Background. A church wants to help its pastor purchase a new home, and so it agrees to pay $50,000 of the purchase price. The pastor signs a promissory note agreeing to pay back the $50,000 in ten annual installments. The church board assures the pastor that the church will "forgive" each annual installment on the date it is due, and so the pastor will not have to pay back anything. Is this transaction legitimate? What are the tax consequences? Church treasurers need to understand the answer to these questions, since this kind of arrangement is common and often misunderstood.
An IRS memorandum. The IRS recently released an internal memorandum (a "field service advisory") that addresses the tax consequences of debt forgiveness. Here are the facts of the arrangement the IRS was addressing. A widow and mother of three adult children owned a partial interest in farm land. She suffered a stroke and was later determined by a court to be incompetent. A guardian was appointed to handle her financial affairs. The guardian sold the farm land to the children in exchange for non-interest bearing promissory notes signed by each child. The sales agreement called upon each child to pay the guardian $10,000 annually. However, the agreement contained a "cancellation" provision specifying that the payments owed by the children each year would be "forgiven" by the guardian. The children and guardian recognized that these annual cancellations of debt constituted gifts, but they had no tax impact since they were not more than the annual gift tax exclusion of $10,000 for each child.