Question

Hazel, a solvent individual but a recovering alcoholic, embezzled $6,000 from her employer. In the same year that she embezzled the funds, her employer discovered the theft. Her employer did not fire her and told her she did not have to repay the $6,000 if she would attend Alcoholics Anonymous. Hazel met the conditions and her employer canceled the debt.

a. Hazel did not realize any income because her employer made a gift to her.
b. Hazel must include $6,000 in gross income from discharge of indebtedness.
c. Hazel must include $6,000 in gross income under the tax benefit rule.
d. Hazel may exclude the $6,000 from gross income because the debt never existed.
e. None of these.

Answer 1

Hazel must include the $6,000 cancellation of debt in her gross income. This is due to tax laws that view discharged debts as taxable income unless specific exceptions apply. The correct option is B.

Step-by-step explanation:

In the scenario where Hazel, a solvent individual but a recovering alcoholic, embezzled $6,000 from her employer, we have to determine the tax implications of her employer's decision to not require repayment as long as Hazel attends Alcoholics Anonymous.

The correct answer to this tax question is that Hazel must include $6,000 in gross income from discharge of indebtedness. This is because the Internal Revenue Code typically treats the cancellation of debt as income to the debtor.

In this case, Hazel received a financial benefit when her employer canceled the debt in exchange for her attendance at Alcoholics Anonymous, and that benefit is generally considered taxable income.

Option (a) is incorrect as the cancellation of a debt due to services rendered (in this case, attending Alcoholics Anonymous) does not qualify as a gift for tax purposes. Option (d) is incorrect because the debt did exist; it was simply forgiven.

Option (c) would apply if Hazel had previously taken a tax deduction for the embezzled funds, which she has not. Therefore, option (b) is the most accurate under tax law, as it represents income from discharge of indebtedness.