Daily Tax Update - August 11, 2010: IRS issues Sec. 108(i) regs

The Daily Tax Update will be published on a periodic basis until Congress returns from its August recess on September 13th.

IRS and Treasury Issue temporary and proposed regulations regarding deferred discharge of indebtedness income of corporations, partnerships, and s Corporations under section 108(i): Today, the IRS and Treasury issued two sets of Temporary and Proposed regulations under section 108(i). The first set provides guidance to C corporations regarding the acceleration of deferred cancellation of indebtedness income (“COD income”) and original issue discount ("OID") deductions and the calculation of earnings and profits as a result of an election under section 108(i). The second set provides guidance to partnerships and S corporations and their partners or shareholders regarding the deferral of COD income and OID deductions under section 108(i).

  • Section 108(i) was added to the Code by the American Recovery and Reinvestment Tax Act of 2009 and provides an election for deferral of the inclusion of COD income arising in connection with the reacquisition of certain applicable debt instruments after December 31, 2008 and before January 1, 2011. If a taxpayer makes the election, the deferred COD income is generally includable in gross income ratably over a 5-year period, beginning with the taxpayer’s fourth or fifth taxable year following the year of the reacquisition. Any OID deductions associated with debt instruments issued in conjunction with the reacquisition are likewise deferred.
  • Section 108(i)(5)(D) requires a taxpayer to accelerate the inclusion of any remaining items of deferred COD income or deferred OID deduction under certain circumstances, including the liquidation or sale of substantially all the assets of the taxpayer, the cessation of business by the taxpayer, or similar circumstances.
  • With respect to corporations, the Temporary and Proposed Regulations are intended to focus more precisely on the underlying purpose of section 108(i)(5)(D) to ensure that the government’s ability to collect the deferred tax liability associated with the deferred COD income is not impaired. The preamble to the Temporary and Proposed Regulations states, “Accordingly, while these temporary regulations do not require acceleration in every instance enumerated in the statute, they provide instead for acceleration in a limited number of circumstances in which corporations have impaired their ability to pay their incipient tax liability.”
  • The Temporary and Proposed Regulations generally provide that an electing corporation will be required to accelerate deferred COD income under section 108(i)(5)(D) if the electing corporation (i) changes its tax status; (ii) ceases its corporate existence in a transaction to which section 381(a) does not apply, or (iii) engages in a transaction that impairs its ability to pay the tax liability associated with its deferred COD income (the net value acceleration rule). Under the Temporary and Proposed Regulations, these are the only three events that accelerate an electing corporation’s deferred COD income.
    • Under the net value acceleration rule, an electing corporation generally is required to accelerate its remaining deferred COD income if immediately after an impairment transaction, the gross value of the corporation’s assets is less than 110% of the sum of its total liabilities and the tax on the net amount of its deferred items.
    • The Temporary and Proposed Regulations address the specific application of the net value acceleration rule to consolidated groups, regulated investment companies, and real estate investment trusts. The rules also contain special exceptions for distributions and charitable contributions consistent with historical practice.
  • The Temporary and Proposed Regulations also provide, consistent with previously issued Rev. Proc. 2009-37, that deferred COD income generally increases earnings and profits in the taxable year that it is realized, and deferred OID deductions generally decrease earnings and profits in the taxable year or years in which the deductions would be allowed without regard to the deferral rules of section 108(i).
  • The Temporary and Proposed Regulations with respect to corporations regarding deferred COD income and earnings and profits apply to reacquisitions of applicable debt instruments in taxable years ending after December 31, 2008. The rules with respect to the acceleration of deferred COD income and deferred OID deductions apply prospectively to acceleration events occurring on or after the date the rules are published in the Federal Register. However, electing corporations may apply these rules to all acceleration events prior to that date by taking a return position consistent with the rules.
  • With respect to partnerships and S corporations, the Temporary and Proposed Regulations provide that the deferred items allocated to the direct and indirect partners of an electing partnership and to the shareholder of an electing S corporation will be required to be accelerated if the electing partnership or S corporation (i) liquidates, (ii) sells, exchanges, transfers, or gifts substantially all of its assets, (iii) ceases doing business, or (iv) files a petition in a Title 11 or similar case.
  • The Temporary and Proposed Regulations also provide rules regarding the allocation of COD income to partners in a partnership and shareholders in an S corporation, certain basis adjustments, the computation of the deferred section 752 amount, section 465(e) recapture, and the deferral of OID deductions.
  • The Temporary and Proposed Regulations with respect to partnerships and S corporations are effective for reacquisitions of applicable debt instrument in taxable years ending after December 31, 2008.
  • For additional information, contact Mark J. Silverman at msilverman@steptoe.com, Lisa M. Zarlenga at lzarlenga@steptoe.com or Aaron P. Nocjar at anocjar@steptoe.com.
  • The T.D. 9498 regulation can be accessed here.
  • The REG-142800-09 regulation can be accessed here.
  • The T.D. 9497 regulation can be accessed here.
  • The REG-144762-09 regulation can be accessed here.

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