Continued from “The Frustration of Bad Debt Part 2”
Cited: ABA Journal
Attribute Reduction:
It was mentioned in the previous part that the price for excluding CD income that the debtor must reduce certain specified tax attributes when reducing a debt. That means a debtor who declares bankruptcy, insolvency or qualified farm indebtedness that excludes COD income must reduce their tax attributes in the following order:
- net operating losses
- general business credits
- alternative minimum tax credits
- capital loss carryovers
- basis of assets
- passive activity loss and credit carryovers
- foreign tax credit carryovers.
The credits are reduced at the rate of 331⁄3 cents for each dollar of excluded COD income. The other attributes are reduced on a dollar-for-dollar basis.
The reduction in attributes is made after the determination of taxes for the taxable year of the debt discharge. That means attributes arising in or carried to the year of the discharge may be used to reduce income or tax for the year of the discharge, and the remaining attributes themselves are reduced for the following year.
Flexibility in the rules for reducing attributes allows a debtor, with careful planning, to apply the rules to best advantage. Instead of reducing attributes in the order prescribed above, the debtor may elect, pursuant to IRC section 1017, to first reduce the basis of its depreciable property. In that way, the debtor may choose to preserve net operating losses for future years.
The exclusions from COD income for qualified principal residence debt and qualified real property business debt specifically provide for a reduction in the basis of the property securing the debt instead of following the ordering rules for attribute reductions.
Temporary Deferral of COD Income:
Congress provided additional—albeit temporary—relief to beleaguered debtors when it included a temporary deferral rule in the American Recovery and Reinvestment Act that became law earlier this year.
A couple of definitions will help explain the temporary deferral rule: An applicable debt instrument is one issued by an individual, corporation or other entity in connection with the conduct of a trade or business. This is broadly defined to include any bond, debenture note, certificate, or other instrument or contractual arrangement constituting indebtedness within the meaning of IRC section 1275.
A reacquisition of an applicable debt instrument may be made by the issuing debtor in one of the following ways: (1) acquisition for cash or other property; (2) exchange of the debt instrument for another debt instrument (including an exchange that results in a significant modification); (3) exchange of the debt instrument for corporate stock or a partnership interest; (4) contribution of a debt instrument to capital; or (5) complete forgiveness of a debt instrument by the holder.
Now, the rule: An eligible debtor may elect to defer COD income arising from its reacquisition of an applicable debt instrument during calendar years 2009 or 2010, in accordance with IRC section 108(i). The debtor may include the income ratably over a five-year period beginning in the fifth tax year following a reacquisition that occurs in 2009 and the fourth tax year for a reacquisition occurring in 2010. (See IRS Revenue Procedure 2009-37 for additional guidance.)
The debtor may make a deferral election separately for each applicable debt instrument that is reacquired. The election may apply to all or only a portion of the COD income that results from each instrument. Once made, a deferral election is irrevocable. Debtors who are not sure whether they will be deemed to have realized COD income in 2009 or 2010 may file protective elections under section 108(i).
If the debtor elects to defer, then the other exclusions from COD income are not applicable. But because the deferral election may apply to only a portion of COD income, the debtor has the flexibility to exclude some of it and defer other COD income. An insolvent debtor, for example, might elect to exclude COD income and reduce tax attributes to the extent of the debtor’s insolvency, but defer any COD income in excess of its insolvency.
If the taxpayer dies, liquid dates, or cells substantially all assets or ceases to do business, any COD income that is deferred under section 108(i) will be accelerated and added to income for that catch your.
Continued in “The Frustration of Bad Debt Part 4”
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My Take: I think after this humongous article, I would rather hire an accountant to take care of it. Because if I tried to take care of it my family would be hunting for a burial urn, I would probably have a stroke trying to figure it all out.
I wonder if you would be going through prison metal detectors if you missed all this up. Of course, hopefully you would be going through a walk through metal detector to visit someone in prison instead of being there yourself. Of course, nobody wants to go to prison over debt or taxes so would be a good idea to get professional assistance.
You just need to make sure you know what can be deducted or excluded. I doubt pet keepsake urns would fit either of these criteria. Now, you might be able to take off Virginia cleaning services if they are used for your business. Now if it is for medical reasons, you might be able to take Washington DC maid service off your taxes.
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