Ernesto and Marilyn Patacsil v. Comm., TCM 2023-8
This post is part of our series on recent important tax cases that may be of interest to accounting, tax, and finance professionals. For more like this, see our Federal Tax Update and California Federal Tax Update, which offer a comprehensive analysis of the year’s most pivotal tax developments.
Proof of Insolvency Lacking for Exclusion of Cancelation of Debt Income (Ernesto and Marilyn Patacsil v. Comm., TCM 2023-8)
The discharge of indebtedness is income (§61(a)(12)). Section 108(a) provides an exclusion to the extent of the taxpayer’s insolvency (§§108(a)(1)(B) & (3)) and defines an insolvent taxpayer as one who has an “excess of liabilities over the fair market value of assets” (§108(d)(3)). The burden to prove insolvency is on the taxpayer. Because Ernesto and Marilyn Patacsil couldn’t prove the FMV of their assets and the extent of their liabilities, the cancellation of debt due to the foreclosure of their properties was not excludable. Why do we care? FMV of properties immediately before the cancellation is required. The judge seemed willing to accept a Zillow number on FMV if the taxpayers (or their CPA) had evidence of the date the Zillow valuation was obtained (i.e., the date the loan was cancelled). Since it is likely we’d be doing the tax return months after the cancellation, we should advise the client that an undated Zillow number won’t work and that they need an appraisal or “broker price opinion” to prove insolvency.