Steven Jacobowitz ( 2023 )

United States Tax Court
T.C. Memo. 2023-107STEVEN JACOBOWITZ,
Petitioner
v.
COMMISSIONER OF INTERNAL REVENUE,
Respondent
—————
Docket No. 14387-19. Filed August 16, 2023.
—————
Thomas S. Groth, for petitioner.
William C. Bogardus, for respondent.
MEMORANDUM FINDINGS OF FACT AND OPINION
ASHFORD, Judge: By statutory notice of deficiency dated April
29, 2019, the Internal Revenue Service (IRS or respondent) determined
a deficiency in petitioner’s federal income tax of $15,266 for the 2016
taxable year. After certain concessions by petitioner, 1 the issue
remaining for decision is whether for 2016 petitioner must include in
gross income cancellation of indebtedness (COD) income of $34,964. 2
We hold he must.
FINDINGS OF FACT
Some of the facts have been stipulated and are so found. The
Stipulation of Facts and the attached Exhibits are incorporated herein
1 By way of a Stipulation of Settled Issues petitioner conceded that he is liable
for unreported education program payments of $1,412, as well as an unreported
additional 10% tax of $141 on the education program payments.
2 Some monetary amounts are rounded to the nearest dollar.
Served 08/16/23
2
[*2] by this reference. Petitioner resided in Connecticut when his
Petition was timely filed with the Court.
Petitioner was the sole member of an entity named
Sagasolutions.com (Sagasolutions), a single-member limited liability
company he established in November 2003. Sagasolutions ceased to
exist in approximately May 2008. During its existence it designed and
delivered technical solutions to companies having problems in the areas
of customer service, sales, and marketing. Additionally, during its
existence it was a disregarded entity for federal income tax purposes; it
never filed Form 8832, Entity Classification Election, with the IRS to be
classified otherwise. The last year for which Sagasolutions’ income (or
loss) was reported to the IRS was 2009.
On January 17, 2006, Sagasolutions secured a $25,000 small
business line of credit with Connecticut-based Newtown Savings Bank
(Newtown). In connection with this line of credit petitioner executed on
Sagasolutions’ behalf a promissory note and a security agreement. The
promissory note set forth the terms of the line of credit, including the
interest rate, the minimum advance amount, the monthly principal
repayment amount and date, the amounts for finance charges and other
fees, and that the line of credit would be linked as overdraft protection
to petitioner’s personal checking account, also at Newtown. 3 The
security agreement set forth in pertinent part what property of
Sagasolutions was pledged as security for the repayment of the line of
credit and under what circumstances Sagasolutions would be in default
of its payment or other obligations with respect to the line of credit.
Sagasolutions took advances from, and made payments to, the
line of credit numerous times from January 2006 to September 2010.
The first advance, of $7,000, was on January 24, 2006, and the last, of
$625, was on April 5, 2010. When Sagasolutions’ last principal payment
of $52 was made on September 27, 2010, the outstanding principal
balance for the line of credit was $24,948.
Newtown sent Sagasolutions and the IRS a Form 1099−C,
Cancellation of Debt, for 2016. This form indicated that as of December
30, 2016, Newtown had discharged the outstanding principal balance
and accrued interest, which totaled $34,964, after the September 27,
3 Sagasolutions had its own bank account at Newtown over which petitioner
had sole signature authority; alternatively, the line of credit may have been linked as
overdraft protection to that bank account.
3
[*3] 2010, payment owed on the line of credit. The form also indicated
that the reason for the discharge was “Statute of limitations or
expiration of deficiency period.”
Petitioner prepared and timely filed (with the assistance of Ernst
& Young as required by his employer at the time) his 2016 federal
income tax return. As relevant here, on this return petitioner reported
adjusted gross income of $709,153, consisting of wages of $707,265,
taxable interest of $13, taxable dividends of $1,411, and capital gains of
$464. Petitioner did not report on this return the COD income totaling
$34,964.
Following an examination of petitioner’s 2016 federal income tax
return, the IRS determined in pertinent part that the outstanding
principal balance and accrued interest owed on the line of credit that
Newtown discharged, totaling $34,964, was taxable “other”/COD income
to petitioner. The April 29, 2019, notice of deficiency issued to petitioner
reflects this determination.
OPINION
I. Burden of Proof
As a preliminary matter we address who has the burden of proof
in this case.
In general, the IRS’s determinations set forth in a notice of
deficiency are presumed correct, and the taxpayer bears the burden of
proving otherwise. Rule 142(a); 4 Welch v. Helvering, 290 U.S. 111, 115
(1933). For this presumption to adhere in cases (such as this one)
involving unreported income, the Commissioner must provide some
reasonable foundation connecting the taxpayer to the income-producing
activity. El v. Commissioner, 144 T.C. 140, 142−43 (2015) (citing
Llorente v. Commissioner, 649 F.2d 152, 156 (2d Cir. 1981), aff’g in part,
rev’g in part and remanding 74 T.C. 260 (1980)). Once the
Commissioner has done this, the burden shifts to the taxpayer to prove
by a preponderance of the evidence that the Commisioner’s
determinations are arbitrary or erroneous. Id. at 143. Similarly, under
section 6201(d), if a taxpayer in any court proceeding asserts a
4 Unless otherwise indicated, statutory references are to the Internal Revenue
Code, Title 26 U.S.C. (Code), in effect at all relevant times, regulation references are
to the Code of Federal Regulations, Title 26 (Treas. Reg.), in effect at all relevant times,
and Rule references are to the Tax Court Rules of Practice and Procedure.
4
[*4] reasonable dispute with respect to any item of income reported on
an information return (such as a Form 1099−C) and has fully cooperated
with the Commissioner, then the Commissioner shall have the burden
of producing reasonable and probative information concerning the
deficiency, in addition to the information return. See also Kleber v.
Commissioner, T.C. Memo. 2011-233, slip op. at 5.
It is undisputed that Sagasolutions was a single-member limited
liability company with petitioner as its sole member and that petitioner,
on behalf of Sagasolutions, executed a promissory note and a security
agreement for a line of credit with Newtown. It is also undisputed that
Sagasolutions had an outstanding line of credit balance of $24,948 and
that Newtown forgave that outstanding balance plus accrued interest,
which totaled $34,964; with respect to that $34,964, Newtown sent the
IRS and Sagasolutions a Form 1099−C, and petitioner’s dispute, as
discussed below, involves solely whether the $34,964 is taxable COD
income to him (and thus not as to the accuracy of the form). On the basis
of this undisputed evidence, we are satisfied that respondent has
provided a reasonable foundation connecting petitioner with the
unreported income. The burden thus shifts to petitioner to show that
the IRS’s determination with respect to this income was arbitrary or
erroneous. 5
II. COD Income
A taxpayer’s gross income includes “all income from whatever
source derived,” including COD income. § 61(a)(12). 6 “The underlying
rationale for the inclusion of canceled debt as income is that the release
from a debt obligation the taxpayer would otherwise have to pay frees
up assets previously offset by the obligation and acts as an accession to
wealth—i.e., income.” Weiderman v. Commissioner, T.C. Memo. 2020-
109, at *23 (quoting Bui v. Commissioner, T.C. Memo. 2019-54, at *7−8);
see also Landreth v. Commissioner, 50 T.C. 803, 813 (1968) (“Where a
debtor is relieved of his obligation to repay the loan, his net worth is
increased over what it would have been if the original transaction had
5 Petitioner does not otherwise contend that the burden of proof as to any
matter should shift to respondent under section 7491(a), nor has he established that
the requirements for shifting the burden of proof under that section have been met.
Accordingly, the burden of proof remains on petitioner. See § 7491(a)(2).
6 In 2017 section 61 was amended, with section 61(a)(12) becoming section
61(a)(11). See Tax Cuts and Jobs Act of 2017, Pub. L. No. 115-97,
§ 11051(b)(1), 131 Stat. 2054, 2089.
5
[*5] never occurred. This real increase in wealth may be properly
taxable.” (citing United States v. Kirby Lumber Co., 284 U.S. 1 (1931))).
COD income is recognized for the year in which the debt is canceled and
is taxed at ordinary rates. Weiderman, T.C. Memo. 2020-109, at *23−24
(and cases cited thereat).
As indicated supra p. 4, petitioner does not dispute that
Sagasolutions owed $24,948 (plus interest) to Newtown and that
Newtown canceled that debt, which, as of the December 30, 2016,
cancellation date, totaled $34,964. Instead, petitioner contends that (1)
this COD income should not be attributed to him but to Sagasolutions;
(2) the debt in any event was discharged before 2016; (3) any COD
income that may be attributed to him should be characterized as capital
gain; and (4) the portion of the COD income that is interest is excludable
from his gross income pursuant to section 108(e)(2). Below we address
each contention in turn.
A. Tax Consequences to Petitioner of Sagasolutions’
Discharged Debt
Petitioner contends that the COD income arising from Newtown’s
discharge of Sagasolutions’ debt should not be attributed to him but
rather to Sagasolutions. Petitioner relies on Conn. Gen. Stat. § 34-
251a(a) (2017), which provides:
A debt, obligation or other liability of a limited liability
company is solely the debt, obligation or other liability of
the company. A member or manager is not personally
liable, directly or indirectly, by way of contribution or
otherwise, for a debt, obligation or other liability of the
company solely by reason of being or acting as a member or
manager. This subsection applies regardless of the
dissolution of the company.
His rationale is that despite his being Sagasolutions’ sole member,
because he did not personally guarantee Sagasolutions’ line of credit
with Newtown, his individual assets cannot be reached to satisfy any
outstanding line of credit balance; as a result he did not realize any
taxable income when Newtown discharged the debt. Under petitioner’s
rationale, without a personal guaranty, for a disregarded entity there
can be no tax consequences for discharged indebtedness. Such a
rationale is ill conceived.
6
[*6] Although state law governs the legal relationships that are
established when an entity is formed, federal law governs whether an
entity is taxed, or disregarded, as a corporation. Moye v. Commissioner,
T.C. Memo. 1997-554, slip op. at 15 (and cases cited thereat). Treasury
Regulation §§ 301.7701-1 through 301.7701-3 provide rules for the
classification of business entities for federal tax purposes. Known as the
“check-the-box” regulations, these regulations generally grant broad
discretion to business owners, who can often elect (by “checking the box”
for a certain entity type on a form filed with the IRS, hence the name)
whether an entity through which they conduct business is treated as an
association (i.e., a corporation), a partnership, or a disregarded entity
for federal tax purposes. Treas. Reg. § 301.7701-3(a); see also DAF
Charters, LLC v. Commissioner, 152 T.C. 250, 259–60 (2019) (and cases
cited thereat).
The check-the-box regulations do not always grant entity owners
a choice, though, listing some types of entities that are irrevocably
considered corporations. DAF Charters, LLC, 152 T.C. at 260 (citing
Treas. Reg. § 301.7701-2(b)). Entities not in this list may elect their
treatment, and the regulations provide default options for entities that
fail to choose. Id. (citing Treas. Reg. § 301.7701-3(b)). In particular, a
domestic entity that is not a corporation and has a single owner is
disregarded as an entity separate from its owner unless the owner elects
otherwise. Id. (citing Treas. Reg. §§ 301.7701-2(c)(2)(i), 301.7701-
3(b)(1)(ii)). The effect of being disregarded is that, in general, the entity
is treated as a sole proprietorship or branch of its owner. Id. (citing
Treas. Reg. § 301.7701-2(a)). Although the entity may be recognized
separately from its owner under state or other federal law, any items of
income and loss generated by the entity are directly attributable to and
reported by the entity’s owner for federal tax purposes (and the entity is
not subject to corporate income tax or any partnership or S corporation
income allocation rules, all of which are codified under subtitle A of the
Code). 7 Id.7 We also note that, pursuant to Treasury Regulation § 1.108-9(a)(3), the
insolvency exclusion of section 108(a)(1)(B) applies to the discharged indebtedness of a
disregarded entity at the ownership level, i.e., the insolvency exclusion applies to the
discharged indebtedness of a disregarded entity only to the extent the owner of the
disregarded entity is insolvent; if the disregarded entity is insolvent, but the owner of
the disregarded entity is not, then the section 108(a)(1)(B) exclusion does not apply to
the discharge of indebtedness income. This regulation would be superfluous if, as
petitioner contends, there is no recognition of income from the discharge of debt for the
disregarded entity.
7
[*7] Sagasolutions never filed Form 8832 with the IRS electing to be
treated as a corporation. As a result, Sagasolutions is treated as a
disregarded entity for federal tax purposes, see Treas. Reg. § 301.7701-
2(a); see also Comensoli v. Commissioner, T.C. Memo. 2009-242, slip op.
at 8, aff’d, 422 F. App’x 412 (6th Cir. 2011), and petitioner, as its sole
member, is required to report on his federal income tax return any
income (or loss) attributable to Sagasolutions. Thus, petitioner should
have reported COD income of $34,964, i.e., the amount of Sagasolutions’
debt that Newtown discharged.
B. Timing of the Debt Cancellation
Petitioner next contends that Sagasolutions’ debt was discharged
before 2016. In support of his contention, petitioner claims that (1) the
property used to secure the line of credit was abandoned in 2008 and
(2) Sagasolutions’ last payment to the line of credit was in 2008.
Petitioner’s contention is without merit.
The question as to the year in which a debtor’s obligation is
canceled (thus giving rise to COD income) is one of fact to be determined
on the basis of the evidence. Miller Tr. v. Commissioner, 76 T.C. 191,
195 (1981). A debt is deemed discharged (and COD income is generated)
the moment it becomes clear that the debt will never have to be paid.
Cozzi v. Commissioner, 88 T.C. 435, 445 (1987). Determining when that
moment occurs requires a practical assessment of the facts and
circumstances relating to the likelihood of payment. Id. (and cases cited
thereat). “Any ‘identifiable event’ which fixes the loss with certainty
may be taken into consideration.” Id. (citing United States v. S.S. White
Dental Mfg. Co., 274 U.S. 398 (1927)).
Treasury Regulation § 1.6050P-1(b)(2) provides an exclusive list
of seven “identifiable events” which constitute a discharge of debt for
canceled debt information reporting purposes under section 6050P. The
occurrence of one or more of these events triggers a creditor’s obligation
to send a Form 1099−C to the IRS and the debtor reporting the COD
income. Treas. Reg. § 1.6050P-1(a). As relevant here, the third of the
seven “identifiable events” giving rise to COD income (and thus the
reporting requirement), provided in Treasury Regulation § 1.6050P-
1(b)(2)(i)(C), is “[a] cancellation or extinguishment of an indebtedness
upon the expiration of the statute of limitations for collection of an
indebtedness, subject to the limitations described in paragraph (b)(2)(ii)
of this section, or upon the expiration of a statutory period for filing a
8
[*8] claim or commencing a deficiency judgment proceeding.” (Emphasis
added.)
With respect to abandoning the property of Sagasolutions that
secured the line of credit, petitioner testified at trial that when
Sagasolutions ceased to exist in 2008, he “left a lot of . . . furniture”
where it had an office and “was shocked in 2009 that [Newtown] hadn’t
come after [him] for whatever was left of Saga[solutions].” We need not,
and do not, accept petitioner’s self-serving testimony when he has failed
to present credible, corroborative, documentary evidence. See Tokarski
v. Commissioner, 87 T.C. 74, 77 (1986). Petitioner offered no evidence
of what furniture was left behind or its value, nor of whether Newtown
was ever informed of the alleged abandonment.
In his opening brief petitioner on the one hand claims that “[i]t is
clear from the evidence . . . that [Sagasolutions] was no longer making
any payments [with respect to its line of credit with Newtown] as early
as 2008,” but then on the other hand just a few sentences later in his
brief he contends that “it is clear from the Transaction History that no
payments were being made [with respect to the line of credit]
subsequent to September 2010.” The documentary evidence in this case
shows that Sagasolutions defaulted on its line of credit sometime in 2010
(not 2008), and at the latest on October 5, 2010, which was the next due
date with respect to the line of credit after a final principal payment of
$52 was made in September 2010.
Connecticut law mandated that Newtown bring an action within
six years of when the action accrued. See Conn. Gen. Stat. § 52-576(a)
(1971) (“No action for an account, or on any simple or implied contract,
or on any contract in writing, shall be brought but within six years after
the right of an action accrues . . . .”). With Newtown’s right of action
accruing sometime in 2010 (and at the latest on October 5, 2010), its
opportunity to bring an action with respect to the line of credit expired
sometime in 2016 (and no later than October 5, 2016). Newtown did not
bring an action (nor did it attempt to seize or foreclose on any of
Sagasolutions’ property that was pledged as security for the repayment
of the line of credit) during the 2010–16 timeframe. When the six-year
period for bringing a claim expired, an identifiable event occurred and
it triggered Newtown’s obligation under section 6050P and the
accompanying Treasury regulations to issue Form 1099−C. Newtown
properly did so, indicating that as of December 30, 2016, it had
discharged the outstanding principal and accrued interest owed on the
line of credit (totaling $34,964) because the time in which to bring a
9
[*9] claim had expired. Consequently, 2016 was the correct year of the
discharge of Sagasolutions’ debt.
C. Characterization of the Discharged Debt
Petitioner further contends that any COD income that may be
attributable to him should be characterized as capital gain. In support
of his contention, he relies on L&C Springs Assocs. v. Commissioner, 188
F.3d 866 (7th Cir. 1999), aff’g T.C. Memo. 1997-469, and 2925 Briarpark,
Ltd. v. Commissioner, 163 F.3d 313 (5th Cir. 1999), aff’g T.C. Memo.
1997-298. 8 Petitioner’s contention is without merit.
In L&C Springs Assocs., the U.S. Court of Appeals for the Seventh
Circuit did not opine on the nature of the income, which is the focus of
the dispute here; rather, at issue in L&C Springs Assocs. was at what
time the taxpayer abandoned certain property, thereby triggering gain
from cancellation of indebtedness for purposes of section 1001. L&C
Springs Assocs., 188 F.3d at 868. In 2925 Briarpark, Ltd., the issue was
whether the taxpayer-partner and the limited partnership realized gain
from dealings in property under section 61(a)(3), rather than
cancellation of indebtedness income under section 61(a)(12); the U.S.
Court of Appeals for the Fifth Circuit did not opine on whether the gain
was capital. Sagasolutions and Newtown never agreed that
Sagasolutions would surrender or abandon the property that secured
the line of credit in exchange for Newtown’s canceling the debt, and
petitioner has taken no steps to show that the resulting COD income
was from the exchange of a capital asset as defined in section 1221. The
COD income is ordinary income under section 61(a)(12).
D. Amount of COD Income
Lastly, petitioner contends that because the line of credit was a
business loan and the interest paid with respect thereto would have
8 In a footnote in his opening brief petitioner also attempts to draw support
from I.R.S. Priv. Ltr. Rul. 202050014 (Dec. 12, 2020) (which he refers to as “PLR-
117300-20”). A “written determination” of the IRS may not be used or cited as
precedent, § 6110(k)(3), and written determinations are defined to include IRS private
letter rulings, § 6110(b)(1)(A); see also Plano Holding LLC v. Commissioner, T.C.
Memo. 2019-140, at *17 n.6 (“Private letter rulings have no precedential value and
merely represent the Commissioner’s position as to a particular set of facts.”) (and
cases cited thereat). In any event, I.R.S. Priv. Ltr. Rul. 202050014 is not helpful to
petitioner. Like L&C Springs Assocs. and 2925 Briarpark, Ltd., as discussed above,
I.R.S. Priv. Ltr. Rul. 202050014 addresses a situation factually distinct from the
instant case.
10
[*10] been a deductible business expense, the portion of the COD income
that is interest ($10,016) is excludable from his gross income under
section 108(e)(2). Petitioner’s contention is without merit.
Section 108(e)(2) provides that no income shall be realized from
the discharge of indebtedness to the extent that payment of the liability
would have given rise to a deduction. As tax deductions are a matter of
legislative grace, Segel v. Commissioner, 89 T.C. 816, 842 (1987), the
taxpayer has the burden of (1) proving that any claimed deduction is
allowable pursuant to some statutory provision and (2) substantiating
the expense giving rise to the claimed deduction by maintaining
adequate records, § 6001; Higbee v. Commissioner, 116 T.C. 438, 440
(2001); Hradesky v. Commissioner, 65 T.C. 87, 89–90 (1975), aff’d per
curiam, 540 F.2d 821 (5th Cir. 1976). Section 163(h)(1) provides that in
the case of a taxpayer other than a corporation no deduction is allowed
for personal interest paid or accrued during the taxable year. Interest
paid or accrued on indebtedness properly allocable to a trade or business
is excluded from the definition of personal interest and so is deductible.
§ 163(h)(2)(A).
Petitioner offered no evidence at trial that the $10,016 of interest,
which accrued after the last principal payment was made with respect
to the line of credit, would have been an ordinary and necessary business
expense. Statements in a party’s brief, such as petitioner’s assertion
regarding the interest, are not part of the evidentiary record. See Rule
143(c) (“[S]tatements in briefs . . . do not constitute evidence.”); see also
Ashkouri v. Commissioner, T.C. Memo. 2019-95, at *36. Indeed, the
evidentiary record unmistakably shows that Sagasolutions stopped
doing business in 2008 and that 2009 was the last year that
Sagasolutions’ income (or loss) was reported to the IRS, before the
interest started accruing in 2010. Accordingly, the total amount of the
canceled debt, i.e., $34,964, is COD income to petitioner for 2016.
E. Conclusion
In sum, petitioner has not shown that the IRS’s determination
with respect to the COD income of $34,964 for 2016 was arbitrary or
erroneous. Accordingly, we sustain the IRS’s determination.
11
[*11] We have considered all of the arguments made by the parties and,
to the extent they are not addressed herein, we find them to be moot,
irrelevant, or without merit.
To reflect the foregoing,
Decision will be entered for respondent.