Preslar v. Commissioner: Debt-Discharge Income and its Rationale

Abstract

In Preslar v. Commissioner, the Tenth Circuit examined the “disputed debt” exception and concluded that the result was at odds with similar holdings from the Third Circuit. The Third and Tenth Circuits interpret the underlying logic of debt discharge income differently. The Third Circuit invokes the disputed-debt exception when the original debt is either unenforceable or unliquidated, while the Tenth Circuit invokes the exception only when the original amount is unliquidated. The Tenth Circuit stated that the exception “rests on the premise that if a taxpayer disputes the original amount of a debt . . ., a subsequent settlement of that dispute is ‘treated as the amount of debt cognizable for tax purposes.’” There being no evidence of a good faith dispute over the amount of the debt, the disputed-debt exception could not be invoked to surpass the debt-discharge income rule. By taxing people when an asset is freed through loan-forgiveness, the IRS ensures that those taxpayers do not arbitrarily receive tax-free consumption. The Tenth Circuit should have found that the method of payment can affect the amount of the debt, that a dispute as to method can be a dispute as to amount, and that, following the Tax Court\u27s factual findings, the Preslars had a legitimate dispute as to method and amount. A debt-discharge should not be excluded from gross income when it is disputed only as to enforceability. However, having adopted the correct rationale and exception construction, the court promptly misapplied it