Debt Modifications: Tax Planning Options Including New 10-Year Potential Deferral

Abstract

With the recent decline in the real estate market, many taxpayers, both individually and/or in partnerships, are seeking to renegotiate the terms of their existing debt instruments. There is some concern though that these debt modifications could lead to possible cancellation of debt (COD) income with potential tax consequences at a time when affected taxpayers can least afford to pay them. To help alleviate this issue, the American Recovery and Reinvestment Tax Act of 2009 added subsection(i) to Internal Revenue Code Section 108 which gives taxpayers the option to elect to delay recognition of their 2009 or 2010 COD income until 2014 and then include it in income ratably in their 2014 through 2018 calendar tax years. Section 108(a)(1)(B) may still be used by insolvent taxpayers to exclude gross income up to their amount of indebtedness. This paper reviews the options available to taxpayers and gives specific examples under IRC Section 108 to either exclude or defer their cancellation of debt income. It also discusses the potential tax cost for these options and advantages as well as some specific issues pertaining to partnerships. Compliance issues under Rev. Proc. 2009-37 for affected taxpayers is also discussed with the additional potential for taxpayers to elect to defer only part of their COD income.