William & Mary Business Law Review


Philip G. Cohen


The focus of this Article is a revisit of a very well-known and much written about Third Circuit Court of Appeals decision, Zarin v. Commissioner, concerning whether the taxpayer had COD income. Zarin dealt with whether a compulsive and unlucky gambler could avoid COD income when he settled with the casino for substantially less than what he owed. Along with a plethora of diverse third-party assessments of the case, the judges who heard the case and its appeal were also divided. The Tax Court opinion was decided by an eleven to eight vote for the Internal Revenue Service (IRS), with three separate dissenting opinions, and was followed by a Third Circuit reversal, with a two to one split of the judges. In a much-criticized decision, the divided Third Circuit Court of Appeals reversed a split Tax Court and held that the hapless gambler did not have discharge of indebtedness income. While many esteemed scholars have made plausible arguments to the contrary, this Article concludes that Zarin should have been determined to have COD income from his settlement with the casino. Zarin was not subject to tax when he received the gambling chips because both parties had an understanding it would be repaid. This tax benefit he received at the time of the loan resulted in COD income upon the indebtedness’ settlement for less than what was owed, unless an exception applied, and none should have in this case.

This Article will also examine some of the theories for determining if a taxpayer has COD income and how they relate to Zarin. The loan proceeds methodology, or a variation thereof, is the proper means of establishing whether a taxpayer has COD income, prior to considering whether any of the exceptions apply. The freeing of assets and the Kerbaugh-Empire form of the whole transaction approaches should no longer be followed by the courts.