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B. Did the Insolvency Exception Apply in 1997?
Petitioners concede that BankTEXAS forgave their loan of
$32,000 in 1997. The parties agree that resolution of the issue
as to whether petitioners must include this income in 1997
depends on whether, immediately before BankTEXAS forgave their
loan on April 20, 1997, petitioners were insolvent within the
meaning of sections 108(a)(1)(B) and (d)(3) (insolvency
exception).
Petitioners contend that the evidence demonstrates that
their liabilities exceeded the fair market value (FMV) of their
assets in 1997. Additionally, petitioners argue that further
evidence, such as the foreclosure on their house and BankTEXAS’s
unsuccessful attempts to collect on the loan, support a
conclusion that they were insolvent. Respondent argues that
petitioners were not insolvent and that section 108(a)(1)(B) does
not apply. Respondent contends that petitioners’ proof of the
FMV of their assets in 1997 was “incomplete and highly
questionable” because it was based on petitioners’ memory.
Section 61(a) defines the term “gross income” broadly to
mean all income from whatever source derived, including income
from discharge of indebtedness. Sec. 61(a)(12). Section 108(a)
provides certain exceptions to section 61(a)(12). See Gitlitz v.
Commissioner, 531 U.S. 206, 213 (2001). Section 108(a)(1)(B)
excludes from gross income any amount that otherwise would be
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