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90 Second Lessons: Nothing in Life is Certain but Death and Taxes: Cancellation of Debt Income

Editor’s Note: this is part of our irregular series in which we answer readers’ questions. If you have a question, submit it to [email protected] and we will try to answer it.

Question

Robin T. wrote in asking, I own a small retail chain that has been struggling. I hired a lawyer to negotiate with my creditors, and she told me I should speak with my accountant about the possible tax consequences of getting my creditors to forgive some of the company’s debt. The IRS can’t be that cruel, can it?

Answer.

Indeed it can, Robin. For federal income tax purposes, income of the Debtor includes income from the discharge or cancellation of indebtedness (cancellation of debt income or “CODI”) for which the Debtor taxpayer is liable, or certain indebtedness which encumbers property owned by the Debtor.

The CODI rules apply to debt reductions, debt forgiveness or discharge, repurchases or acquisition of debt for less than the face value of the debt, debt modifications or debt exchanges, capital contributions of debt to corporations and tax partnerships, exchanges of debt for equity in corporations or tax partnerships, debt relieved in connection with the sale or disposition of encumbered assets and other debt transactions.

Generally, CODI is required to be taken into income for federal income tax purposes, upon the occurrence of an identifiable event indicating that the indebtedness will never be paid or have to be paid by the Debtor. However, the general CODI inclusion rule is subject to numerous statutory and judicial exceptions, exclusions and modifications, the most important of which are in an insolvency case, the CODI exclusion for bankrupt and insolvent Debtor (or Equity Holder) taxpayers.


[Editor’s note: To learn more about this and related topics, you may want to attend the following webinars:

This 90 Second Lesson is based, in substantial part, on material reprinted from “Commercial Bankruptcy Litigation 2d” and “Strategic Alternatives For and Against Distressed Businesses,” with permission of Thomson Reuters. If you are a Westlaw subscriber, you can read more about this particular subject here.]

About The DailyDAC Editors

The editors and editorial board of DailyDAC include preeminent restructuring and insolvency professionals, journalists, and editors. They are devoted to providing reliable and plain English education and deal intelligence about assignments, corporate bankruptcy, receiverships, out-of-court workouts and similar topics.

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