I see two issues that are still not clear. Maybe we need to see the charges, the plea agreement and the later settlement documents.
First issue, whether section 1041 is applicable. Is there a transfer of property, both for the investments and also the IRAs? If so, is it within 1041 given that wife is dead?
Second issue, COD income. The
Zarin case linked earlier involved a compulsive gambler who won on the tax issue of COD income, i.e., there was none. THe Third Circuit stated the issue here:
Initially, we find that sections 108 and 61(a)(12) are inapplicable to the Zarin/Resorts transaction. Section 61 does not define indebtedness. On the other hand, section 108(d)(1), which repeats and further elaborates on the rule in section 61(a)(12), defines the term as any indebtedness "(A) for which the taxpayer is liable, or (B) subject to which the taxpayer holds property." I.R.C. Sec. 108(d)(1). In order to bring the taxpayer within the sweep of the discharge of indebtedness rules, then, the IRS must sholevant to our factsw that one of the two prongs in the section 108(d)(1) test is satisfied. It has not been demonstrated that Zarin satisfies either.
. There was no "debt" because the liability was not enforceable under the gambling laws of the state. There was also no "debt" because the casino's chips are not property. Those points are not particularly relevant to our facts. (Nor, by the way, is the reasoning in CCA 200039037/TAM 200039038, which posited nthat in Zarin-type facts, the reduction in "debt" was really a purchase price adjustment).
This excerpt is important. It summarizes what a contested liability is in our context.
Instead of analyzing the transaction at issue as cancelled debt, we believe the proper approach is to view it as disputed debt or contested liability. Under the contested liability doctrine, if a taxpayer, in good faith, disputed the amount of a debt, a subsequent settlement of the dispute would be treated as the amount of debt cognizable for tax purposes. The excess of the original debt over the amount determined to have been due is disregarded for both loss and debt accounting purposes. Thus, if a taxpayer took out a loan for $10,000, refused in good faith to pay the full $10,000 back, and then reached an agreement with the lendor that he would pay back only $7000 in full satisfaction of the debt, the transaction would be treated as if the initial loan was $7000. When the taxpayer tenders the $7000 payment, he will have been deemed to have paid the full amount of the initially disputed debt. Accordingly, there is no tax consequence to the taxpayer upon payment.
.
Why I think the actual documents would help is this. We can't be sure whether, in our facts, the debt is contested. A court approved a plea agreement. Husband disputed his murder charge, but agreed to manslaughter, and the $124 million was (we think) for damages, including punitive damages. We don't know for sure, but I'd guess the Court approved the damages as well. Then, maybe, negotiations ensued that ended up with a settlement at the $3 million plus number. I'm not aware there was an appeal, but maybe there was, and that would matter. Does all that amount to a disputed/contested liability, or is it merely a negotiated settlement of an adjudged liability, a settlement made because the husband did not have that kind of money and therefore the creditor settled for what they could get. If so, i.e., if it's not a contested debt, the only other exclusion I see in section 108 is insolvency. Measuring that insolvency immedIately before the settlement, husband is clearly insolvent. Not after the settlenet though.