Cancellation of indebetness incom 108(i)

Treasury Recognizes Need for Guidance on Provision Deferring Cancellation of Debt Income


Treasury attorneys on June 4 indicated that they are thinking "a lot" about the issues raised by new Code Sec. 108(i), which provides an election to defer cancellation of indebtedness (COI) income from the reacquisition of an "applicable" debt instrument. Jeffrey Van Hove and Steven Frost, both with the Office of Tax Legislative Counsel, spoke with practitioners at a program sponsored by BNA Tax Management. The program was held at the office of Buchanan, Ingersoll & Rooney, in Washington, D.C., and moderated by Don Reynolds and Richard Marshall of the firm.



The COI provision was enacted in the American Recovery and Reinvestment Act of 2009 (P.L. 111-5). Van Hove said that the Treasury is asking itself what policies Congress is pursuing. The Treasury's tentative view is that Code Sec. 108(i) is a relief provision and should not be interpreted restrictively, Van Hove commented.



The Treasury plans to issue guidance sequentially, Van Hove said. Because companies may be facing deadlines for making the election, initial guidance is likely to be a revenue procedure on how to elect to defer COI income. Subsequent guidance would address more substantive issues but might not be issued until later in the summer. Since the provision only applies for two years, the Treasury does not want to get tied up trying to resolve overly complex issues, Van Hove said.



Jim Sowell of KPMG LLP, Washington, D.C., who led the discussion, said it would be helpful to allow taxpayers to elect how much COI income they want to defer. This would take pressure off the need to define a debt instrument. The New York State Bar Association has issued a report favoring this approach.



Code Sec. 108(i) applies to the reacquisition of an applicable debt instrument, Sowell pointed out. This term is defined as a debt instrument issued by a C corporation or by any other taxpayer in connection with the conduct of a trade or business. Guidance is needed on the trade or business requirement, he said. One approach would be to require tracing of funds; another, less-restrictive approach, would be to treat reacquisitions "in connection with" the business as sufficient. If a partnership is involved, there may also be an issue whether to attribute the business of the partnership to its partners.



Sowell suggested the use of safe harbors. Frost responded that using safe harbors would be a reasonable approach. Van Hove noted that the American Bar Association proposed, as a safe harbor, that tracing not be required if business assets secured the debt and 50 percent of the assets were business assets. Frost urged practitioners to send in comments on this and other issues.



A reacquisition of debt can involve an actual exchange or a deemed exchange under Code Sec. 1001, Sowell said, adding that people are struggling with the concept of a deemed exchange. Sowell noted that complete forgiveness of debt qualifies for deferral, but partial forgiveness is not specifically covered by the statute.


Property Foreclosures


The statute's application to a property foreclosure ("debt for property") is unclear, Sowell said. In a foreclosure, the lender will reduce the debt by the value of the property. Debt forgiveness could occur if the lender reissues the debt and later forgives it, or if the lender forgives debt at the time of the foreclosure. The former transaction appears to qualify for deferral under Code Sec. 108(i), Sowell indicated, but courts have treated the latter transaction solely as a foreclosure, without a separate forgiveness of debt.



Van Hove agreed that property transfers are an important topic that needs to be addressed in any guidance. One question is whether there is a policy reason not to allow deferral for these transactions. He noted that the statute's definition of a reacquisition applies to specified transactions "without limitation," suggesting that the list of applicable transactions could be expanded.


Partnerships


The statute gives the deferral election to a partnership, not to individual partners. This is controversial, Sowell said. Van Hove responded that one possible approach, as suggested by the American Bar Association, would be to allow partners to opt out of the partnership's deferral election. One problem, he said, is that the deferral election is irrevocable, and asked whether an opt-out provision would be inconsistent with that requirement. Another problem might be the treatment of multiple-tier partnerships.



Sowell raised the issue of reporting by a partnership. If a partnership elects to defer the income, must it report that to partners at the same time, or can it wait until the income is taxable, he asked. Another issue is the effect of deemed distributions on the partner's basis in the partnership and whether they could give rise to income.



Another question is the treatment of sales and redemptions of partnership interests under the acceleration rules, Sowell said, noting that the definition of a redemption is unclear. Van Hove said that the grounds for acceleration arguably include not only the termination of the taxpayer but a "continuity of business enterprise" notion.



Finally, a key issue is the treatment of earnings and profits (E&P) when a taxpayer elects to defer income, Sowell said. Most taxpayers favor deferring E&P until income is reported.