Michael and Sharon Bross stood up to a credit card company that, as they saw it, overcharged them. The company backed down. I think people who do that deserve a medal. The IRS thinks they should be taxed. Sadly, the Tax Court agreed with the IRS. They call it cancellation of indebtedness income (COI). I call it unfair.
I understand why, in general, cancellation of indebtedness needs to be included in gross income. In a lot of situations, having indebtedness cancelled is equivalent to receiving money. A lot of times it strikes me as kicking somebody when they are down, but that is an emotional response. I really think that the stand that the Tax Court takes on discharges of credit card interest is wrong. My view is that talking a credit card company out of screwing you should not be a taxable event. Here is some of the story:
Before the year in issue petitioners intended to take advantage of a deferred interest financing arrangement offered by a credit card company in connection with the purchase of furniture from a certain furniture store (financing arrangement). In effect, the financing arrangement allowed for no interest to accrue on certain furniture purchases financed through charges to a credit card issued to petitioner by a certain credit card company if the charges were completely paid by certain specified dates. If the charges were not completely paid by the specified dates, then interest would be charged to the credit card account in an amount computed from the date of purchase.
I’ve made purchases like that myself and have always regretted it. It is not that they caught me being slightly late and charged me a ton of back interest. It is that I found the prospect so nerve wracking that I paid the thing off much earlier than I should have. Of course since money doesn’t really earn interest anymore, it doesn’t bother me that much.
Petitioners misinterpreted the terms of the financing arrangement, and petitioner was charged interest that petitioners believed he did not owe. Petitioners unsuccessfully attempted to resolve the dispute with the credit card company over an extended period during which additional interest and late payment penalties added to the amount the credit card company claimed that petitioner owed. All of the interest and late payment penalties charged to the credit card account were consistent with the terms of the credit card agreement entered into between petitioner and the credit card company pursuant to the financing arrangement.
The Tax Court kind of held it against Mr. Bross that he was an attorney. Mrs. Bross is a real estate agent. I guess the idea is that they should have known better than to listen to the furniture salesman who explained the deal and read the fine print for themselves.
As it turned out, during 2007 petitioner reached an agreement with the credit card company. As part of that agreement and in return for a partial payment, the credit card company canceled the unpaid balance of the credit card account. In due course, the credit card company issued to petitioner a Form 1099-C, Cancellation of Debt, showing $3,214.28 as the amount of debt canceled.
We begin by noting that petitioners’ claim that the credit card company misrepresented the terms of the financing arrangement is not supported by the record. Petitioner agreed to the terms of the financing arrangement at the time of the furniture purchases. Furthermore, the terms of the financing arrangement were also included in the monthly credit card statements generated by the credit card company. At most, petitioners, although both highly educated professionals, misunderstood those terms.
This is one of the reasons, I am not a Tax Court judge. In my mind, if there is a credit card company involved, there should be a presumption that financing arrangements are being misrepresented.
Under the circumstances, petitioner’s claim that he was not liable for the portion of the credit card debt ultimately discharged did not render that debt a “contested liability” within the meaning of the above-referenced authorities.
All kidding aside, this is the reasoning of the Tax Court in this, and similar cases, that I just don’t get. How was this not a contested liability ? The taxpayer argued with the credit card company and the credit card company gave in. Given that it was interest that was forgiven, I don’t really see that the taxpayers had an accretion of wealth from the transactions. They just avoided getting screwed. Avoiding getting screwed should not be a taxable event.
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Originally published on Forbes.com Jan 14th, 2013