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Law School Case Brief

Preslar v. Commissioner - 167 F.3d 1323 (10th Cir. 1999)

Rule:

The "contested liability" or, as it is occasionally known, "disputed debt" doctrine rests on the premise that if a taxpayer disputes the original amount of a debt in good faith, a subsequent settlement of that dispute is treated as the amount of debt cognizable for tax purposes. In other words, the excess of the original debt over the amount determined to have been due may be disregarded in calculating gross income.

Facts:

The Commissioner of Internal Revenue appeals the United States Tax Court's decision to redetermine the tax deficiency assessed against Layne and Sue Preslar for underpayment of 1989 federal income taxes. The Tax Court held the Preslars' settlement of a loan obligation for less than the face amount of the loan did not create taxable income because the contested liability/disputed debt exception to the general discharge-of-indebtedness income rule rendered the write-off nontaxable. The Preslars insisted they were free to treat their settlement with the FDIC as a purchase price adjustment pursuant to 26 U.S.C.S. § 108(e)(5) and/or common law. The Commissioner responded that the Preslars could not invoke § 108(e)(5) because that provision applies only to situations where the seller of property agrees to reduce the amount of the purchaser's debt flowing from the property sale.

Issue:

Did the Tax Court err when it held that Preslars' settlement of a loan obligation for less than the face amount of the loan did not create taxable income because the contested liability/disputed debt exception to the general discharge-of-indebtedness income rule rendered the write-off non-taxable?

Answer:

Yes

Conclusion:

The Court of Appeals for the Tenth Circuit reversed the Tax Court's decision to redetermine the tax deficiency assessed against the taxpayers for underpayment of federal income taxes.  The appellate court held that the Tax Court's invocation of the contested liability doctrine in the face of the record presented was unwarranted. The court held that taxpayers could not treat their settlement as a purchase price reduction because 26 U.S.C.S. § 108(e)(5) applied only to direct agreements between a purchaser and seller. The court further held that taxpayers could not treat their settlement as a common law purchase price reduction because an agreement to reduce a debt between a purchaser and a third-party lender was not a true adjustment of the purchase price paid for the property because the seller received the entire purchase price from the purchaser and was not a party to the debt reduction agreement.

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