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Taxpayer Erroneously Listed as Primary Loan Obligor Did Not Have COD Income

(Parker Tax Publishing November 2017)

The Tax Court held that a taxpayer who intended to cosign on her son's truck loan but was erroneously listed as the primary obligor did not have cancellation of debt income when the truck was stolen, her son stopped making payments on the loan, and the unpaid balance of the loan was discharged. The Tax Court found that (1) the taxpayer's net worth was not increased over what it would have been if the transaction had never occurred, (2) the taxpayer did not intend to personally repay the loan and, in fact, made no payments on the loan, and (3) the lender understood that the taxpayer intended only to be a cosigner. Bullock v. Comm'r, T.C. Memo. 2017-219 (2017).

Floetta Bullock has an adult son who, together with his wife, ran a business hauling cars across the country. In 2007, Bullock's son and his wife applied for a loan to buy a truck to use in their business. Bullock went with her son to a credit union recommended by the truck dealership to finance the purchase. Bullock intended to serve as a cosigner on the loan, but she unwittingly signed paperwork indicating she was the primary obligor. However, after the paperwork was signed, the credit union dealt only with the son, who made the loan payments.

A year later, in 2008, the truck was stolen from the street in front of the home where Bullock and her son and his wife lived. The insurance covered only part of the outstanding loan balance. The insurance company paid the credit union and the son stopped making loan payments on the remaining loan balance. The outstanding balance on the loan of approximately $8,100 was subsequently discharged.

Bullock never received any phone calls or correspondence from the credit union attempting to collect the outstanding balance. But in 2013, the credit union sent Bullock a Form 1099-C, Cancellation of Debt, indicating that she had cancellation of debt (COD) income of $8,100. Bullock did not report the income on her 2013 tax return. In 2016, she received a notice of deficiency from the IRS and filed a Tax Court petition for redetermination.

A bona fide debt must exist in order for cancellation of debt income to arise. There must be a genuine intention to create a debt in order for a bona fide debt to exist. A guarantor of a debt generally does not recognize income on the discharge of a debt because the discharge creates no previously untaxed increase in net worth.

The Tax Court ruled in Bullock's favor and held that the transaction did not create a bona fide debt of Bullock. The Tax Court found that Bullock did not intend to be the primary obligor on the loan when she went to the car dealership and, in fact, did not even realize until the trial that she had signed the paperwork stating otherwise. Bullock had no intention of personally repaying the loan, the Tax Court found, and made no payments on the loan. The Tax Court further found that the credit union understood Bullock to be only a cosigner; it was aware that Bullock's son was responsible for the loan payments and never looked to Bullock for repayment. Without an intention on Bullock's part to repay the debt, there was no bona fide obligation between her and the credit union, the Tax Court concluded.

The Tax Court found that Bullock acted only as a guarantor on the loan and, as such, her net worth was not increased over what it would have been if the transaction had never occurred. When the truck loan was forgiven, Bullock did not realize an untaxed increase in wealth, and therefore did not receive $8,100 in cancellation of debt income during 2013.

For a discussion of cancellation of debt income, see Parker Tax ¶72,301.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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