Daily Tax Update - August 18, 2009


IRS ISSUES GUIDANCE ON ELECTION TO DEFER RECOGNITION OF INCOME FROM CANCELLATION OF INDEBTEDNESS:  Today, the IRS issued Rev. Proc. 2009-37, which provides the exclusive procedures for taxpayers to make an election under section 108(i). Section 108(i) generally permits a taxpayer to elect to defer cancellation of indebtedness income (“COD income”) realized in connection with the reacquisition of an applicable debt instrument after December 31, 2008, and before January 1, 2011. If a taxpayer makes such an election, the taxpayer includes the COD income in gross income ratably over a 5-year period, beginning with the taxpayer’s fourth or fifth taxable year following the taxable year of the reacquisition (depending on whether the reacquisition is made in 2009 or 2010).

  • Rev. Proc. 2009-37 sets forth the required contents of the election statement that must be attached to the federal income tax return for the taxable year in which the reacquisition of the applicable debt instrument occurs. Additional, specific election requirements and procedures are provided with respect to partnerships, S corporations, certain foreign corporations, certain foreign partnerships, and tiered pass-through entities. In addition, there are annual reporting requirements for each taxable year after an election is made until the taxable year in which all items deferred under section 108(i) have been recognized. 
  • Rev. Proc. 2009-37 states that a taxpayer may make an election for any portion of COD income realized from the reacquisition of any applicable debt instrument. In addition, a taxpayer may treat two or more applicable debt instruments that are part of the same issue and reacquired during the same taxable year as one applicable debt instrument.
  • Rev. Proc. 2009-37 permits a partnership to elect to defer under section 108(i) any portion of COD income allocated to a partner. For example, a partnership can elect to defer under section 108(i) a partner's full distributive share of COD income while also not electing to defer another partner's share of the same COD income, thereby permitting that partner to use the section 108(a) COD income exclusions rather than the section 108(i) deferral. This aspect of Rev. Proc. 2009-37 helps partners that face differing economic circumstances take full advantage of all section 108 benefits. However, partnership agreements would still need to be revised to ensure that the partnership followed each partner's instruction with respect to the section 108(i) election for such partner's distributive share of COD income.
  • Rev. Proc. 2009-37 is effective for reacquisitions of applicable debt instruments in taxable years ending after December 31, 2008. The IRS will treat a section 108(i) election as effective if a taxpayer, using any other reasonable procedure, files an election on or before September 16, 2009. However, if the election does not comply with the requirements of Rev. Proc. 2009-37, it will not be effective unless the taxpayer files a corrected election on or before November 16, 2009. Taxpayers may also make protective section 108(i) elections.
  • Treasury and the IRS intend to issue regulations regarding the computation of a corporation’s earnings and profits with respect to COD income and OID deductions deferred under section 108(i). Except in the case of regulated investment companies and real estate investment trusts, these regulations generally will provide that deferred COD income increases earnings and profits in the taxable year that it is realized, and not when the deferred COD income is includible in gross income.  Similarly, OID deductions deferred under section 108(i) generally will decrease earnings and profits in the taxable year or years in which the deduction would be allowed without regard to section 108(i). 
  • For additional information, contact Mark J. Silverman - msilverman@steptoe.com, Aaron P. Nocjar - anocjar@steptoe.com, or Lisa M. Zarlenga - lzarlenga@steptoe.com.

SENATE BUDGET COMMITTEE CHAIRMAN – NO DEADLINE FOR FINISHING HEALTH CARE:  In an interview yesterday, Senate Budget Committee Chairman Kent Conrad said that the six bi-partisan Finance Committee health care reform negotiators won’t be bound by a deadline. Conrad said, “What we have agreed to is that we are going to be ready when we’re ready. And we are working; we hope to be able to reach conclusion by the middle of September. But we have agreed that if we still don’t have all of the answers back from [the Congressional Budget Office] that we will not be bound by any deadline–that the most important thing is to get this right.” Conrad added, “This affects every American person. It affects one-sixth of the American economy. This is not something that should be held hostage to any specific deadline.”

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