Memo to File-3-1 Client: Gerald A. Bunker Subject: Insurance Payment of Indebtedness

1. Memo to File-3-1 • Client: Gerald A. Bunker • Subject: Insurance Payment of Indebtedness • For: Tax Partner • Researched • By: Tax Student-3 • Date: Sept 4, 2005

2. Facts-3-2 • Gerald A. Bunker lost his job when a hurricane destroyed his employer’s facilities. Prior to that event, Bunker had accrued credit card debt of approximately $45,000. While employed, Bunker had purchased insurance on his credit cards that would cover payment of his debt in the event of death, disability or unemployment. As a result, $15,844.09 of Bunker’s debt was paid per the insurance contracts in 2001. Bunker did not report this amount as part of his income in tax year 2001.

3. Issues-3-3 • 1. Are the payments by the insurance companies totaling $15,844.09 subject to tax? • Conclusions • 1. The payments made by the insurance companies are considered income under section 61(a)(12) and 108(a)(1)(B).

4. Discussion of Reasoning and Authorities-3-4 • 1. Gross income includes income from discharge of indebtedness (unless otherwise noted) under section 61(a)(12). • Income from discharge of indebtedness is excluded from gross income when the taxpayer is insolvent under section 108(a)(1)(B). In this case, the client is not insolvent, therefore the income is not excluded.

5. Memo to File • Client: Joe Taxpayer • Subject: Credit card debt paid by insurer • For: Tax Partner • Researched by: Tax Research Student-1-1 • Date: September 6, 2005

6. Facts-1-2 • Joe Taxpayer, employed at Kelly Air Force Base, purchased credit card insurance that provided for payment of a portion of acquired credit card debt upon the occurrence of death, disability, or unemployment. Due to events out of Taxpayer’s control, Taxpayer lost his employment. This event satisfied one of the three occurrences that allowed Taxpayer to apply for insurance benefits. After applying for such benefits, the insurance provider approved and made payments to various credit card grantors in 2001 on behalf of Taxpayer totaling $11,396. The insurance provider reported these payments to the IRS as miscellaneous income. In spite of this, Taxpayer did not report these payments as income on his 2001 individual income tax return.

7. Issues-1-3 • 1. Are payments made to credit card grantors pursuant to credit card insurance policies income to the debtor? • Conclusions • 1. Payments made to credit card grantors by an insurance carrier on behalf of the credit card grantee are considered income under IRC Sec. 61.

8. Discussion of Reasoning and Authorities-1-4A • IRC Sec. 61(a) defines gross income as “all income from whatever source derived,” unless specifically excepted. Furthermore, IRC Sec. 61(a)(12) provides that gross income includes income from discharge of indebtedness.

9. Discussion of Reasoning and Authorities-1-4A • Under the provisions of the insurance policy, Taxpayer realized economic benefits when the insurer made payments on his behalf in the form of debt relief. Although Taxpayer did not directly receive the payments under the policy, the payment of a “legal obligation of a taxpayer is income to him even though such income is not actually received by him.” Amos v. Commissioner, 47 T.C. 65,70 (1966).

10. Discussion of Reasoning and Authorities-1-4B • Generally, insurance payments that represent a replacement of property that has been destroyed or damaged are not taxable to the extent of the basis in the property. Unlike insurance recovery amounts for damaged property, insurance payments for debt relief have no basis. The payments made by the insurer represented damages for lost profits, and thus, are income. T.C. Memo.2005-35.

11. Client: Client-2-1 • Subject: Credit Card Insurance Payments • For: Dr Godfrey • Researched by: Tax-Student 2 • Date: September 6, 2005

12. Facts-2-2 • Client recently became unemployed after a hurricane destroyed his workplace. He had $10,000 in credit card debt at the time and credit card insurance that paid the debt when he became unemployed. • Issues • Will payment of credit card debt cause client to have taxable income?

13. Conclusions-2-3 • Client’s payment of credit cards is a discharge of indebtedness. • Client was not insolvent and therefore cannot exclude from income any of the payments towards his credit card debt.

14. Discussion of Reasoning and Authorities-2-4 • Section 108(a)(1)(B) provides that Gross income does not include any amount that would be includible in gross income by reason of the discharge of indebtedness of the taxpayer if the discharge occurs when the taxpayer is insolvent. • Section 108(a)(3) limits the exclusion from income to the amount of insolvency. • In Gereald A. Bunker, Petitioner v. Commissioner (TC Summary Opinion 2005-35) the tax court ruled that payments by credit card insurance companies toward the balance owed on credit cards were discharge of indebtedness because the taxpayer was relieved of the obligation to pay the issuers of his credit card.

15. Memo to File • Client: Jobless Dude • Subject: Taxability of Debt Payment • For: Client • Researched by: Tax Student • Date: September 3, 2005

16. Facts • Jobless Dude lost his job when a hurricane destroyed his employer’s facilities. He had insurance that paid off his credit card bill since he had incurred involuntary job loss. • Issues • 1. Will this payment cause Jobless Dude to recognize income on his Form 1040 tax return? • Conclusions • 1.Debt repayment by an insurance company is taxable as income under Section 61(a)(12) and therefore must be recognized as income on Jobless Dude’s Form 1040 tax return.

17. Discussion of Reasoning and Authorities • 1. Section 61(a) provides that “gross income [includes] all income from whatever source derived” unless specifically exempted. In addition, section 61(a)(12) specifically includes “income from discharge of indebtedness” as gross income. Since the $10,000 owed to the credit card companies is, in fact, debt, this repayment by the insurance company is considered a discharge of indebtedness and must be included in Jobless Dude’s gross income.

18. Discussion of Reasoning and Authorities • The Code does allow income from discharge of indebtedness to be excluded from gross income in section 108(a). However, Jobless Dude did not declare bankruptcy, the indebtedness is not farm indebtedness, and the discharge is not qualified a real property business indebtedness. Finally, Jobless Dude does not qualify as insolvent, the final allowance for exclusion. Section 108(d)(3) defines insolvent as having an “excess of liabilities over the fair market value of assets” owned. Jobless Dude has no other debt and has substantial assets; therefore, these exclusions do not apply and cannot be used to avoid recognizing the gross income. • Finally, this issue was addressed in Bunker vs. Commissioner, T.C. 35 (2005). This case established that an individual has no basis in credit card liability. Therefore, the insurance payment was not a recovery or restoration of capital and thus, such payments are income.

19. Memo to File • Client: Client • Subject: Insurance payoff of debt • For: Dr. Howard Godfrey • Researched by: Tax Student • Date: September 1, 2005

20. Facts • Our client recently lost his job when his employer’s facilities were destroyed by a hurricane. Client maintained insurance which paid off his $10,000 credit card liability due to the involuntary loss of his job. Client has no other debt and has substantial other assets. Client has asked us asked us for tax guidance concerning how to handle the insurance payment of his debt on his income tax return. • Issues • Is the payment of an individual’s debts by an insurance company taxable income to the individual?

21. Conclusions • Debts paid by an insurance company on behalf of an individual are discharge of indebtedness income which is taxable income under Section 61(a)(12). • Discussion of Reasoning and Authorities • Internal Revenue Code Section 61(a) defines gross income as "all income from whatever source derived," unless otherwise provided. The Supreme Court has consistently given this definition of gross income a liberal construction “in recognition of the intention of Congress to tax all gains except those specifically exempted.” Commissioner v. Glenshaw Glass Co., 348 U.S. 426, 430 (1955); see also Roemer v. Commissioner, 716 F.2d 693, 696 (9th Cir. 1983), revg. 79 T.C. 398 (1982) (all realized accessions to wealth are presumed taxable income, unless the taxpayer can demonstrate that an acquisition is specifically exempted from taxation). In addition, I.R.C. § 61(a)(12) specifically provides that gross income includes income from discharge of indebtedness. In this case, Client’s credit card debt has been paid by the insurance company, so this qualifies as discharge of indebtedness income. The discharge did not occur during a title 11 case, our client is not insolvent, the debt was not qualified farm nor qualified real property business indebtedness, so the exclusions of IRC § 108 do not apply.

22. Conclusions • Our client also cannot successfully contend that the insurance payments on his credit cards are analogous to insurance recovery amounts for damaged property, which benefits do not constitute gross income. Generally, the taxability of recovery payments depends upon the nature of the claim. Bunker v. Commissioner, T.C. Summary Opinion 2005-35 (2005). If the recovery represents damages for lost profits, the payment is considered income; however, if the recovery represents a replacement of capital destroyed or damaged, the recovery does not constitute income to the extent the recovery does not exceed the basis of the damaged or destroyed property. State Fish Corp. v. Commissioner, 48 T.C. 465, 473 (1967). In Client’s case, he has no basis in his credit card liability. Therefore, the payment by the insurance company is not a recovery or restoration of capital, and therefore are taxable income.