## Facts

- David Zarin, a high-stakes gambler, received casino credit from Resorts International Hotel & Casino through “markers” exchanged for gambling chips.
- Zarin’s credit line increased substantially over time; he previously incurred and repaid large gambling losses.
- New Jersey gaming authorities cited Resorts for credit-related violations involving Zarin, and an emergency order made further credit extensions to him unlawful.
- Despite regulatory prohibitions, Resorts continued extending credit to Zarin through practices later found to violate New Jersey casino regulations.
- By 1980, Zarin’s unpaid, dishonored markers totaled about $3.435 million; Resorts cut off credit and sued in New Jersey state court.
- Zarin disputed liability, asserting the alleged obligation was unenforceable under New Jersey law (including arguments tied to regulatory violations and his gambling condition).
- The parties settled in 1981 for $500,000 in full satisfaction of Resorts’ claim.
- The Commissioner treated the $2.935 million difference as discharge-of-indebtedness income under I.R.C. §§ 61(a)(12) and 108; the Tax Court agreed.
- Zarin appealed to the Third Circuit.

## Issues

1. Whether the settlement of Resorts’ $3.435 million claim for $500,000 produced taxable discharge-of-indebtedness income under I.R.C. §§ 61(a)(12) and 108.
2. Whether Zarin’s alleged obligation constituted “indebtedness” within I.R.C. § 108(d)(1) where the markers were asserted to be unenforceable under state law.
3. Whether the contested liability (disputed debt) doctrine treated the settlement amount as the only debt cognizable for tax purposes, eliminating cancellation-of-debt income.

## Decision

- The Third Circuit reversed the Tax Court and held Zarin realized no discharge-of-indebtedness income.
- The court held the claim did not create “indebtedness” under I.R.C. § 108(d)(1) because:
  - Zarin was not “liable” on an enforceable obligation within § 108(d)(1)(A) given the state-law unenforceability tied to illegal credit extensions; and
  - Casino chips were not “property” held “subject to” the debt within § 108(d)(1)(B) because they functioned as a gambling accounting device without conventional independent value.
- Independently, the court applied the contested liability doctrine, concluding:
  - Zarin’s dispute over enforceability/amount was in good faith; and
  - the settlement fixed the relevant liability at $500,000, leaving no separate “cancelled” amount taxable as income.

## Legal Principles

- Discharge-of-indebtedness income under I.R.C. § 61(a)(12) and § 108 depends on the existence of “indebtedness” as defined in I.R.C. § 108(d)(1).
- Under I.R.C. § 108(d)(1), “indebtedness” requires either (A) taxpayer liability on the obligation or (B) property held subject to the obligation.
- Where a claimed obligation is unenforceable under applicable law, a court may conclude the taxpayer is not “liable” for purposes of § 108(d)(1)(A).
- Items used solely as a mechanism to facilitate wagering, lacking meaningful independent value outside the issuing context, may be treated as not constituting “property” for § 108(d)(1)(B).
- Under the contested liability doctrine, a good-faith dispute over a debt’s enforceability or amount, followed by a settlement, generally results in treating the settlement amount as the debt for tax purposes, without cancellation-of-debt income for the difference.

## Conclusion

The Third Circuit held that Zarin’s settlement of Resorts’ disputed and state-law-unenforceable casino markers for $500,000 did not generate cancellation-of-debt income because the claim did not constitute “indebtedness” under § 108(d)(1) and, in any event, the contested liability doctrine treated the settlement amount as the only recognized liability.


Zarin v. Commissioner, 916 F.2d 110 (3d Cir. 1990)