Rural Doctor Received Cancellation of Debt Income Stemming from Forgiveness of Incentive Loans

April 24, 2015

The Tax Court held that a hospital’s forgiveness of loans provided as an incentive for a physician to establish a practice in rural Florida gave rise to cancellation of debt income. The court disagreed with the physician’s contentions that he was not personally liable for the loan. Wyatt v. Comm’r, T.C. Summary 2015-31.

Background

In 2006, Darrel Wyatt, a physician board certified in obstetrics and gynecology, moved to Putnam County, Florida and became affiliated with the Putnam Community Medical Center (hospital). Putnam County is in a medically underserved rural area of Florida, and the hospital recruited Wyatt as part of its effort to better serve the community’s health needs.

In July of 2006, Wyatt and the hospital entered into a recruiting agreement whereby the hospital agreed to help Wyatt establish his practice in exchange for his commitment to practice in the area. An addendum to the agreement established a loan program, through which the hospital guaranteed gross payments of $32,953 a month and agreed to loan Wyatt the difference between that amount and the actual income he received from his practice each month for a year (the “guarantee period”).

At the end of this guarantee period, Wyatt was required to immediately repay the loans, unless he requested a deferred payment plan and signed a promissory note. However, if Wyatt remained within Putnam County and continued his practice after the end of the guarantee period, the hospital agreed to forgive the loans ratably over a three year period.

During his first year, Wyatt received loans of $260,627 from the hospital pursuant to the agreement. After the one-year guarantee period, Wyatt remained in Putnam County practicing medicine and maintained his affiliation with the hospital. Over the next four years, the hospital forgave the loans in recognition of Wyatt’s continuing service, as per the agreement. Wyatt did not request a deferred payment plan, and did not execute a promissory note or grant the hospital a perfected security interest in his accounts.

On his tax returns for 2007 to 2010, Wyatt included as “Other income” on his Schedule C attachments the amounts forgiven and canceled by the hospital, consistent with the Forms 1099-MISC that he received from the hospital. Wyatt reported total tax of $37,995 on his return for 2008, and $32,625 for his 2009 return. After Wyatt failed to pay any part of his tax liability for 2009, the IRS issued a notice of intent to levy for that year.

Wyatt sought to compromise his liabilities for 2007 through 2010, the four years for which the hospital forgave the loans. He offered to pay $20,055 in satisfaction of his outstanding tax liabilities, which was equivalent to the taxes for those years without regard to the canceled amounts, claiming there was doubt as to his liability for the canceled loans. The IRS rejected the offer and issued a notice of determination addressing only the 2009 tax year.

Analysis

A debt of a taxpayer that is discharged by the creditor generally must be included in the gross income of the taxpayer (Code Sec. 61(a)(12)).

The Tax Court noted that both Wyatt and the IRS agreed that the payments Wyatt received from the hospital pursuant to the agreement represented a bona fide loan. However, Wyatt contended that 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. Wyatt claimed that because he never signed a promissory note, he was not obligated to repay the loan.

The court disagreed with this characterization, stating that the fact Wyatt never executed a promissory note was not determinative of his personal liability for the loan. The court noted that if he had failed to honor his part of the bargain, there was nothing in the agreement that would have barred the hospital from suing him to recover the unrepaid loan amount. The court pointed out that the agreement required repayment of the loan immediately upon completion of the guarantee period unless he requested a deferred payment plan. Although Wyatt did not formally request a deferred payment plan, the hospital did not choose to demand immediate payment because he remained in the community, continued his medical practice, and maintained his affiliation with the hospital, and the hospital found it unnecessary to pursue any collection remedy against him.

The court found that the hospital assumed the risk of being an unsecured creditor, presumably because it had faith that Wyatt would fulfill his side of the bargain by remaining in Putnam County. But the court noted the assumption of that risk by the hospital did not negate the fact that a loan existed for which Wyatt was personally liable. Additionally, even if the loan was nonrecourse, the court observed that just because a taxpayer is not personally liable for a debt does not mean that cancellation of indebtedness cannot give rise to income (Gershkowitz v. Comm’r, 88 T.C. 984 (1987)).

The Tax Court held that because Wyatt had paid nothing to the hospital on his loan after the one-year guarantee period and the hospital forgave the balance of the loan ratably over the course of the next 36 months, Wyatt had received income from cancellation of indebtedness and was required to include those amounts on his 2009 return.

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