Zarin Vs. Commissioner Accounting Fraud Case Study

Zarin v Commissioner

Synopsis:

Zarin is an engineer working in Atlantic City, New jersey who occasionally gambled. In June 1978 Zarin applied for a credit line with Resorts International Hotels, which after a credit check they granted Zarin a credit line in the amount of $10,000. With time Zarin was granted additional credit lines in regular intervals without any further credit checks. Due to his “High Roller” status he was also provided with various complimentary services and privileges. In November 1979 his credit line was increased to $200,000. Then between June 1978 and December 1979 Zarin lost $2,500,000 which he paid in full.

In 1979 the Casino Control Commissioner issued an emergency order which would make further extensions of credit lines to Zarin illegal. However, Resorts continued to provide lines of credits to Zarin under the practices known as “considered cleared” and “this trip only” credit (both now illegal). By 1980, Zarin was a compulsive gambler at Resorts, and they continued to increase his credit line. However, in April Zarin issued personal checks and counterchecks to Resorts that were returned for insufficient funds for a total of $3,435,000. In April 1980 Resorts finally cut off Zarin’s line of credit.

Resorts filed an action against Zarin for the $3million owed to them in which Zarin denied liability on the grounds of that Resort’s claim was unenforceable under New Jersey regulations intended to protect compulsive gamblers. In September 1981 Resorts and Zarin settled in the amount of $500,000.

Tax: In 1981 the commissioner claimed that should Zarin recognize $2,935,000 of income from the discharge of indebtedness (Original Debt of $3,435,000 less the settlement of $500,000). Zarin’s deficiency for 1981 was calculated to be $2,047,245 and with interest (as of April 1990) Zarin allegedly owes the IRS $5,209,033 in additional taxed. Zarin appeals the order of the Tax Court.

Section 61(a)(12) “Gross income includes income from discharges of indebtedness”

Question:Should Zarin recognize $2,935,000 as Gross Income as a discharge of indebtedness?

Test of Indebtedness per Section 108(d)(1)

Defines the term as any indebtedness as (A) for which a taxpayer is liable or (B) subject to which the taxpayer holds property

Zarin fails this test on both counts due to the New Jersey state law. Regarding the taxpayer being liable, Zarin’s debt owed to Resorts was unenforceable due to the state law and therefore not considered liable. Furthermore, the second test states the taxpayers holds the property. However, per New Jersey state law gambling chips are not property of the “gambler” in this case Zarin. The law states that “gambling chips are the casino’s property until transferred to the gambler in exchange of markers. At that point the chips become evidence of indebtedness and not property of the gambler.” The chips had no economic substance and therefore were not property to Zarin.

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