Daily Tax Update - July 2, 2013: Treasury, IRS Issue Final Regulations Regarding Deferred Discharge of Indebtedness Income

THE DAILY TAX UPDATE WILL BE PUBLISHED ON A PERIODIC BASIS UNTIL CONGRESS RETURNS JULY 9

Treasury, IRS Issue Final Regulations Regarding Deferred Discharge of Indebtedness Income of Corporations, Partnerships, and S Corporations Under Section 108(i):  Today, Treasury and the IRS issued final regulations under Section 108(i).  The first set of final regulations 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 of final regulations 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).  Treasury and the IRS had issued temporary and proposed regulations on August 10, 2011.  These final regulations apply on or after the date they are filed in the Federal Register, to reacquisitions of applicable debt instruments in taxable years ending after December 31, 2008. 

  • 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.
  • The final regulations that provide guidance to C corporations adopt the proposed regulations without significant change.  The preamble to these final regulations explains that the regulations are intended to focus on the underlying purpose of section 108(i)(5)(D) to ensure that the government’s ability to collect the tax liability associated with the deferred COD income is not impaired. 
  • The final regulations that provide guidance to partnerships and S corporations and their partners and shareholders also adopt the proposed regulations without significant change.  These final regulations provide that the election must be made by the partnership or S corporation.  Section 108(i) applies to the reacquisition of an “applicable debt instrument,” which the statute defines as any debt instrument issued by a C corporation or any other person in connection with the conduct of a trade or business by such person.  The statute does not define “in connection with the conduct of a trade or business.”  The final regulations also do not define the phrase, but provide five safe harbors under which a debt instrument is deemed to be issued in connection with a partnership’s or S corporation’s conduct of a trade or business for purposes of section 108(i).  If none of the safe harbors apply, then the determination of whether a debt instrument is an applicable debt instrument is based on the facts and circumstances.  The final regulations also address partners’ deferred section 752 amounts, events which will cause deferred items to be accelerated, and the treatment of real estate investment trusts.