In tax law, to err is easy; to forgive generally creates income. For example, forgiveness of debt is taxable income because when you don’t have to pay back a loan, you get an economic benefit that is an accession to wealth.
The rule applies to “forgivable loans” as well. These loans are sometimes called “golden handcuffs” due to the way they’re structured: You get money upfront and must meet conditions, such as remaining with an employer a certain number of years, in order to have the loan forgiven.
In T.C. Summary Opinion 2015-31 (Wyatt), the taxpayer, a gynecologist, entered into a recruiting agreement with a hospital. The agreement guaranteed the taxpayer a set amount of gross cash receipts per month and considered the advanced amounts a loan.
Under an addendum to the agreement, the loan would be forgiven over a 36-month period if the taxpayer fulfilled certain requirements for a specified length of time, such as staying in full-time medical practice in the county and maintaining his affiliation with the hospital.
The taxpayer received $260,627 in payments and fulfilled his obligations under the agreement. The hospital cancelled the loan in full over a 36-month period and issued Form 1099-Misc for each year.
The taxpayer and the IRS agree the amount the taxpayer received was a bona fide loan.
However, the taxpayer says he never formally requested a deferred payment plan, executed a promissory note or granted the hospital a perfected security interest in his accounts receivable or other assets as required by the addendum to the agreement.
Because of this, the taxpayer contends the loan was a nonrecourse loan and he was not personally liable for its repayment. Consequently, he says he did not receive income when the loan was forgiven and canceled by the hospital.
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Contrary to what the taxpayer appears to assume, the fact that he never executed a promissory note is not determinative of personal liability. If he had failed to honor his part of the parties’ bargain, nothing in the recruiting agreement would have barred the hospital from suing him to recover the unrepaid loan amount.
The taxpayer did not formally request a deferred payment plan and the hospital did not choose to demand immediate payment because, consistent with the parties’ expectations, the taxpayer remained in the community, continued his medical practice, and maintained his affiliation with the hospital.
The possibility that the taxpayer might have been asked to “grant the hospital a perfected security interest” if he had not remained in practice in the county or had otherwise breached his obligations under the recruiting agreement or had been granted a deferred payment plan is not incompatible with personal liability, as personal liability is often a feature of a secured loan.
In any event, there is nothing in the record to suggest the taxpayer and the hospital ever entered into a security agreement. Indeed, the hospital’s chief executive officer stated because the taxpayer complied with all of the terms of the recruiting agreement, the hospital found it unnecessary to pursue any collection remedy against him, such as demanding a perfected security interest in his accounts receivables or other assets.
In other words, the hospital assumed the risk of being (and remaining) an unsecured creditor, presumably because it had faith the taxpayer would fulfill his side of the bargain. But the assumption of that risk by the hospital did not negate the fact that a loan existed in respect of which the taxpayer was personally liable.
Further, although the court does not accept the premise of the taxpayer’s contention regarding the nature of the loan, it bears mention that just because a taxpayer is not personally liable for a debt does not mean cancellation of indebtedness cannot give rise to income.
In sum, the taxpayer paid nothing to the hospital on his loan after the one-year guarantee period. Thereafter, the hospital forgave the balance of the loan ratably over the course of the next 36 months. Under these circumstances, forgiveness and cancellation of the loan gave rise to income.
Accordingly, the taxpayer received income from cancellation of indebtedness.