San Francisco Tax Preparation / CPA: Future pension payouts not counted as asset in determining insolvency exclusion

Filed in CCH NEWS FEED by on April 24, 2017

The Tax Court, in Schieber v. Commissioner, TC Memo. 2017-32, found that the right to a continuing monthly payment state pension plan was not an asset in determining insolvency for purposes of exclusion from cancellation of indebtedness income. The court rejected the IRS’s argument that the ability of the taxpayers to use their monthly pension payments to continue to pay off existing tax indebtedness was sufficient to disprove insolvency.

The taxpayer-husband’s public employees’ defined benefit pension provided monthly payments with cost of living increases. Other than the monthly amounts as they became payable, the husband and his wife could not access the value in the plan. They could not convert their interest into a lump-sum cash amount, sell their interest, assign their interest, borrow against their interest or borrow from the plan. The plan withheld federal income tax from the payments.

A mortgage lender cancelled $418,000 of the taxpayers’ debt. The taxpayers claimed that their liabilities exceeded their asset by $293,000, and that should be excluded from cancellation of indebtedness income under the insolvency exception provided in Code Sec. 108. The IRS, however, claimed that the taxpayers were not insolvent since the income stream from the pension should be counted as an asset.

The Tax Court observed that although the Tax Code does not define assets, case precedent did find that an asset exempt from creditors could still be an asset for purposes of Code Sec. 108 because such an asset can give the taxpayer the ability to pay an immediate tax on income from the canceled debt. The IRS argued that the taxpayers’ interest in the pension plan should be considered an asset because they could use their monthly payments to pay liabilities.

However, the Tax Court appeared to view the insolvency test to be one predicated on whether the asset gives the taxpayer the ability to pay an “immediate tax on income” from the canceled debt, not to pay the tax gradually over time. Here, the taxpayers’ interest in the pension plan could not be used to immediately pay the income tax on canceled-debt income. Therefore, the court found that it could not be considered an asset within the meaning of Code Sec. 108.

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