Cancellation of Debt Income - The Good, the Bad and the Unexpected
By Karen Hughes
The American Recovery and Reinvestment Act of 2009 provides, at the taxpayer’s election, for a deferral of income recognition on any cancellation of debt income from the reacquisition of an “applicable debt instrument” prior to January 1, 2011. Any such deferral is until 2014, at which point the taxpayer recognizes the income ratably over a five-year period. Income tax deferral of this sort is meant to induce debtors (and creditors) to rework debts that would potentially have, under pre-stimulus law, created an intolerable, immediate income tax burden.
While there are several important exceptions, generally any cancellation of debt is income to the taxpayer in the year of cancellation. A cancellation of debt includes, but is not limited to, debt restructures/modifications, new issuances of debt to replace a prior issuance, acquisition of debt by a related party, and forgiveness (partial or full) of a debt. More specifically, cancellation of debt income can easily occur in a foreclosure situation.
Generally speaking, any type of income tax deferral is a good thing. However, the two main caveats to making this election to defer cancellation of debt income are:
(1) We do not know what the applicable income tax rates will be at the time the cancellation of debt income must be recognized (i.e., it will be unclear how beneficial this deferral could be until we have a sense of what income tax rates will be in 2014 and forward); and
(2) The Texas Comptroller has published its policy statement clarifying that, because the margin tax is calculated based on the Internal Revenue Code of 1986, as it was in effect for the federal tax year beginning on January 1, 2007, (without regard to any changes made by federal law or Regulations adopted thereafter) any such federal election is disregarded for Texas margin tax purposes.
For more information regarding cancellation of debt income and the consequences of electing deferral, please contact any of the following:
Brian Dethrow at 214.953.5794 or bdethrow@jw.com
Susan Halsey at 817.334.7203 or shalsey@jw.com
Karen Hughes at 214.953.5789 or khughes@jw.com
Steve Moore at 512.236.2074 or smoore@jw.com
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