Rood v. Commissioner
1996 Tax Ct. Memo LEXIS 262, 71 T.C.M. 3125, 1996 T.C. Memo. 248 (1996)
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Rule of Law:
Income from cancellation of indebtedness is generally taxable, but no income arises if the debt cancellation is in settlement of a good faith dispute regarding the debt's amount or enforceability, provided the debtor provides sufficient corroborating evidence of such a dispute.
Facts:
- Edward B. Rood, an attorney, maintained a line of credit at Caesar’s Palace casino in Las Vegas, Nevada, where he gambled.
- Between May and October 1985, Rood incurred gambling debts at Caesar's.
- In October 1985, Rood provided Caesar's with two personal checks for $110,000 and $75,000 which were repeatedly returned due to insufficient funds or missing endorsements, increasing his outstanding balance to $435,000.
- Rood made various payments totaling $80,000 on his account between May 1986 and March 1988, reducing the balance to $355,000.
- Rood alleged that in December 1985, he hosted a charity golf tournament at Caesar's, where he invited players to gamble on his credit, and that repayments by some of these players were not properly recorded by a casino employee, leading to a 'running telephone dispute' with Caesar's about the correct amount of his debt.
- In April and May 1988, Caesar's informed Rood that it would pursue legal action if his account was not settled and offered a lump-sum settlement of $142,000.
- In accordance with an agreement, Rood paid Caesar's $100,000 by check dated June 29, 1988 (received September 2, 1988), and Caesar's wrote off the remaining $255,000 balance of his account in September 1988.
- Rood was not insolvent during 1988 and did not report the $255,000 written off by Caesar’s as income on his 1988 Federal income tax return.
Procedural Posture:
- The Commissioner of Internal Revenue determined a deficiency of $60,457 in Edward B. Rood’s 1988 Federal income tax.
- Edward B. Rood filed a petition with the United States Tax Court, challenging the Commissioner's determination.
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Issue:
Does the cancellation of an allegedly disputed gambling debt by a casino result in taxable income from cancellation of indebtedness when the debtor fails to provide sufficient evidence of a good faith dispute regarding the debt's amount or enforceability?
Opinions:
Majority - WELLS, Judge
Yes, the cancellation of this gambling debt does result in taxable income from cancellation of indebtedness because Edward Rood failed to establish that the settlement was of a good faith disputed debt. The court affirmed that Section 61(a)(12) of the Internal Revenue Code generally includes income from the cancellation of indebtedness in gross income, based on the rationale that it frees assets previously offset by the liability. While an exception exists for debt cancellations made in settlement of a good faith dispute concerning the debt's amount or enforceability, the burden of proof rests on the petitioner to demonstrate such a dispute. Rood claimed a 'running telephone dispute' arising from alleged mishandling of chip repayments by other gamblers on his credit in December 1985. However, the court found Caesar's records showed the debts creating the balance occurred in May and October 1985, not December 1985, and no new credit was extended in December. Furthermore, Caesar's IOU envelope, which recorded all contacts, contained no reference to Rood's alleged dispute; conversely, a January 1987 entry stated Rood 'agrees' with the verified balance. The court found Rood's testimony to be uncorroborated by direct evidence, and his failure to produce receipts or call relevant witnesses (like Caesar's collection manager, Mr. Jones) weakened his claim, noting that missing evidence is typically inferred as unfavorable. The court clarified that while a settlement might infer a dispute, it is not conclusive; Caesar's stated reasons for settlement included the age of the account, collection costs, and the benefit of a lump sum, which are business considerations, not concessions to a disputed liability. Ultimately, Rood failed to establish the factual predicate for his alleged dispute by a preponderance of the evidence.
Analysis:
This case underscores the high burden of proof on taxpayers claiming the 'disputed debt' exception to cancellation of indebtedness income. It clarifies that a mere allegation of a dispute or the fact of a settlement alone is insufficient; concrete, corroborating evidence establishing the existence and nature of the dispute is required. The court distinguished legitimate business reasons for a creditor to settle (e.g., collection costs, age of debt) from a good faith dispute about the debt's validity, preventing taxpayers from converting business concessions into untaxed income. It highlights the critical importance of contemporaneous documentation and supporting evidence in tax disputes, particularly when asserting an unwritten 'running dispute.'
