We discussed the “commercial activity” issue in our earlier post:
…it’s problematic when the giver of the gift is the holder of the debt, standing in the shoes of the lender. That makes it look a lot like straight-up debt forgiveness. And the “abolish” language that Strike Debt has used in its literature is consistent with that characterization.
There was a temporary mortgage relief provision enacted in 2007 that expires in 2013. The existence of that exception reinforces the view that debt cancellation = income unless a specific exception applies (section 108(a)(1)(E)). Especially since many mortgages are held by investors who are not the original lender.
Here is what the IRS says about debt cancellation by gift (1995 Market Segment Specialization paper for grain farmers):
Cancellation by Gift (IRC section 102)
Gifts or bequests are excluded from gross income. Congress recognized that the presence of donative intent on the part of the creditor is difficult (if not impossible) to establish in a business setting. The committee reports accompanying the Bankruptcy Tax Act of 1980 state: “*** it is intended that there will not be any gift exception in a commercial context (such as, a shareholder-corporation relationship) to the general rule that income is realized on discharge of indebtedness.” Thus, the gift exception generally applies only in noncommercial contexts.
OWS is relying on the notion that they are organized as a not for profit and is not making money as a lender, hence this make their activity noncommericial. The sale of debt is a commercial activity. When OWS purchases debt, it enters into a commercial relationship with the debtor. OWS would have to overcome the IRS interpetation of legislative intent that there can be no gift in a commercial context. Case law requires detached and disinterested generosity on the part of the donor for a gift.
Moreover, middle class borrowers are not considered a proper charitable class under the tax law. For instance, see this language from a summary of a 2011 IRS private letter ruling. Notice the use of the word “exclusively”:
The IRS observed that it has previously held that helping low income persons obtain adequate and affordable housing can constitute a charitable purpose, but that similar activities to assist moderate income home buyers and owners may not serve a charitable class. The Service further noted that if a purportedly charitable organization operates in an essentially commercial manner, it may be determined to be operated for a non-exempt commercial purpose, rather than for a tax-exempt purpose….
In the current case, the Service determined that the organization did not operate exclusively for an exempt purpose as described in IRC § 501(c)(3). The reasons for this conclusion included the following:
The organization was not operated primarily for the benefit of a charitable class. It did not screen applicants for participation in the DPA program on the basis of income, and did not target the program to areas that were needy of such assistance, such as residential areas experiencing deterioration of living conditions, or suffering from discrimination and prejudice or neighborhood tensions.
Readers may contend that the people being pursued by debt collectors are ones that were unable to pay off their creditors, ergo they must be poor or under financial stress. That isn’t necessarily so. Chase employee Linda Almonte was fired for objecting to the sale of 23,000 loans in which there was a major error in 60%, either in the amount owed or whether a judge had ruled in favor of the bank. Banks are known to sell disputed debt, debt discharged in bankruptcy, debt close to or past the statute of limitations, or where they can’t successfully find borrower wages or bank accounts to garnish. Given that the debt in many cases is old (it has often been traded several times), a borrower could have gone through a rough patch, stared a creditor down, and now is in better financial shape. (Update/clarification: the governing idea is that the test here is income, whether or not the borrower is under financial stress. In other words, if you have moderate income, even if you are up to your eyeballs in debt through no fault of your own, it appears the IRS will not regard your financial duress as making you a suitable case for charity. Note that this is a different notion than under cancellation of debt, where being in bankruptcy or fitting the IRS definition of insolvency IS an out from having the cancelled debt included as income).