Special Deferral Rule for Reporting Cancellation of Indebtedness Income Under New Section 108(i) For 2009 and 2010
Many business companies have hit "hard times" the past several years in being able to maintain profit levels. This in turn has led to job layoffs, foreclosures and a sharp increase in bankruptcy proceedings. In many instances, companies, like individuals encumbered with "underwater debt" or "negative equity" debt, attempt to renegotiate or restructure one or more of its debt obligations in place.
Where such restructuring of an old debt into a revised debt is successful, income tax impacts frequently result to both parties. Focusing on the borrower, frequently a restructured obligation will result in a partial cancellation of indebtedness income which is generally taxable in accordance with §61(a). A limited exclusion from gross income bor debt cancellation is available under §108(a) in four contexts, including the insolvency of the taxpayer. Where, however, one of the four categories qualifying for a partial or full exclusion from gross income are not applicable, the restructured debt will, as to the debtor, require tax payments on the income attributable to cancelled "principal" in the indebtedness.
Congress, as part of The American Recovery and Reinvestment Act of 2009, added new §108(i) which allows for a deferral of income resulting from an otherwise taxable cancellation of indebtedness for "indebtedness discharged by the reacquisition of the debt instrument" in 2009 and 2010. As set forth in the definition of a requisition in §108(i)(4), a "reacquisition" includes (A) any acquisition of the debt instrument by the borrower or a person related to the borrower, and (B) there is an "acquisition", i.e., acquisition of the debt instrument for cash, exchange of the debt instrument for another debt instrument, including by modification, the exchange of the debt instrument for stock or an interest in an entity taxable as a partnership, the contribution of the debt instrument to capital and the complete forgiveness of the debt by the holder of the debt instrument.
Where cancellation of indebtedness income is realized by the debtor in 2009 or 2010, the taxpayer may elect, under new §108(i), to defer the inclusion of the taxable income arising from the cancellation until 2014 at which time the income is reported ratably over a 5 year period extending through 2018. An election is made separately for each debt instrument. See Rev. Proc. 2009-37, 2009-36 IRB 309 (information required).
Taxpayers seeking to take advantage of this special relief rule should understand that the election is irrevocable and in making the election, the taxpayer must satisfy the disclosure requirements. The tax attributes of the taxpayer must also be taken into account particularly where there may be expiring net operating loss carryovers. The deferred income is required to be accelerated under §108(i)(5)(D) where the taxpayer dies, liquidates or sells substantially all of its assets, ceases to do business or in similar situations. The acceleration rule is in need of definitive regulations as support for avoiding an acceleration event could be made, for instance, where the taxpayer is acquired in a non-taxable reorganization described under §368.
