Gary is an internal auditor for Bodine Information Systems (BIF). In 2008, BIF opened a large production plant in Las Vegas, Nevada. Subsequently, Gary has had to spend several months each year at the Las Vegas facility. Gary has always fancied himself a proficient blackjack player. During his trips to Las Vegas, he stays at a hotel on the Strip and spends a considerable amount of his off-duty time gambling.
In February 2009, Gary applies for and receives a $20,000 line of credit at the hotel to be used for gambling. The line of credit lets him receive gambling chips in exchange for signing markers, which are negotiable drafts payable to the hotel and drawn on Gary’s personal bank account. The hotel’s practice is to hold the markers for 60 days, at which time Gary pays them with a personal check.
By the beginning of 2010, Gary is gambling heavily at the hotel. He requests and receives an increase in his credit limit to $100,000. Gary continues to lose heavily, and through accounting oversights by the hotel, his debt rises to $325,000 by October 2010. The checks that Gary writes to cover the markers are returned for insufficient funds, and the hotel immediately cuts off his credit. The hotel subsequently files suit in state court, seeking repayment of the $325,000 owed on the markers.
In early 2011, Gary negotiates an agreement with the hotel in which he will settle the debt for 4 monthly payments of $25,000 ($100,000). Gary pays the $100,000 per the terms of the agreement. He seeks your advice as to the tax consequences of the settlement with the hotel. That is, does he have to include in his gross income the amount of the debt he didn’t have to repay?