Abstract

COD Overview

If an individual or business borrows money from a creditor (i.e. mortgage lenders, credit card companies, etc.) this does not give rise to any income tax liability because the individual or business has an obligation to repay that money.  If the debt is then forgiven or cancelled, this taxpayer then has incurred cancellation of indebtedness income because their obligation to repay that money has been removed.

Cancellation of a debt was ruled to be taxable income in the Kirby Lumber case, 284 U.S. 1 (1931).  It is income because the borrower's net worth has increased as a result of the cancellation.  This same concept led to the decision in the Glenshaw Glass case, 348 U.S. 426 (1955) where the court defined income as all accessions to wealth, clearly realized, and over which the taxpayer has complete dominion.  Also at play here is the reason why borrowing money is not income, there is no accession to wealth.  When a taxpayer borrows $100 but only pays $90 in full discharge of the debt, their wealth has increased by $10 and the Supreme Court said this is gross income subject to taxation.