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Duffy v. Commissioner (T.C. Memo. 2020-108)

On July 13, 2020, the Tax Court issued a Memorandum Opinion in the case of Duffy v. Commissioner (T.C. Memo. 2020-108). The primary issue before the court in Duffy was whether, because the petitioners’ debt to the bank was nonrecourse, the discharge of indebtedness was included in the petitioners amount realized on the sale of the property and did not give rise to cancellation of indebtedness income under Treas. Reg. § 1.1001-2(a). A secondary issue was whether the supervisor who signed the penalty approval form was required to be the direct supervisor of the individual proposing the penalty.

Background

Petitioners bought a home in 2006 for $2m, paying the sellers a total of $431,000, but being unable to pay the remaining balance. In 2008, when the loan became due, they borrowed $1.4m from JPMorgan Chase Bank (JPMC). Petitioners sold the home in March 2011 for $800,000. JPMC agreed to accept $750,841 of the proceeds in full satisfaction of the mortgage loan that encumbered the property. The documents which the parties stipulated regarding petitioners’ sale of the home do not include any judicial filings by JPMC and make no reference to judicial proceedings to enforce petitioners’ obligation to the bank.

The Notice of Deficiency

The IRS increased petitioners’ cancellation of indebtedness income for 2011 by $108,661, equal to the unpaid interest on the JPMorgan Chase loan that had accrued upon its cancellation.

Income from Cancellation of JPMC Loan

Treasury Regulation § 1.1001-2(a)(1) provides as a general rule that the amount realized from a sale or other disposition of property includes the amount of liabilities from which the transferor is discharged as a result of the sale or disposition. Treasury Regulation § 1.1001-2(a)(2), however, provides that the amount realized on a sale or other disposition of property that secures a recourse liability does not include amounts that are (or would be if realized and recognized) income from the discharge of indebtedness under IRC § 61(a)(12).

Recourse or Non-Recourse Obligation

The IRS’s position reflects his determination that the JPMC loan was a recourse liability of petitioners because the lender, had it chosen to do so, could have proceeded against petitioners for the unpaid balance of the loan after application of $750,841 of the proceeds from the sale of the home.

The IRS acknowledges that, if the JPMC loan were instead nonrecourse–in that the bank’s remedies were limited to the home–the unpaid loan would have been included in the petitioners’ amount realized from the sale of the property. See Treas. Reg. § 1.1001-2(a). In the event that the loan were nonrecourse, the IRS accepts that the canceled loan would have reduced the petitioners’ nondeductible loss without resulting in cancellation of indebtedness income.

Because the documents which the parties stipulated regarding the petitioners’ sale of the home do not include any judicial filings by JPMC, and the Tax Court found no reference to any judicial proceedings in the documents that were stipulated, the Tax Court inferred that the sale was part of an administrative rather than a judicial foreclosure. Therefore, Oregon’s anti-deficiency statute prevented JPMC from seeking satisfaction from the petitioners’ other assets of that part of its loan in excess of the proceeds it received from the sale of the home.

The petitioners’ amount realized from the sale of the home is, thus, determined under the general rule of Treas. Reg. § 1.1001-2(a)(1), rather than the exception for the cancellation of recourse liabilities provided in Treas. Reg. § 1.1001-2(a)(2). It follows that the amount of the JPMC loan from which the petitioners were discharged is included in their amount realized from their sale of the home.

Whose Supervisor Counts for Purposes of IRC § 6751(b)(1)?

In claiming that he has met his burden of establishing compliance with IRC § 6751(b), respondent refers to the parties’ stipulation that “Supervisory Internal Revenue Agent, also known as Exam Group Manager, Patricia Crespi, who was the manager or supervisor of one or more of the auditing revenue agents,” signed a Civil Penalty Approval Form with respect to the IRS’s determination of penalties.

Ultimately, the Tax Court held that the IRS failed to meet the burden of production imposed on him by IRC § 7491(c). In particular, the IRS has not established compliance with the supervisory approval requirement of IRC § 6751(b)(1). The civil penalty approval form included in the record establishes that Ms. Crespi approved the penalties for some of the years in issue, but respondent has not established that Ms. Crespi is “the immediate supervisor of the individual” who made the determination to assess penalties. See IRC § 6751(b)(1).

To establish that Ms. Crespi’s approval complied with IRC § 6751(b)(1), respondent relies on the parties’ stipulation that she “was the manager or supervisor of one or more of the auditing revenue agents.” The stipulation thus does not establish that Ms. Crespi was the immediate supervisor of the person who made the initial determination to assess the penalties in issue.

According to the stipulation, Ms. Crespi supervised some of the agents involved in the audit but not necessarily all of them. Thus, the record does not demonstrate that Ms. Crespi was the immediate supervisor of the individual who made the initial determination to assess the penalties the IRS seeks to impose.

(T.C. Memo. 2020-108) Duffy v. Commissioner

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