IRS Nonacquiesces to Holding that Pension Interest isn't Part of Insolvency Calculation

In an Action on Decision, IRS has announced that it will not acquiesce to the Tax Court’s holding in Schieber, TC Memo 2017-32, that a taxpayer’s interest in his employer’s defined benefit pension plan, with respect to which his only right was to receive monthly payments, was not an asset for purposes of determining whether he was insolvent under Code Sec. 108‘s exclusion for cancellation of debt income (CODI) for insolvent taxpayers.

Background.

Code Sec. 61(a)(12) provides that gross income includes income from the cancellation of a debt. There are, however, exceptions under which a taxpayer may not be required to include such CODI in gross income. One such exception is in Code Sec. 108(a)(1)(B), which excludes from gross income any amount that would otherwise be includable by reason of the cancellation of the taxpayer’s debt, in whole or in part, if the cancellation occurs when the taxpayer is insolvent. Code Sec. 108(a)(3) provides that the amount of income excluded under Code Sec. 108(a)(1)(B) “shall not exceed the amount by which the taxpayer is insolvent.” The term “insolvent” is defined by Code Sec. 108(d)(3) as “the excess of liabilities over the fair market value of assets.”

Schieber’s facts.

The taxpayers, Mr. and Mrs. Schieber, were a married couple. In 2009, Mr. Schieber’s mortgage debt was cancelled. During that year, Mr. Schieber was retired and was receiving monthly payments under a defined benefit pension plan. In the event of Mr. Schieber’s death, Mrs. Schieber had a right to receive the monthly payments. Other than the right to receive the monthly payments, the Schiebers could not access the value in the plan. They could not convert their interest in the plan to a lump-sum cash amount, sell the interest, assign the interest, borrow against the interest, or borrow from the plan.

Holding in Schieber.

The Court held that Mr. Schieber’s interest in the pension was not an asset for purposes of determining whether the Scheibers were insolvent.

IRS contended the Schiebers’ interest in the pension plan should be considered an asset because they could use their monthly payments to pay liabilities.

But the Court disagreed. It looked to the facts in Carlson, (2001) 116 TC 87, which noted that the word “asset” is not defined in the Code. The Carlson Court held that an asset exempt from creditors could still be an asset under Code Sec. 108(d)(3) because even an asset exempt from creditors can give the taxpayer “the ability to pay an immediate tax on income” from the canceled debt. That Court held that a commercial fishing license could be an asset because the license could be used, in combination with other assets, to immediately pay the income tax on canceled-debt income.

The Schieber Court said that the test in Carlson is whether the asset gives the taxpayer the ability to pay an “immediate tax on income” from the canceled debt—not the ability to pay the tax gradually over time. In contrast to Carlson, the Schiebers could not use their interest in the pension plan to immediately pay a tax liability because they were entitled only to monthly payments under the plan and could not convert their interest in the plan to a lump-sum cash amount, sell the interest, assign the interest, borrow against the interest, or borrow from the plan.