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June 2015

IRS Disagrees with Tax Court on Partnership Debt Exclusion in Bankruptcy

The IRS released Action on Decision 2015-1 in February 2015, announcing its non-acquiescence with four U.S. Tax Court rulings: Gracia v. Commissioner (T.C. Memo 2004-147); Mirarchi v. Commissioner (T.C. Memo 2004-148), Price v. Commissioner (T.C. Memo 2004-149) and Estate of Martinez v. Commissioner (T.C. Memo 2004-150). All cases relate to the finding on individual taxpayers that were not in a Title 11 (bankruptcy) proceeding, but were allowed to exclude cancellation of debt income that was discharged to a partnership debtor that was in a bankruptcy court in a Title 11 case. The Tax Court Memo findings appear to run contrary to the statutory language in IRC section 108(d)(6) in the opinion of the IRS.

Wynne Court Holds That Internal Consistency Lives, Applies to Taxation of Resident

The U.S. Supreme Court ruled in Comptroller of the Treasury of Maryland v. Wynne, et ux, that a Maryland individual income tax failed the internal consistency and external consistency commerce clause tests and therefore discriminated against interstate commerce because, while it allowed for credits against the “state” income tax for income taxes paid in other states, it did not allow a similar credit against the “county” income taxes. This is the first time in a very long time that the U.S. Supreme Court has agreed to hear a case involving the constitutionality of a state tax under the commerce clause. Under the constitutional standard set forth in Complete Auto Transit, Inc. v. Brady, 430 U.S. 274 (1977), a tax must be applied to an activity with substantial nexus with the taxing state, be fairly apportioned, not discriminate against interstate commerce, and fairly relate to the services provided by the taxing state. In this case, the individual income tax failed the “internal consistency” test because if every state were to impose the same tax, individuals operating in interstate commerce would pay more than those operating only in Maryland. It failed the “external consistency” test because it denied residents a full credit on tax paid in other states and therefore created a risk of multiple taxation. The Supreme Court held these interstate commerce requirements applied not only to taxes imposed on businesses acting in interstate commerce, but also on individuals, upholding the Court of Appeals determination that the tax was unconstitutional.