Updated: December 31, 2024 at 07:42 AM
Clearly, the discharge of the obligation to repay debt is an economic benefit received by the debtor as discussed in Q
, above, and the unconditional discharge of debt for no consideration is includible in gross income under IRC Section 61(a)(12). On the other hand, if the debtor provides consideration to the creditor, the creditor is deemed to have paid the amount of the debt to the debtor as compensation, which, the debtor in turn used to repay the debt. Under those circumstances, the transaction is treated as an exchange of money for services or property rather than discharge of debt income includible under IRC Section 61(a)(12).
Example: Asher borrows $10,000 from his employer to take a two- week European vacation. When the loan becomes due, Asher’s employer forgives the debt. Because of their employee/employer relationship, the amount of the discharged debt is treated as compensation (not income from discharge of indebtedness). In other words, it is as if Asher’s employer paid him $10,000 as compensation for services, which Asher in turn used to repay the debt. Therefore, the forgiven debt is treated as wage income includible under IRC Section 61(a)(1) rather than IRC Section 61(a)(12).
Example: Asher borrows $10,000 from Ashley to take a two-week European vacation. When the loan becomes due, in lieu of repayment, Ashley accepts a painting from Asher worth $10,000 that he purchased three years ago for $2,000. In this case, it is as if Asher sold the painting to Ashley for $10,000, which Asher in turn used to repay the debt. Similar to any taxable sale or exchange of property, Asher must include $8,000 of capital gain income ($10,000 minus $2,000 (basis in painting)) under IRC Section 61(a)(3).