Carlson v. Comm'r of Internal Revenue

• Citation: 116 T.C. 87,116 T.C. No. 9
• Decision Date: 23 February 2001
• Docket Number: No. 12068–99.,12068–99.
• Parties: Roderick E. CARLSON and Jeanette S. Carlson, Petitioners v. COMMISSIONER OF INTERNAL REVENUE, Respondent
• Court: United States Tax Court

116 T.C. 87

116 T.C. No. 9

Roderick E. CARLSON and Jeanette S. Carlson, Petitioners

v.COMMISSIONER OF INTERNAL REVENUE, Respondent

No. 12068–99.

United States Tax Court.

Feb. 23, 2001.

Taxpayers petitioned for redetermination of deficiencies arising from discharge of indebtedness income and penalties. The Tax Court, Chiechi, J., held that: (1) discharge of indebtedness income was not excludable from gross income pursuant to insolvency exception, and (2) accuracy-related penalty was warranted.

Decision for IRS.

Ps, husband and wife, purchased a fishing vessel (vessel). They financed that purchase by borrowing money from a bank. As security for the loan, Ps granted the bank a mortgage interest in the vessel. Ps became delinquent in making payments to the bank on the loan, and the bank foreclosed on the vessel, sold it as part of that foreclosure, used the proceeds from that sale to reduce the outstanding principal balance of the loan, and discharged the remaining balance of the loan. As a result, Ps realized capital gain of $28,621 and discharge of indebtedness (DOI) income of $42,142.

Ps excluded the DOI income from their gross income pursuant to the insolvency exception of sec. 108(a)(1)(B), I.R.C., because they determined that they were insolvent within the meaning of sec. 108(d)(3), I.R.C. In making the insolvency calculation prescribed by sec. 108(d)(3), I.R.C., Ps excluded certain assets that they claim are exempt from the claims of creditors under applicable State law. The parties agree that if such assets may not be excluded in making that calculation, Ps were not insolvent within the meaning of sec. 108(d)(3), I.R.C., and may not exclude the DOI income from gross income pursuant to sec. 108(a)(1)(B), I.R.C.

Held: The word “assets” as used in sec. 108(d)(3), I.R.C., includes assets exempt from the claims of creditors under applicable State law.

Held, further: Ps are liable for the accuracy-related penalty under sec. 6662(a), I.R.C., to the extent stated herein.

Terry P. Draeger, for petitioners.

Kay Hill, for respondent.

OPINION

CHIECHI, J.

Respondent determined a deficiency in, and an accuracy-related penalty under section 6662(a) ¹ on, petitioners' Federal income tax (tax) for 1993 in the amounts of $14,449 and $2,890, respectively.

The issues remaining for decision are:

(1) Are petitioners entitled to exclude from gross income under section 108(a)(1)(B) discharge of indebtedness (DOI) income in the amount of $42,142? We hold that they are not.

(2) Are petitioners liable for the accuracy-related penalty under section 6662(a)? We hold that they are to the extent stated herein.

Background

This case was submitted fully stipulated. The facts that have been stipulated are so found.

Petitioners' mailing address was in Chignik, Alaska, at the time the petition was filed.

In 1988, petitioner Roderick E. Carlson, whose occupation during the year at issue was commercial fisherman, and petitioner Jeanette S. Carlson purchased the fishing vessel Yantari (Yantari), a 44–foot seiner made of fiber glass that was built in 1982. They paid $202,451 for that fishing vessel, which included the engine. Petitioners financed their purchase of the Yantari by borrowing money (loan) from Seattle First National Bank (bank or Seattle First). As security for that loan, petitioners granted to the bank a so-called preferred marine mortgage interest (mortgage) in the Yantari.

During 1992, petitioners became delinquent in making payments to the bank on the loan. On February 8, 1993, when the unpaid principal balance of the loan was $137,142, the bank foreclosed on the Yantari, the Yantari was sold for $95,000 as part of that foreclosure, the proceeds from that sale were used to reduce the outstanding principal balance of the loan by $95,000, and the bank discharged the remaining $42,142 of the loan. (For convenience, we shall refer collectively to the bank's foreclosure on the Yantari and the concomitant sale of the Yantari and other events that occurred on February 8, 1993, as the foreclosure sale.) As a result of the foreclosure sale, petitioners realized capital gain of $28,621 and DOI income of $42,142.

Immediately preceding the foreclosure sale on February 8, 1993, petitioners had (1) assets located in the States of Alaska and Washington which had an aggregate fair market value of $875,251 and (2) liabilities which totaled $515,930.² Included in petitioners' assets immediately preceding the foreclosure sale on February 8, 1993, was a so-called Alaska limited entry fishing permit which had a fair market value of $393,400. ³ Petitioners' Alaska limited entry fishing permit was a purse seine permit for the commercial fishing of salmon in the Chignik, Alaska fishery (petitioners' fishing permit).

Petitioners jointly filed Form 1040, U.S. Individual Income Tax Return, for 1993 (petitioners' joint return). In petitioners' joint return, petitioners did not report any gain or loss or any DOI income as a result of the foreclosure sale of the Yantari. However, petitioners attached to that return Form 1099–A, Acquisition or Abandonment of Secured Property (Form 1099–A), which the bank issued to petitioners and which showed that, on a date that is not legible, ⁴ the outstanding principal balance of the loan secured by the Yantari was $137,142. The following was written by hand at the bottom of Form 1099–A that was attached to petitioners' joint return: “Taxpayer Was Insolvent—No Tax Consequence” (written statement).

Respondent timely issued to petitioners a notice of deficiency for 1993 (notice). In the notice, respondent determined, inter alia, to increase petitioners' income by $42,142 for “RELIEF OF DEBT” and by $28,629 for “DISPOSITION OF F/V YANTARNI [sic]”. Respondent also determined in the notice to impose an accuracy-related penalty under section 6662(a).

Discussion

Petitioners bear the burden of proving that the determinations in the notice are erroneous. See Rule 142(a); Welch v. Helvering, 290 U.S. 111, 115, 54 S.Ct. 8, 78 L.Ed. 212 (1933). That this case was submitted fully stipulated does not change that burden or the effect of a failure of proof. See Rule 122(b); Borchers v. Commissioner, 95 T.C. 82, 91, 1990 WL 99432 (1990), affd. 943 F.2d 22 (8th Cir.1991).

DOI Income—Section 108

Section 61(a) defines the term “gross income” broadly to mean all income from whatever source derived, including income from discharge of indebtedness. See sec. 61(a)(12). Section 108(a) provides certain exceptions to section 61(a)(12). See Gitlitz v. Commissioner, 531 U.S. –, –, 69 U.S.L.W. 4060, 4062 (Jan. 9, 2001). As pertinent here, section 108(a)(1)(B) (insolvency exception) excludes from gross income any amount that otherwise would be includable in gross income by reason of the discharge in whole or in part of indebtedness of the taxpayer if the discharge occurs when the taxpayer is insolvent. The amount of DOI income excluded under section 108(a)(1)(B) is not to exceed the amount by which the taxpayer is insolvent. See sec. 108(a)(3). The term “insolvent” is defined in section 108(d)(3) as follows:

(3) Insolvent.—For purposes of this section [108], the term “insolvent” means the excess of liabilities over the fair market value of assets. With respect to any discharge, whether or not the taxpayer is insolvent, and the amount by which the taxpayer is insolvent, shall be determined on the basis of the taxpayer's assets and liabilities immediately before the discharge.

The parties' general dispute here is whether, pursuant to section 108(a)(1)(B), petitioners may exclude from gross income for the year at issue $42,142 of DOI income resulting from the foreclosure sale on February 8, 1993. The parties agree that resolution of that issue depends on whether, immediately before that foreclosure sale, petitioners were insolvent within the meaning of section 108(d)(3). The parties' specific dispute here concerns the meaning of the word “assets” as used in section 108(d)(3).

It is petitioners' position that the word “assets” as used in section 108(d)(3) does not include assets that are exempt from the claims of creditors under applicable State law. In support of that argument, petitioners rely principally on Cole v. Commissioner, 42 B.T.A. 1110 (1940), and Hunt v. Commissioner, T.C. Memo.1989–335. According to petitioners, petitioners' fishing permit, which had a fair market value of $393,400 immediately preceding the foreclosure sale on February 8, 1993, is an asset exempt from the claims of creditors under the law of the State of Alaska.⁵ Petitioners maintain that, pursuant to Cole and Hunt, petitioners' fishing permit should be excluded in performing the insolvency calculation under section 108(d)(3). If the Court were to sustain petitioners' position, the parties agree that petitioners would be insolvent within the meaning of section 108(d)(3) and that the insolvency exception of section 108(a)(1)(B) would exclude from their gross income for the year at issue $42,142 of DOI income resulting from the foreclosure sale on February 8, 1993.

Respondent counters that Cole v. Commissioner, supra, and Hunt v. Commissioner, supra, on which petitioners rely do not apply in the instant case. According to respondent, the plain meaning of the word “assets”, as well as the legislative history of section 108(a)(1)(B), rejects the narrow definition of that word which petitioners proffer. Respondent argues in the alternative that even if the Court were to sustain petitioners' position as to the meaning of the word “assets” as used in section 108(d)(3), petitioners have failed to show that petitioners' fishing permit is in all instances exempt from the claims of creditors under the law of the State of Alaska.

Our function in interpreting the Code is to construe it in a way that will give effect to the intent of Congress. See Merkel v. Commissioner, 109 T.C. 463, 468, 1997 WL 793502 (1997), affd. 192 F.3d 844 (9th Cir.1999). Our starting point in...