among other statutory provisions, argues that petitioners had
ordinary income from the discharge of indebtedness.12
The forgiveness of a shareholder’s debt by an S corporation
is considered a distribution of property. See Haber v.
Commissioner, 52 T.C. 255, 262 (1969), affd. per curiam 422 F.2d
198 (5th Cir. 1970); see also sec. 301(c); sec. 1.301-1(m),
Income Tax Regs. The tax treatment of a distribution of property
12 In the notice of deficiency, respondent treated the
income from discharge of indebtedness as ordinary. In opening
statements at trial, both parties addressed the proper
characterization under subch. S rules of any income from
discharge of indebtedness. The parties were directed to file
seriatim briefs. In their opening brief, petitioners addressed
the characterization issue with only cursory legal analysis. In
his brief in answer, respondent addressed the issue more
thoroughly, with citations to the appropriate subch. S rules. In
reply, petitioners argue that respondent’s brief improperly
asserts new issues relating to subch. S distributions.
Petitioners’ arguments are without merit. See Pagel, Inc. v.
Commissioner, 91 T.C. 200, 211-212 (1988), affd. 905 F.2d 1190
(8th Cir. 1990).
Page: Previous 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 NextLast modified: May 25, 2011