Edward D. and Donna L. Johns - Page 6




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               Petitioner stated:  "If I have to pay income tax on the                
          portion the [companies] cancelled I will have learned one thing.            
          It does not pay to try and do the right [and] moral thing, just             
          file bankruptcy [and] clear your debts."  Petitioners contend               
          that they should not have to include the $13,938 of discharged              
          debt in their income because they were insolvent in 1996.                   
          Respondent contends that petitioners were not insolvent in 1996             
          because all of petitioners' property should be included in the              
          calculation of the fair market value of their "assets" under                
          section 108(d)(3), regardless of whether some property is exempt            
          from creditors' claims under State law.                                     
               Under section 61(a)(12), gross income includes "all income             
          from whatever source derived, including * * * income from                   
          discharge of indebtedness".  Under certain circumstances, a                 
          taxpayer may exclude from gross income the income from discharge            
          of indebtedness if the discharge occurs when the taxpayer is                
          insolvent.  Sec. 108(a)(1)(B).  The exclusion cannot exceed the             
          amount by which the taxpayer is insolvent.  Sec. 108(a)(3).  For            
          purposes of this section, "insolvent" is defined as "the excess             
          of liabilities over the fair market value of assets."  Sec.                 
          108(d)(3).  Such a determination is to be made on the basis of              
          the taxpayer's assets and liabilities immediately before the                
          discharge.  Sec. 108(d)(3).                                                 







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