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Discussion
I. Discharge of Indebtedness
As a general rule, the Internal Revenue Code imposes a
Federal tax on the taxable income of every individual. See sec.
1. Section 61(a) defines gross income for purposes of
calculating taxable income as “all income from whatever source
derived” and further specifies that “Income from discharge of
indebtedness” is included within this broad definition. Sec.
61(a)(12). The underlying rationale for such inclusion is that
to the extent a taxpayer is released from indebtedness, he or she
realizes an accession to income due to the freeing of assets
previously offset by the liability. See United States v. Kirby
Lumber Co., 284 U.S. 1, 3 (1931).
Statutory exceptions to the above rule are set forth in
section 108. Section 108(a) excludes from the operation of
section 61(a) indebtedness which is discharged in a title 11
case, which is discharged when the taxpayer is insolvent, which
consists of qualified farm indebtedness, or which consists of
qualified real property business indebtedness. Additional
circumstances in which no income from cancellation of
indebtedness need be recognized are established by case law. For
instance, the refinancing of a debt may operate as an exception
to the requirement of inclusion. See Zappo v. Commissioner, 81
T.C. 77, 85-86 (1983). When one obligation has merely been
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