Imagine taking out loans and make regular and timely payments on the loan unforeseen circumstances occur such as job loss or personal illness. You inform the lender and explain your situation. Fortunately, the lender agrees to forgive a portion of your loan. However, you discover when you file your annual income tax return in the amount of the loan that is forgiven is considered income and taxable. This is called cancellation of debt (“COD”) income, unsuspecting conclusion that we should all be aware that especially in the current economic climate.
Under section 108 of the Internal Revenue Code and subject to limited exceptions, amounts due to discharge debt (which is equivalent to a loan forgiveness) as part of the gross income of the taxpayer. Exceptions to this rule leverage release (1) in accordance with the bankruptcy continues, (2) the taxpayer is bankrupt, (3) by non-corporate taxpayers if the debt was incurred or assumed by the taxpayer in connection with real estate used in business activities and the debt was secured by real estate, or (4) is qualified principal residence indebtedness is discharged before 1 January 2013.
New COD Income Deferral Rules
The August 11, 2010 Treasury Department and IRS released two sets of temporary regulations on rules under the Internal Revenue Code section 108 (i) of COD income incurred by C corporations ( see TD 9497 and reg- 142800-09) and S companies or partnerships ( see TD 9498 and REG-144762-09) with respect to the repurchase of existing debt instruments, made in 2009 or 2010.
provisions of American Recovery and Reinvestment Act of 2009 (as codified in the Internal Revenue Code section 108 (i)) allow certain taxpayers to repurchase certain debt instruments in 2009 and 2010 to elect to include specific COD income ratably over 5 years starting in 2014. The taxpayer may repurchase its own debt or related entity acquired debt. The debt can be acquired for cash, in exchange for new debt or equity, contributed to capital or forgiven.
An the bond is a debt instrument issued by the C company or other entity in connection with the implementation of economic activities by such person.
If the unit that made the election were to liquidate, sell most of its assets, or otherwise stop all business functions, COD was recognized at the time. Similar acceleration rules would apply to the spouse or S corporation shareholders who performed interested partnership or S corporation that had elected the suspension. The rules would apply to partnerships.
August 17, 2009, the IRS issued Revenue Procedure 2009-37 provide rules and procedures for making elections under the new code section 108 (i). The IRS added that additional guidance may be among their own policies addressing issues of revenue procedures and regulations may be retroactive. The income approach provides :.
– Taxpayers make the election are providing additional information yields starting the year after the year in which the election is made
– Cooperation room to make the election of a company-by-partner and debt demand debt basis
-. The automatic 12-month extension of the due date of the election to make the election under Treasury Regulation section 301.9100-2 (a)
-. Methods that a taxpayer may make a protective election under Internal Revenue Code section 108 (i)
The Temporary Regulations
Temporary regulations C companies generally reflect a narrower interpretation of the statutory events acceleration and rather focus on the events that impair the ability to pay tax liability related to deferred revenue. These temporary regulations do not require acceleration in all cases apply the rules in three cases the companies have reduced their ability to pay their tax liability. These three cases are:
– When voting company changes the tax status
– When it stops the corporate existence of its trade rules relating to the transfer of properties in a particular law. The acquisition of the Internal Revenue Code section 381 (a) does not apply to
– .. When it conducts business, which reduces its ability to pay the tax liability associated with the COD income
Cooperation and S Corporations
A second set of temporary regulations were issued on the application of Internal Revenue Code section 108 (i) to partnerships and S companies that have made this choice. Acceleration rules applicable to partnerships and S companies differ from those that apply to C corporations, and include the following:
– Rules determine whether the sale of voting partnership or S company of some, but not all, of its assets includes sales, exchange, transfer, gift or substantially all of the assets
-. Rules of the sale of assets in a tiered arrangement cooperation
-. Property for sale, gift. or other measures on the part of the holding in voting partnership or S corporation
– Rules on the transfer of voting cooperation of all of its assets to a partnership in transport which includes the contribution of assets to the Partnership. exchange for interest in cooperating
-. Rules on the transfer of voting partnership or S corporation assets in similar kind of exchange
Temporary Regulations also provide the following with respect to prefer cooperation and elect S Company
– Five harbor where a debt instrument issued by a partnership S or companies deemed to be issued in connection with the trade association or S corporation or company for the purposes of the Internal Revenue Code section 108 (i)
-. The rules for the allocation of cod income to partners and S corporation shareholders
-. Rules for the company or S corporation shareholder adjusts its foundation in companion objects or S corporation stock to account for their involvement in the deferred COD income
– .. rules governing how the capital accounts of a partner should be set to account for sharing partners for cooperation deferred COD income
– rules to prevent 108 (i) election of triggering recovery of losses due to Internal Revenue Code section 465 (e).
These new rules COD income deferral will provide benefit to many taxpayers. However, careful review of current and future projected income of the taxpayer is required to determine whether to Section 108 (i) election is precious. Some taxpayers do not have to take the election as they may be able to shelter COD income through insolvency or bankruptcy. Because of red tape to prepare the return and information reporting requirements in recent years, it could significantly increase the burden of record-keeping and compliance related to the application again. Regardless, this election may still allow for significant opportunities Suspension and should be considered.