Can you avoid paying Federal income tax by having your employer make loans to you in lieu of wages, and then have the employer forgive the loans over time? The court addressed this in Wyatt v. Commissioner, T.C. Summary Opinion 2015-31.
Facts & Procedural History
Dr. Wyatt was a gynecologist. He recruited to practice in Putnam County Florida by a hospital as part of its effort to better serve the community’s health needs.
To help Dr. Wyatt establish his medical practice, the hospital agreed to loan Dr. Wyatt $32,953 for twelve months. At the end of each month the hospital was to pay Dr. Wyatt the difference between his gross receipts less the $32,953 amount. The loan was to be due immediately, payment deferred over a period of time.
The agreements specified that the hospital would forgive and cancel 1/36th of the loan for each full calendar month Dr. Wyatt: (i) remained in the full-time practice of medicine in the community after the end of the twelve month period; (ii) maintained active medical staff membership and privileges in good standing at the hospital; and (iii) remained available for emergency room coverage for patients of hospital’s emergency room, including without limitation unassigned call coverage.
Dr. Wyatt received $260,627 from the hospital during the twelve month period. The $260,627 was forgiven in 2007-2010 as Mr. Wyatt complied with the loan forgiveness terms. The hospital issued Forms 1099-MISC, Miscellaneous Income, to report the $260,627 loan forgiveness for tax years 2007 through 2010. Dr. Wyatt reported this amount on his income tax returns for 2007 through 2010, but did not pay the tax. The IRS assessed this amount of tax, but Dr. Wyatt did not believe that they amounts were taxable. Litigation ensued.
Cancellation of Debt Income
The court noted that the advances were loans and that loans are not includible in computing federal income taxes.
The court also noted the exception, whereby loans are included if they are forgiven. This is referred to as cancellation of indebtedness income. Cancellation of indebtedness produces income in an amount equal to the difference between the amount due on the obligation and the amount paid for the discharge.
The Absence of a Loan Document
Dr. Wyatt argued the loan was a nonrecourse loan, i.e., that he was not personally liable for its repayment, and that, as a consequence, he did not receive income when the loan was forgiven and canceled by the hospital. Dr. Wyatt based this argument on the fact that he never signed a promissory note for the loan.
The court did not agree. It concluded that the documents were sufficient to enable the hospital to collect. Also, the court noted that just because a taxpayer is not personally liable for a debt does not mean that cancellation of indebtedness cannot give rise to income. Thus, the court upheld the IRS’s determination that Dr. Wyatt owed the tax.