T.C. Memo. 2002-191
UNITED STATES TAX COURT
GEORGE W. EARNSHAW, Petitioner v.
COMMISSIONER OF INTERNAL REVENUE, Respondent
Docket No. 5221-01. Filed August 5, 2002.
George W. Earnshaw, pro se.
Charles M. Berlau, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
COHEN, Judge: Respondent determined a deficiency of $3,514
in petitioner’s Federal income taxes for 1998. The issue for
decision is whether petitioner must recognize discharge of
indebtedness income as a result of settlement of his Mastercard
account with MBNA America Bank (MBNA). Unless otherwise
indicated, all section references are to the Internal Revenue
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Code in effect for the year in issue, and all Rule references are
to the Tax Court Rules of Practice and Procedure.
FINDINGS OF FACT
Some of the facts have been stipulated, and the stipulated
facts are incorporated in our findings by this reference.
Petitioner resided in Shawnee Mission, Kansas, at the time that
he filed the petition in this case. Petitioner is a lawyer
admitted to practice in Kansas. Petitioner filed his income tax
return for 1998 using the cash receipts and disbursements method
of accounting.
Prior to April 1996, petitioner had two credit card accounts
with MBNA, a Mastercard account and a Visa account. On April 8,
1996, the balance due on petitioner’s Visa account was
transferred to his Mastercard account. On or about June 9, 1996,
petitioner sent to MBNA a check for $1,000, a copy of his May
1996 statement with a handwritten notation, and a separate
handwritten note. In the handwritten notation on the statement
and in the handwritten note, petitioner stated: “My current
balance is $29,837.61.” Petitioner requested verification or
correction of the balance.
On August 12, 1996, petitioner obtained a cash advance of
$1,200 against his Mastercard account. The sum advanced and a
$10 cash advance fee were posted to petitioner’s account on
August 14, 1996.
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From July 20, 1996, through September 19, 1997, petitioner
made the following payments on his account:
Posting Date Payment Amount
7-20-96 $1,000
10-21-96 800
3-14-97 350
4-21-97 350
5-22-97 350
6-19-97 350
7-19-97 350
8-19-97 350
9-19-97 350
Total $4,250
Beginning with the July 1996 statement, a total of $6,146.66
in finance charges was posted to petitioner’s Mastercard account.
Late fees were also posted to petitioner’s Mastercard account
from July 19 to December 18, 1996, and in October, November, and
December 1997. Petitioner objected to some of the late fees on
the ground that timely payments were made. In or before
September 1997, petitioner began contesting the late fees and
finance charges posted to his account. Beginning in October
1997, petitioner ceased making payments, advising MBNA that he
might resume payments when a dispute over the late fees was
resolved. In a letter dated January 15, 1998, MBNA offered to
settle petitioner’s account for a payment of $12,700 by
February 1, 1998. On January 28, 1998, petitioner sent a check
to MBNA in the amount of $12,700.
At the time of the settlement of petitioner’s account,
MBNA’s records reflected a balance of $32,566.70. MBNA sent to
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petitioner and to the Internal Revenue Service a Form 1099-C,
Cancellation of Debt, reporting discharge of indebtedness income
in the amount of $19,866.70. On April 21, 1999, petitioner sent
the Form 1099-C back to MBNA with a cover letter in which he
stated, among other things:
The debt was never a “forgiveness” of anything, but as
you know a compromise of many issues of a vague,
doubtful, and disputed claim. * * *
I stopped my payments to you after many accusations on
both sides, and after a period of time, I was offered a
complete settlement of the account for $17,500. After
considerable negotiations, a settlement was effected of
$12,750 [sic]. This was to save us both a law suit and
legal expense, as well as an equitable conclusion of
your improper handling of my account.
Petitioner attached to his 1998 tax return a statement as
follows:
No amounts pursuant to the attached 1099 have been
included in individual income. The cancellation should
be characterized as a compromise of a doubtful and
disputed claim. No deductions were taken for these
expenditures.
Respondent determined that petitioner received cancellation
of indebtedness income in 1998 in the amount of $19,866.70.
Respondent also determined that petitioner had unreported
interest income of $128 and adjusted petitioner’s taxable Social
Security income. Petitioner did not in his petition or at trial
dispute the interest or Social Security income adjustments. He
is thus deemed to have conceded them.
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OPINION
Petitioner contends that he did not have cancellation of
indebtedness income from his settlement with MBNA, because the
settlement reflected compromise of a disputed liability.
Petitioner testified at trial that he disputed the finance
charges on his account because of changing interest rates charged
by MBNA. Respondent contends that petitioner acknowledged as of
May 1996 a balance owing to MBNA and that the amount of
petitioner’s Mastercard account was always liquidated.
Section 61(a)(12) includes in the general definition of
gross income “income from discharge of indebtedness”. Respondent
relies on the discussion of this provision in Preslar v.
Commissioner, 167 F.3d 1323 (10th Cir. 1999), revg. T.C. Memo.
1996-543. In Preslar, the Court of Appeals for the Tenth
Circuit, to which our decision in this case is appealable,
examined the history of the discharge of indebtedness income rule
and the “contested liability” exception to recognition of
discharge of indebtedness income. The debt in Preslar was the
balance owing on a $1 million promissory note. The note had been
given to a bank by the taxpayers in connection with the purchase
of a ranch that was to be developed by the taxpayers. The bank
permitted the taxpayers to repay the loan by assigning the
installment sales contracts of purchasers of the developed
property to the bank at a discount. When the payee-bank became
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insolvent, the Federal Deposit Insurance Corporation (FDIC) was
appointed as receiver. The FDIC refused to accept further
assignments of sales contracts as repayment. The taxpayers
ceased making payments and filed an action against the FDIC. The
action was settled after the FDIC agreed to accept $350,000 in
full satisfaction of the indebtedness, on which the then balance
was $799,463. The Court of Appeals held that the contested
liability doctrine did not apply because the amount of the
taxpayers’ debt was at all times liquidated. The Court stated,
in part:
In addition, the Preslars’ characterization of
their dispute with the FDIC as the culmination of their
dispute over the ranch loan is not faithful to the
evidence. The dispute with the FDIC focused only on
the terms of repayment; it did not touch upon the
amount or validity of the Preslars’ debt. * * * In
sum, the Preslars’ underlying indebtedness remained
liquidated at all times. [Id. at 1330.]
We agree with respondent that the rationale of Preslar and
similar cases applies to the balance of petitioner’s Mastercard
account as of the time in May 1996 that he made a $1,000 payment
and acknowledged the balance of $29,837.61 before the payment.
Petitioner has not disputed that he owed reimbursement to MBNA
for the $1,200 cash advance in August 1996 and the $10 cash
advance fee, and those amounts also appear to be liquidated.
We do not agree with respondent, however, that Mastercard’s
subsequent posting of various finance charges and late payment
fees to petitioner’s account creates a liquidated indebtedness.
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We need not address all of the implications of the Preslar
opinion as to the scope of exceptions to the discharge of
indebtedness income. The question in this case is whether a debt
existed as asserted by respondent in the amount of $32,566.70
before the settlement between petitioner and MBNA. On the facts
of this case, we do not totally agree with either party.
Petitioner argues that respondent’s failure to call any
witnesses from MBNA gives rise to a negative inference.
Respondent was not required to call such witnesses, and the
records maintained by MBNA were received in evidence as a result
of the stipulation. The MBNA statements, however, standing
alone, do not establish a debt between petitioner and MBNA beyond
the amount that petitioner admitted in his handwritten notes on
the May 1996 statement. Petitioner’s testimony about the ongoing
dispute is not contradicted. He explained his failure to have
documents corroborating the dispute with MBNA between June 1996
and September 1997 as attributable to his disposal of those
records after the dispute was resolved. The pattern of his
payments, however, shows a 3-month gap between the July and
October 1996 payments and almost 5 months between the October
1996 payment and a payment in March 1997. The payments made for
March through September 1997 were minimal in relation to the size
of the account. Petitioner objected to certain late fees on the
ground that timely payments were made. Between January and
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September 1997, no late fees are reflected on his account. The
annual rate at which finance charges were accrued dropped from
April 1997 through December 1997, according to MBNA’s records.
Apparently, some negotiations were going on during that time.
There is no indication that the settlement with MBNA was
based on petitioner’s inability to pay the amounts in dispute,
and he denies that he was insolvent at the time. The record
fully supports the inference that a dispute between petitioner
and MBNA existed and was carried on over many months. We accept
his testimony that he engaged in an ongoing dispute with MBNA
that ultimately induced MBNA to compromise petitioner’s account
for substantially less than the balance recorded in its
statements to petitioner.
As of June 1996, petitioner’s undisputed balance was
$28,837.61. His account increased by uncontested charges of
$1,200 for a cash advance and $10 for a cash advance fee. He
subsequently made nine payments totaling $4,250 and a settlement
payment of $12,700. The net uncontested, liquidated balance,
which we conclude should be the amount of petitioner’s
cancellation of indebtedness income, is $13,097.61.
Petitioner has made other arguments that have no merit. In
his trial memorandum, he suggested that the amount of
indebtedness canceled should be treated as “damages”. Respondent
infers that petitioner is suggesting that the reduction in his
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debt would be damages excludable from gross income under section
104(a)(2). We agree with respondent that nothing in the record
would support that claim.
Petitioner asserts that respondent should have conceded this
case at the conclusion of trial but that respondent’s counsel
refused to do so, allegedly based on a posttrial ex parte
communication with the Court. At the conclusion of trial, as
reflected in the transcript, the Court directed respondent’s
counsel to brief cases dealing with settled or compromised
claims. No off-the-record or ex parte communications between the
Court and respondent’s counsel have occurred. Respondent’s brief
discusses the evidence and case law supporting respondent’s
position. Petitioner has not complied with the Court’s order or
rules concerning briefs.
Petitioner has also complained that MBNA presumably received
a deduction for the amount reported on Form 1099-C as income to
petitioner. MBNA’s tax liability is not before the Court. It is
unnecessary, in any event, that a correlation exists between
petitioner’s income, as a cash basis taxpayer, and deductions of
MBNA, presumably an accrual basis taxpayer. Other arguments and
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assertions by petitioner are similarly irrelevant and lacking in
merit.
Decision will be entered
under Rule 155.