Roderick E. Carlson and Jeanette S. Carlson - Page 18




                                       - 18 -                                         
          We observed in Merkel:                                                      
                    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.  That test is based on                  
               the so-called freeing-of-assets theory derived from the                
               Supreme Court’s statement in Kirby Lumber that the                     
               transaction “made available $137,521.30 assets previ-                  
               ously offset by the obligation of bonds now extinct”.                  
               * * * The net assets test is a corollary of the princi-                
               ple in Dallas Transfer that an insolvent debtor does                   
               not realize income when discharged of indebtedness.                    
               Under the net assets test, if the debtor remains insol-                
               vent (liabilities exceed assets) after being discharged                
               of indebtedness, no assets have been freed as a result                 
               of the discharge since the debtor’s assets are still                   
               more than offset by his postdischarge liabilities, and,                
               thus, no gross income is realized; if the debtor is                    
               solvent (assets exceed liabilities) after being dis-                   
               charged, then the discharge has freed the debtor’s                     
               assets from the offset of his liabilities to that                      
               extent, and, 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.                                                        
          Id. at 472-473; fn. ref. omitted.                                           
               We explained in Merkel that Congress                                   
               codified the net assets test in section 108(a)(1)(B),                  
               (a)(3), and (d)(3) as a means of determining an exclu-                 
               sion 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 exclu-                  
               sion, * * * 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 liabilities for the purpose of determining                  
               whether the debtor’s net worth turns positive (assets                  





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