2009 Economic Stimulus Package: Certain Debt Repurchases by Businesses Granted Relief from Tax on Cancellation of Indebtedneses Income

Originally published February 17, 2009

Keywords: 2009 Economic Stimulus Package, debt

repurchases, relief, tax, indebtedness income, cancellation of

indebtedness, COD, distressed debt, discounted debt, original issue

discount, OID, issue price

The economic stimulus package, signed into law on February 17,

2009, grants corporations and businesses that repurchase their debt

at a discount a right, under certain circumstances, to elect to

defer the recognition of their cancellation of indebtedness (COD)

income for up to five years. The provision is intended to help

businesses deleverage and restructure their balance sheets. It is

also expected to help reduce the amount of distressed and

discounted debt held by financial institutions.

Generally, when taxpayers (or certain related parties)

repurchase their debt at a discount, they are required to recognize

COD income in an amount equal to the difference between the

purchase price paid and the debt's principal amount (or in the

case of debt issued with original issue discount (OID), its

adjusted issue price). Similarly, when a debtor satisfies an

outstanding debt by issuing new debt, the debtor will realize COD

income to the extent the adjusted issue price of the original debt

instrument exceeds the issue price of the "new" debt

instrument. Historically, the tax cost of COD income could only be

avoided if the taxpayer qualified for an exclusion (e.g.,

bankruptcy or insolvency) or if the taxpayer had sufficient net

operating losses or other losses to offset the COD income.

The stimulus package added Section 108(i) to the Internal

Revenue Code, which allows taxpayers to elect to defer COD income

for "applicable debt instruments" repurchased in 2009 and

2010 by the taxpayer or a related party. Subject to certain

limitations and qualifications, an election will defer COD income

for a period of five years for debt instruments repurchased in 2009

and four years for debt instruments repurchased in 2010.

Partnerships must allocate the deferred income to the partners when

the debt is repurchased; however, the partners are permitted to

defer any income or gain from the COD for the four or five year

deferral period, as applicable. The term "applicable debt

instruments" includes most bonds, debentures, notes or other

forms of indebtedness issued by C corporations or other trades or

businesses. The repurchase of indebtedness may be effectuated

through a repurchase for cash, debt, or stock; a contribution of

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