2009 Tax Act Provides Relief From Cancellation Of Indebtedness Income

Mr. Rubinger is based in our

Fort Lauderdale office.

On February 17, 2009, President Obama signed the American

Recovery and Reinvestment Act of 2009 (the 2009 Act). Admittedly,

the 2009 Act will not be of universal benefit to taxpayers. For

example, the five-year net operating loss carryback is available

only to businesses whose average annual gross receipts for the past

three years does not exceed $15 million.

One provision of the 2009 Act, however, should provide welcome

relief to a broad scope of taxpayers: Section 108(i).1

In general, under new Section 108(i), certain taxpayers are able to

elect to defer the recognition of cancellation of indebtedness

income (COD income) arising from a "reacquisition" of

debt instruments after December 31, 2008, and before January 1,

2011. Under the new provision, the COD income that is deferred must

be included in the taxpayer's gross income ratably in the five

taxable years beginning with: (i) repurchases in 2009, the fifth

taxable year following the taxable year in which the repurchase

occurs, or (ii) repurchases in 2010, the fourth taxable year

following the taxable year in which the repurchase occurs. The

provision is effective for discharges in taxable years ending after

December 31, 2008.

Current Law

In general, a taxpayer is required to include COD income in its

gross income. Under Section 108(a), however, a taxpayer has the

ability to exclude COD income from its gross income if: (i) such

taxpayer is in a Title 11 bankruptcy case, (ii) such taxpayer is

insolvent, or (iii) the COD income arises with respect to certain

qualified real property business indebtedness. In situations where

a taxpayer is able to exclude COD income from its gross income

under Section 108, such taxpayer is typically required to reduce

certain tax attributes, including net operating losses, general

business credits, minimum tax credits, capital loss carryovers, and

basis in property, by the amount of the COD income.

For all taxpayers, the amount of COD income generally is equal

to the excess of the adjusted issue price of the indebtedness being

satisfied over the amount paid (or deemed paid) to satisfy such

indebtedness. This rule generally applies to: (i) the acquisition

by the debtor of its debt instrument in exchange for cash, (ii) the

issuance of a debt instrument by the debtor in satisfaction of its

indebtedness, including a modification of indebtedness that is

treated as an exchange (a debt-for-debt exchange),2

(iii) the transfer by a debtor corporation of stock, or a debtor

partnership of a capital or profits interest in such partnership,

in satisfaction of its indebtedness (an equity-for-debt

exchange),3 and (iv) the acquisition by a debtor

corporation of its indebtedness from a shareholder as a

contribution to capital.4

Related Party Acquisitions

In addition to a taxpayer recognizing COD income as a result of

a direct acquisition of its own debt, indebtedness directly or

indirectly acquired by a person that is "related" to the

taxpayer is treated as if it were acquired by the taxpayer

directly.5 Thus, where a taxpayer's indebtedness is

acquired for less than its adjusted issue price by a person related

to the taxpayer, the taxpayer recognizes COD income.

New Section 108(i)

As noted above, under new Section 108(i) of the 2009 Act, a

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