Zarin was a high roller. Resorts
International Hotel gave him a $10k line of credit to gamble at their
casino. Over time, they raised the limit again and again.
Zarin kept losing more and
The New Jersey Casino Control
Commissioner found a number of violations with Resorts and ordered them to
stop extending Zarin's credit.
That was to protect
compulsive gamblers like Zarin.
Resorts kept extending Zarin's
credit, and eventually Zarin ended up owing them over $3.4M.
Eventually Resorts sued Zarin
for their $3.4M. Zarin argued that the claim was unenforceable because
the commissioner told Resorts to stop extending Zarin's credit.
Eventually Zarin paid $500k and Resorts forgave the other $2.9M.
The IRS stepped in and claimed
that the $2.9M of forgiven debt was taxable as gross income. Zarin disagreed.
The IRS that the $2.9M was income
from the discharge of his indebtedness,
and 26 U.S.C. §108(e)(1) says that, "the general rule
is that gross income includes income from the discharge of
See also §61(a)(12), which says basically the same thing.
See also United States
v. Kirby Lumber Co. (284 U.S. 52
The Tax Court found for the
IRS. Zarin appealed.
The Appellate Court reversed.
The Appellate Court found
that Zarin's debt was a contested liability.
Basically, Zarin's debt
wasn't 'forgiven', the debt was unenforceable as a matter of New Jersey
law. So it was like he never had the debt in the first place.
Under the Contested
Liability Doctrine, if the taxpayer
disputes the debt in good faith, and it is wiped clean, it doesn't count
as discharge of his indebtedness.
The Court found that Zarin's
debt did not meet the definition of debt in §108(d)(1).
§108(d)(1) defined indebtedness as
"(A) for which the taxpayer is liable, or (B) subject to which the
taxpayer holds property."
Since Zarin was found to
not be liable for the debt, and didn't hold any of the Casino's
property, the money he owed the casino didn't meet the definition.
In a dissent it was argued
that Zarin did hold property, he got chips. It was Zarin's own fault for
losing the chips. He also got a benefit (having fun gambling), so it is
unfair for Zarin to not pay taxes.