Sect. 108 and Cancellation of Debt Income: Navigating IRS Rules Deferring Tax Under This Complex Code Section and Under Latest Guidance

Transcription

1 Presenting a live 110 minute teleconference with interactive Q&A Sect. 108 and Cancellation of Debt Income: Navigating IRS Rules Deferring Tax Under This Complex Code Section and Under Latest Guidance WEDNESDAY, APRIL 20, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: Davis Smith, Shareholder, Kaufman Gilpin McKenzie Thomas Weiss, Montgomery, Ala. Robert Barnett, Member, Capell Barnett Matalon & Schoenfeld, Jericho, N.Y. Wayne Strasbaugh, Partner, Ballard Spahr, Philadelphia Annette Ahlers, Partner, Pepper Hamilton, Washington, D.C. For this program, attendees must listen to the audio over the telephone. Please refer to the instructions ed to the registrant for the dial-in information. Attendees can still view the presentation slides online. If you have any questions, please contact Customer Service at ext. 10.

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5 Sect. 108 and Cancellation of Debt Income: Navigating IRS Rules Webinar April 20, 2011 Robert Barnett, Capell Barnett Matalon & Schoenfeld b Wayne Strasbaugh, Ballard Spahr LLP Annette Ahlers, Pepper Hamilton pp Davis Smith, Kaufman Gilpin McKenzie Thomas Weiss dsmith@kgmlegal.com

6 Today s Program Tax Planning For Debt Restructuring: Key Concepts [Robert Barnett] Principal Transactional Exceptions [Wayne Strasbaugh] Slide 7 Slide 26 Slide 27 Slide 39 Acquisitions Or Repurchases Slide 40 Slide 45 [Robert Barnett] Attribute Reductions Slide 46 Slide 56 [Annette Ahlers] Qualified Real Property Business Indebtedness Slide 57 Slide 64 [Robert Barnett] Exclusions For Bankrupt, Insolvent Corporate Taxpayers Slide 65 Slide 72 [Davis Smith]

7 Robert Barnett, Capell Barnett Matalon & Schoenfeld TAX PLANNING FOR DEBT RESTRUCTURING: KEY CONCEPTS

8 Introduction: Planning Approach Get the facts! Entity considerations Some elections are made at entity levell Loss utilization history Review balance sheet and projections NOL + PAL credit carryforwards Solvency of debtor 8

9 Cancellation Of Debt IRC 61(a)(12) Except as otherwise provided in this subtitle, gross income means all income from whatever source derived, including (but not limited to) income from discharge of indebtedness. 9

10 Cancellation Of Debt (Cont.) Generally, the difference between the balance of the indebtedness and the amount of consideration accepted by the lender Income is realized at the time the debt is satisfied. Solvent taxpayers generally report ordinary income on canceled or reduced debt. 10

11 McCormick, TC Memo What is correct amount of CODI? The McCormick family received a 1099 C from Citi Financial IRC 6201(d): In any court proceeding: Taxpayer asserts reasonable dispute To income reported on an information return Taxpayer fully cooperated THEN 11

12 Burden Of Proof Shifts To IRS Correct CODI was $49.66 IRS could not rely on 1099C CCA : Borrowers received payments in settlement of unfair lending dispute; viewed as equitable reformation Timing, Gaffney, TC Summary

13 Example 1 Debtor transfers property in a voluntary foreclosure. Of RECOURSE DEBT RECOURSE DEBT: Debt for which h a borrower is personally liable. Whether a debt is recourse or non-recourse may vary from state to state, depending on state law. 13

14 Example 1 (Cont.) 1099C reports Debt cancelled in Box 2 $465,000 Box 7: FMV $195,000 Box 3 should report accrued but unpaid interest. 14

15 Example 1 (Cont.) Recourse debt is bifurcated Amount of debt cancelled = $465,000 Fair market value = - $195,000 CODI: $270,000 OR IS IT? 15

16 CODI 108(e)(2) Should NOT include amounts which would give rise to a tax deduction if paid How was FMV determined? 16

17 Gain/Loss Taxpayer s gain or loss is measured by the difference between the amount realized and the adjusted basis of the property. 17

18 Example: Rental Rental property Purchase price = $500, Adjusted basis = $400,000 IRC 1231 Loss = $205,000 (400, ,000) 18

19 Non-Recourse Debt Amount realized = $465,000 Basis = - $400, Capital gain = $65,000 Non-recourse debt is defined as debt for which a borrower is not personally liable. 19

20 When Is Debt Discharged? Debt modification: Any change in terms, collateral, etc. Significant modification: Will trigger an exchange of the old debt for a new debt 1001 Old debt satisfied for issue price of new debt 20

21 Repurchase Debtor buys back its debt. Related parties example: Acquire $1,000 of debt for $500 COD + OID result OID income recognized by related party over term of new debt. Debtor has a corresponding deduction. Presumption (six months prior) 21

22 Exchanges Debt for debt: Satisfied old debt with amount of $ equal to the ISSUE PRICE of new debt 22

23 Exchanges (Cont.) CODI = Adjusted issue price of old debt minus issue price of new debt OID = Stated redemption price at maturity minus issue price of new debt USE AFR INTEREST RATE on new debt, so debt is equivalent 23

24 Form 982 Form 982 is used to reduce tax attributes due to discharge of indebtedness. The form must be attached to a timely filed return. Extensions of time to file may be allowed if the taxpayer acted reasonably and in good faith under Treas. Reg IRC 1017 provides rules for basis reduction. 24

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27 Wayne Strasbaugh, Ballard Spahr LLP PRINCIPAL TRANSACTIONAL EXCEPTIONS

28 I. Basic terms Debt For Debt D b Exchanges A. Issue price 1. Issued for money: Cash paid 2. Publicly l traded d debt: Fair market value 3. Issued for publicly traded property: FMV of property surrendered 4. Other cases: Imputed issue price, or SRPM B. Stated redemption price at maturity (SRPM) C. QSI 1. All payments other than qualified stated interest (QSI) 1. Interest payable at least annually, at a single fixed rate 28

29 Debt for Debt D Exchanges (Cont.) II. Measurement of income in debt-for-debt exchange (IRC Sect. 108 (e)(10)) A. In determining the amount of discharge of indebtedness, the debtor is treated as having satisfied existing debt for an amount of debt equal to issue price of new debt. B. If an issue price would otherwise be SRPM, then the issue price is reduced by unstated interest. C. EXAMPLE: Original note with principal amount of $100, interest of 10% payable annually and term of three years is exchanged for replacement note with principal amount of $130, with no interest payable currently and term of three years. Assume that 10% compounded annually is the applicable federal rate (AFR), and that neither note is publicly traded. 29

30 Debt For Debt D b Exchanges (Cont.) 1. Imputed issue price of replacement note is $100, and there is no discharge of indebtedness income. Debtor deducts $30 as original issue discount (OID) over the term of the replacement note. 2. If AFR were 11%, imputed issue price of replacement note would be less than $100, and there would be discharge of indebtedness income that would be matched by additional deductions d of accrued OID over the term of the replacement note. 3. If replacement note were publicly traded and had FMV (i.e. issue price) of less than $100, then there would be discharge of indebtedness income regardless of adequacy of AFR proposed regulations would significantly broaden definition of publicly traded, if adopted in current form. 30

31 Debt For Debt D b Exchanges (Cont.) III. Deemed exchanges of debt instruments (Treas. Regs. Sect ) A. Outgrowth th of Cottage Savings Assn. v. Commissioner, i 499 U.S. 554 (1991) B. Focus on modifications: Any alteration is a modification, except that modifications occurring by operation of the terms of the debt instrument are not alterations. C. Significant ifi modifications i 1. Change in yield of more than de minimis amount (25 basis points) 2. Change in timing of payments; safe harbor for extension of the lesser of five years or 50% of original term 3. Substitution of new obligor on recourse instruments 4. Substitution of a substantial amount of collateral on non-recourse instruments 5. Certain other changes (e.g. subordination) that change payment expectations D. Result of deemed exchange is measurement of potential discharge of indebtedness under IRC Sect. 108 (e)(10) 31

32 Debt For Stock Exchanges I. Measurement of discharge of indebtedness income (Sect. 108 (e)(8)) A. Debt is deemed satisfied to the extent of the fair market value of the stock received. B. Tiny residue of common law stock-for-debt exception from recognition of discharge of indebtedness income that was whittled away by Bankruptcy Tax Act of 1980 and subsequent statutes. See Capento Sec. Corp. v. Commissioner, 47 B.T.A. 691 (1942), aff'd 140 F.2d 381 (1st Cir. 1944); and Commissioner v. Motor Mart Trust, 156 F.2d 122 (1st Cir. 1946) C. Sect. 351 does not protect creditor contributor from recognition of gain or loss, unless debt is a security. IRC Sect. 351 (d)(2) D. In case of S corporation, necessary to elect to close books to avoid discharge of indebtedness income to creditor 32

33 Debt for Stock Exchanges (Cont.) E. Different result if simultaneous steps? Formation of new corporation by creditor and debtor. Cf. Kniffen v. Commissioner, 39 T.C. 553 (1962); IRC Sect. 357(d) F. EXAMPLE: Debt with principal amount of $100 is exchanged for stock of debtor worth $90, and debt is extinguished. Discharge of indebtedness income of $10 is recognized. G. EXAMPLE: Debt with principal amount of $100 is contributed to Newco by creditor, and assets subject to debt are contributed by debtor. Debtor potentially recognizes gain under Sect. 357(c) prior to extinguishment of debt by merger of debtor and creditor. 33

34 Debt For Partnership Interest Exchanges I. Measurement of discharge of indebtedness income (IRC Sect. 108(e)(8)) A. Debt (recourse or non-recourse) is deemed satisfied to the extent of the FMV of a profits or capital interest received. Liquidation value may be used to determine FMV if capital accounts are maintained under IRC Sect. 704(b), valuation by partners and partnership is consistent, and certain other requirements are met. B. Consequence of enactment of American Jobs Creation Act of 2004 (AJCA): Prior common law was assumed by many to contain a complete debt-forpartnership interest exclusion. C. Recognized discharge of indebtedness income allocated to partners immediately before the discharge exchange D. Presumably allocated first as chargeback of minimum gain, if nonrecourse debt; need to allocate in way consistent with deemed distributions under IRC Sect. 752 but yet satisfy IRC Sect. 704(b) substantial ti economic effect 34

35 Debt For Partnership Interest Exchanges (Cont.) E. EXAMPLE: Debt of $100 is exchanged for 10% profits and capital interest worth $90. Discharge of indebtedness income of $10 is allocated in accordance with partnership percentage interests prior to the issuance of the new interest. Deemed distribution of $10 under IRC Sect. 752 F. Proposed regulations (Prop. Regs. Sec ) issued in 2008 indicate that creditor will recognize no gain or loss on exchange by reason of Sect. 72l. Loss of partial bad debt deduction was criticized by many commentators. Two-step transactions raise old-and-cold issues. G. Proposed regulations indicate equity received for accrued interest or original issue discount (OID) is taxable, even if accrued prior to contributor partner s ownership. Also, one would allocate equity received first to accrued interest and OID. 35

36 Contribution Of Debt By Existing Shareholder I. Measurement of discharge of indebtedness income (IRC Sect. 108(e)(6)) A. Shareholder is treated as having satisfied the debt in amount equal to its basis for the debt. 1. If shareholder is the original lender, then basis should be equal to amount of debt, and no discharge of indebtedness income would be created. 2. If shareholder acquired debt at a discount after issuance or has accrued interest as a cash basis taxpayer, then discharge of indebtedness income would be recognized. 3. In case of an S corporation, basis reductions to debt for S corporation losses are not taken into account. IRC Sect. 108(d)(7) 36

37 Contribution Of Debt By Existing Shareholder (Cont.) 4. Technically, an exception appears to be available without regard to corporate solvency. But, if contribution does not make corporation solvent, it may not be a capital contribution and therefore may not be within this exception. Compare Mayo, 16 TCM 49 (1957); Giblin, 227 F.2d 682 (5 th Cir. 1955) with Lidgerwood, 229 F.2d 241 (2d Cir. 1956) a. Creditor receives bad debt deduction if IRC Sect. 108(e)(6) inapplicable B. How to distinguish from stock-for-debt exception? 1. May simply be a matter of form. See LTR ; LTR ; LTR But cf. TAM Meaningless gesture cases suggest that Sect. 351 may apply, in which case issuance of stock to shareholder will be imputed and stock-for-debt exception will govern. See Rev. Rul

38 Contribution Of Debt By Existing Shareholder (Cont.) C. Where not meaningless gesture, shareholder arguably has made gift to other shareholders D. Application to partnerships? 1. It appears that there is no analog for contribution of debt to a partnership by an existing partner. 2. Proportionate contributions of partnership debt may result in discharge of indebtedness income, if no corresponding increase in equity value. 3. EXAMPLE: Partnership holds property with FMV of $70 subject to non-recourse debt of $100 held proportionately by partners. Partners contribute debt increasing partnership equity value (representing value of interests received) by $70. Apparently, $30 of discharge of indebtedness income is recognized. 38

39 Partial Debt Exchanges: Which Exception? I. EXAMPLE: Debt of $100 held by a sole shareholder with basis of $100. Shareholder h contributes $50 of debt to corporation. Is transaction: A. Exchange of debt for stock in a meaningless gesture transaction governed by IRC Sect. 108(e)(8), with possible discharge of indebtedness income depending on the value of shares of stock constructively received? B. Capital contribution of debt of $50 under IRC Sect. 108(e)(6), with no discharge of indebtedness income because there was no formal exchange of remainder of debt? C. Exchange of $100 debt for debt of $50 under IRC Sect. 108(e)(10) and the deemed exchange rule of Treas. Regs. Sect ? D. A combination of alternative C with either of alternatives A or B? E. Does codification of the economic substance doctrine have any effect on the answer to these questions? 39

40 Robert Barnett, Capell Barnett Matalon & Schoenfeld ACQUISITIONS OR REPURCHASES

41 Acquisition By Debtor Will give rise to CODI if purchased at a discount 41

42 Acquisition Of Indebtedness By Person Related To Debtor IRC 108(e)(4) and Reg provide that: The acquisition of outstanding indebtedness by a person related to the debtor from a person who is not related to the debtor is treated as an acquisition by the debtor, and results in the realization by the debtor of CODI income under IRC 61. Such income may still be excludible from gross income to the extent provided in 108(a). 42

43 Who Is Considered A Related Party? For purposes of 108, persons are considered related if they are related within the meaning of 267(b) as modified by 108(e)(4)(B) or 707(b)(1). 267(b) provides, in relevant part, that related party includes: Members of a family An individual and a corporation more than 50% in value of the outstanding stock of which is owned, directly or indirectly, by or for such individual Two corporations which are members of the same controlled group Presumption: Six months prior 43

44 Family Notwithstanding 267(b), 108(e)(4) limits members of a family to the individual s spouse, children, grandchildren, parents, and any spouse of the individual s children or grandchildren. For example: The father-in-law of the individual would NOT be considered a related party under the terms of the statute and regulations. 44

45 Purchase Example: Related party acquires $1,000 debt for $500 COD + OID result OID income recognized by related party over term of new debt; debtor has corresponding deduction Presumption: Six months prior 45

46 Annette Ahlers, Pepper Hamilton ATTRIBUTE REDUCTIONS

47 General Rules Sect. 108(b)(1): The amount of COD excluded from gross income under Sect. 108(a)(1) requires the reduction of attributes of the taxpayer. Sect. 108(b)(2): In general, attributes shall be reduced in the following order: 1. Net operating losses (NOLs); first any loss from the current year, then NOL carryovers from prior years 2. General business credits, including any carryovers 3. Minimum tax credit available under Sect. 53(b) as of the beginning g of the taxable year of the discharge 4. Capital loss carryovers; current year first, then any carryover 5. Basis reduction of the property of the taxpayer 6. Passive activity loss and credit carryovers; any loss under Sect. 469(b) from the taxable year of discharge 7. Foreign tax credit carryovers to or from the taxable year of the discharge, for purposes of determining the credit allowable under Sect

48 Amount Of Reduction Under 108(b)(3): The exclusions are dollar-for-dollar the amount excluded by 108(a). For reduction of credits and passive activity losses, the reductions shall be 33 1/3 cents for each dollar excluded by 108(a). 48

49 Ordering Rules 108(b)(4): Reductions made after determination i of tax for taxable year of discharge First, reduce tax losses of the year of discharge. Second, reduce carryovers from prior years, in the order from which such carryovers arose (oldest NOLs reduced first). Third, credit reductions shall be made in the order from which such carryovers are taken into account. For affiliated groups filing a consolidated d return, attribute t reduction is done on a consolidated basis, not on a separate company basis. See CCA (April 26, 2010) and Treas. Reg. Section T 49

50 Available Elections Sect. 108(b)(5): The taxpayer may elect to apply any portion of the attribute reduction first to reduce the tax basis of depreciable property. Limitation: it ti Such reduction cannot exceed the aggregate adjusted d bases of the depreciable property held by the taxpayer as of the beginning of the taxable year following the year of the discharge. If this election is made, other attributes are not reduced. An election must be made on the taxpayer s return for the taxable year in which the discharge occurs, or upon permission of the secretary. 50

51 Attribute Reduction Planning Consideration of election to reduce bases of property ahead of NOLs or other tax attributes May benefit taxpayer in short term, because NOLs would be available to offset income in post-cod years, and tax basis of certain assets would not benefit taxpayer in same way (longer life depreciation or amortization) Only works if COD does not exceed tax bases of these assets, and if other rules (such as sections 382, 384 or 269) do not otherwise limit the use of the NOLs or other tax attributes 51

52 Sect Ordering Rules Applies to the reduction of property held by the taxpayer Reduction is taken into account with respect to property held on the first day of the taxable year following the year of the COD event Basis of property is not reduced below zero 52

53 Sect Ordering Rules (Cont.) A taxpayer must reduce its tax basis in its property in the following order: Real property used in a trade or business or held for investment, other than real property described in 1221(1), that secured the indebtedness discharged Personal property used in a trade or business or held for investment (other than inventory, accounts receivable, and notes receivable) that secured the indebtedness Remaining property used in a trade or business or held for investment Inventory, accounts receivable, notes receivable and real property described in 1221(1) Property not used in a trade or business nor held for investment 53

54 Attribute Reduction In Bankruptcy (Special Liability Floor Rule) ) Treas. Reg. Sect (b)(3): If COD income arises from a discharge while the taxpayer is in a Title 11 bankruptcy or while the taxpayer is insolvent: The basis reduction under Sect. 108(b)(2)(E) shall not exceed the excess of the aggregate adjusted bases of the property and the amount of money held by the taxpayer, over The aggregate of the liabilities of the taxpayer immediately after the discharge Can create a black hole COD in which COD exceeds amount of attributes or basis that can be reduced; thus, no COD income and no attribute required for such amounts 54

55 Qualified Real Property Business Indebtedness d Taxpayer is not a C corporation Sect. 108(a)(1): Excluded COD reduces the basis of the depreciable real property of the taxpayer Apply Sect in making the required reductions Limited Excluded amount cannot exceed the excess of the outstanding principal amount of indebtedness, over the FMV of the real property that is qualified real property business property. Overall exclusion cannot exceed the aggregate adjusted bases of the depreciable real property held by the taxpayer immediately before the discharge. Cannot include real property acquired in contemplation of such discharge 55

56 Qualified Principal Residence Basis reduction Indebtedness d 108(h): Amount excluded from gross income under 108(a)(1)(E) shall be applied to reduce the basis of the principal residence of the taxpayer. Cannot be reduced below zero Up to $2 million in principal amount Discharge cannot relate to the provision of services performed for the lender. Principal residence is defined in Sect

57 Robert Barnett, Capell Barnett Matalon & Schoenfeld QUALIFIED REAL PROPERTY BUSINESS INDEBTEDNESS

58 QRPBI: Qualified Real Property Business Indebtedness d Taxpayers other than C corporations can exclude from gross income discharge of qualified real property business indebtedness. Amount excluded must reduce the taxpayers basis in real property. Amount cannot exceed the basis of real property held by the taxpayer. Anti-stuffing provision disallows purchase in contemplation of such discharge. 58

59 Election Elective exclusion: USE FORM 982 Qualified real property business indebtedness: Debt incurred to acquire, construct, or substantially renovate real propertyp Used in a trade or business, and Secured by such real property Note that the insolvency and bankruptcy exceptions come first. 59

60 Limitations And Recapture The exclusion cannot exceed: The amount by which the principal amount of the debt exceeds the fair market value of the property p securing the debt, or The aggregate adjusted bases of the taxpayer s depreciable real property The basis reduction is treated as ordinary income RECAPTURE upon sale of the property, based upon the IRC 1250 depreciation rules using the straight line method of depreciation. 60

61 Partnership PARTNERSHIP discharge and whether the debt was incurred in connection with a real property p trade or business is made by reference to the business of the partnership The ELECTION to exclude or discharge real property business indebtedness is made at the partner level on a partner-by-partner basis. 61

62 IRC 1017 IRC 1017 provides that the partner s interest in the partnership is treated as depreciable real property, to the extent of the partner s proportionate interest in the partnership s depreciable real property. A partner s election to treat the partnership interest as depreciable real property p will result in both the partner s basis in the partnership p and the partnership s basis in the depreciable real property allocable to such partner as reduced. Generally, the partnership may grant or withhold consent, unless the taxpayer owns more than 50% partnership interest. 62

63 S Corporation Election made at corporate level + attribute reduction No adjustment to shareholder stock Acts as a deferral 63

64 Principal Residence Temporary exclusion before Jan. 1, 2013 QUALIFIED principal residence indebtedness Not a second home Later 121 exclusion may protect basis reduction Insolvency exclusion may be preferable 64

65 Davis Smith, Kaufman Gilpin McKenzie Thomas Weiss EXCLUSIONS FOR BANKRUPT, INSOLVENT CORPORATE TAXPAYERS

66 Exclusion For Bankrupt Corporate Taxpayers: Sect. 108(a)(1)(A) ()()() COD income excluded if occurs in a Title 11 case Refers to a petition for bankruptcy filed under Title 11 of the United States Code, but only if: The taxpayer is under the jurisdiction of the court in such case, and The discharge of the debt is either Granted by court order, or Pursuant tto a plan approved by the court Debt does not have to be listed debt as long as discharged by court Entire amountofof COD income excluded If more than one exclusion applies under Sect. 108(a)(1), then bankruptcy exclusion has priority. 66

67 Exclusion For Insolvent Corporate Taxpayers: Sect. 108(a)(1)(B) ()()() Two primary differences between bankruptcy exclusion and insolvency exclusion Bankruptcy exclusion excludes all COD income, while certain limitations apply to the amount of COD income that may be excluded by insolvent taxpayers. Qualification for bankruptcy exclusion is objective, while qualificationfor for insolvency exclusion is subjective. Limitation of insolvency exclusion Definition of insolvent Sect. 108(d)(3) Excess of liabilities over fair market value of assets Determined immediately before the discharge 67

68 Calculation Of Insolvency Fair market value is based on valuing corporation as a going concern Not liquidation value Off balance sheet assets, such as goodwill and going concern value, are included in the calculation. Should obtain an appraisal, since IRS may challenge Contingent liabilities are included only if the liabilities are more likely than not to result in a payment by the debtor. All or nothing test Guarantees are not included, unless preponderance of evidence shows guarantor will be called upon to pay. Taxpayer has burden of proof. Unclear whether tax liabilities arising from workout should be included in calculation 68

69 Calculation of Insolvency (Cont.) Contested liability doctrine If dispute is over the amount of the liability, then no COD income should arise from a settlement. If dispute is over the enforceability of the liability, then COD income would result from a settlement. Non recourse debt: Two 2 options Full amount of non recourse debt included in calculation, or Include the full amount of the debt only if the non recourse debt is being discharged; otherwise, include non recourse debt only to extent of the fair market value of the collateral l This is Service s position see Rev. Rul Bonds and other corporate issued obligations are valued at adjusted issue price. Immediately before : Do nottake take into considerationthereductioninliabilitiesasa the reduction in as a result of the discharge Insolvency exclusion has priority over exclusions for qualified real property business indebtedness and qualified farm indebtedness. 69

70 Application To Consolidated Groups Consolidated groups Eligibility for exclusions is determined on a separate company basis Which member of the group is the debtor, for tax purposes? For example, if one member is a guarantor and other members and parent are thinly capitalized, is the guarantor the debtor for tax purposes? Inter company debt Sect. 108(a) does not apply to COD income generated by settlement of inter company debt. COD income should be offset by bad debt deduction available to other members of the group. 70

71 Application To Flow Through Entities S corporations: Qualification for exclusions under Sect. 108 are determined at the entity level. Partnerships (including LLCs): Qualification for exclusions under Sect. 108 are determined at the partner level. Partner cannot piggyback partnership bankruptcy filing to qualify for a bankruptcy exclusion. Disregarded entities (QSubs and SMLLCs) Does a disregarded entity qualify for the bankruptcy or insolvency exclusions? Recently released proposedregulations regulations provide that the owner, not the disregarded entity, must qualify. 71

72 Planning Considerations Bankruptcy generally provides more certainty for the tax consequences. Objective criteria for qualification Exclude full amount of COD income Drawback is that bankruptcy may be more costly than a workout Pre packaged bankruptcy may be an attractive option. Combines certainty of tax consequences with cost efficiency of workout Timing is everything in the application of insolvency exclusion. Insolvency is determined immediately before the discharge. Contribution of new capital to the corporation could affect the insolvency calculation. If possible, a cash injection into debtor should be simultaneous with the debt discharge. 72