PORTFOLIO

Discharge of Indebtedness, Bankruptcy and Insolvency (Portfolio 540)

Tax Management Portfolio, Discharge of Indebtedness, Bankruptcy and Insolvency, No. 540-3rd, examines and analyzes the tax treatment of individuals, corporations, and partnerships that realize discharge-of-indebtedness income, inside or outside bankruptcy, whether or not the person realizing the income is insolvent. It also considers the tax treatment of individuals, corporations, and partnerships that have become insolvent and, as a result, are subject to the provisions of the federal bankruptcy laws or state laws applicable to receiverships. 

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Tax Management Portfolio, Discharge of Indebtedness, Bankruptcy and Insolvency, No. 540-3rd, examines and analyzes the tax treatment of individuals, corporations, and partnerships that realize discharge-of-indebtedness income, inside or outside bankruptcy, whether or not the person realizing the income is insolvent. It also considers the tax treatment of individuals, corporations, and partnerships that have become insolvent and, as a result, are subject to the provisions of the federal bankruptcy laws or state laws applicable to receiverships.

The Portfolio discusses the tax treatment of debt discharge, including the exclusion of debt discharge from gross income and the corresponding reduction of tax attributes under §108; the tax treatment of the bankruptcy estate of individuals entering bankruptcy under Chapter 7 or 11 of the Bankruptcy Code, including the transfer of tax attributes to and from an individual's bankruptcy estate under §1398(g); the tax-free reorganization of corporations in a Title 11 or similar case; the special tax problems of financially troubled corporations; and the tax treatment of financially troubled partnerships.


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AUTHORS

WILLIAM TATLOCK
William Tatlock, B.A., Yale University (1956); LL.B., Harvard University (1959); LL.M. (Taxation), New York University (1977); member, New York City, New York State, New Jersey, and American Bar Associations.

TABLE OF CONTENTS

Detailed Analysis

I. Introduction

A. In General

B. Federal Legislative Background

C. State and Local Taxes

D. Overview of the Bankruptcy Code

1. Proceedings

2. Commencement of a Bankruptcy Case

3. Order for Relief

4. The Bankruptcy Estate

5. Proofs of Claim

6. Priority in Distribution of Estate's Assets

7. Appointment of Trustee

8. Filing a Plan

9. Discharge

10. Tax Provisions

a. Status of Tax Claims

b. Automatic Stay

c. Determination of Taxes

E. Tax Advantages of Bankruptcy

II. Discharge of Indebtedness

A. Kirby Lumber and Progeny

B. Tax Benefit Approach

1. Section 108(e)(2)

2. Section 111(c)

C. Amount of Income

1. Determining the Amount of the Debt

2. Determining the Amount Paid to Satisfy the Debt

D. Related Parties

1. In General

2. Who Are Related Parties?

3. Direct Acquisitions

4. Indirect Acquisitions

5. Exceptions

a. One-Year Rule

b. Securities Dealers

6. Amount of Discharge-of-Indebtedness Income Realized

a. Indebtedness Acquired by Purchase Six Months or Less Before Acquisition Date

b. Indebtedness Not Acquired by Purchase Six Months or Less Before Acquisition Date

c. Nonrecognition Transactions

d. Tax Avoidance Transactions

7. Correlative Adjustments

a. Legislative History

b. The Regulations

(1) In General

(2) Deemed Issuance Rule

(3) Treatment of Related Holder

(4) Subsequent Dispositions

8. Consolidated Return Regulations

E. When Is Income Realized?

F. Sale or Exchange Distinguished

1. In General

2. Nonrecourse Debt

3. Recourse Debt

G. Discharge of Indebtedness as a Gift

H. Discharge of Nonrecourse Debt Other Than by Disposing of the Property Securing the Debt

1. No Personal Liability Exception

2. Current Law

I. The Reduction in Purchase Price Exception

1. The Judicially Created Exception

2. The Statutory Exception

J. Contingent Obligations

K. Overall Loss on Transaction

L. No Increase in Debtor's Assets

M. Disputed Debts

N. Exclusions from Gross Income under § 108

1. Prior Law

2. Current Law

a. The Bankruptcy and Insolvency Exclusions

(1) In General

(2) Bankruptcy

(3) Insolvency

(4) Alternative Minimum Tax

(5) Attribute Reduction

(6) Basis Reduction

(a) The Property

(b) Ordering Rules

(c) The Floor

(d) No Disposition Rule

(e) Recapture Rule

(f) Election to First Reduce the Basis of Depreciable Property

b. Attribute Reduction as an Alternative to Debt-Discharge Income for Solvent Debtors

(1) Qualified Business Indebtedness – Prior Law

(2) Qualified Farm Indebtedness

(3) Qualified Real Property Business Indebtedness

c. Student Loans

d. Victims of Terrorism Tax Relief Act of 2001

e. Effective Date of Section 108

f. State and Local Taxes

O. Contributions to Capital and Stock-for-Debt and Debt-for-Debt Exchanges

P. Reporting Requirements

1. Foreclosures and Abandonments

2. Discharged Indebtedness

a. Creditor Reporting Requirements

(1) In General

(2) The Regulations

(a) Identifiable Events

(b) Exceptions

(c) Multiple Creditors

(d) Coordination of Form 1099-A and Form 1099-C

b. Debtor Reporting Requirements

III. Bankrupt Individuals and Their Estates

A. In General

1. Prior Law

2. Bankruptcy Tax Act

3. State and Local Taxes

B. Transfer of Tax Attributes Between Debtor and Estate

1. Prior Law

2. Bankruptcy Tax Act

3. State and Local Taxes

C. Carrybacks

1. Prior Law

2. The Bankruptcy Tax Act

3. State and Local Taxes

D. Allocation of Income and Expense Between Debtor and Estate

1. Prior Law

2. Bankruptcy Tax Act

a. Income

b. Expense

3. State and Local Taxes

E. Tax Treatment of the Debtor

1. Tax Liabilities of an Individual Debtor's Bankruptcy Estate Distinguished from Tax Liabilities of the Debtor

2. Debtor's Taxable Year in Which Bankruptcy Occurs

a. Prior Law

b. Bankruptcy Tax Act

c. State and Local Taxes

3. Transfer of Property Between Debtor and Estate

a. Prior Law

b. Bankruptcy Tax Act

c. State and Local Taxes

4. Effect of Debt Discharge on the Debtor

F. Tax Treatment of the Estate

1. Gross Income

2. Deductions

a. Prior Law

b. Bankruptcy Tax Act

c. State and Local Taxes

3. Taxable Income

a. Bankruptcy Tax Act

b. State and Local Taxes

4. Method of Accounting and Taxable Year

a. Bankruptcy Tax Act

b. State and Local Taxes

5. Returns

a. Bankruptcy Legislation

(1) Bankruptcy Tax Act

(2) The Bankruptcy Abuse Prevention and Consumer Protection Act

b. State and Local Taxes

G. Abandonment of Property by the Estate

H. Cases Under Chapters 12 and 13

I. Dismissed Cases

J. Receivership, Foreclosure, and Similar Proceedings

IV. Corporations

A. In General

B. Types of Reorganizations

1. Recapitalizations

2. Asset Transfers

a. Prior Law

b. G Reorganizations

(1) Exclusivity of G Reorganization Provisions

(2) Title 11 or Similar Case

(3) Distribution Qualifying Under § 354, § 355 or § 356

(a) Exchange of Stock or Securities

(b) Section 354(b)(1)

(c) Section 355

(4) Continuity of Interest

(5) Continuity of Business Enterprise

(6) Business Purpose

(7) Subsidiary Reorganizations

c. Troubled Financial Institutions

(1) In General

(2) Title 11 or Similar Case

(3) Continuity of Interest

(a) Paulsen v. Comr.

(b) Legislative Developments

(4) Continuity of Business Enterprise

(5) Net Operating Losses

(6) Treatment of Federal Financial Assistance

(a) In General

(b) Notice 89-102

(c) The Regulations

(7) Pre-1996 Bad Debt Reserve Treatment

(8) Losses on Deposits in Insolvent Financial Institutions

(9) Interest on Frozen Deposits

(10) Exemption of Insolvent Banks from Tax

C. Tax Effects of Insolvency Reorganizations and Liquidations

1. The Debtor

a. Recognition of Gain or Loss

(1) In General

(2) Section 357(b) and (c)

(3) Section 351

b. Exchange of Old Debt for New Debt

(1) Consequences of Debt Modification

(a) Section 1001 Regulations

(b) Installment Sale Rules

(2) Discharge-of-Indebtedness Income

(3) Pre-1990 Determination of Issue Price in Tax-Free Reorganizations

(4) Issue Discount and Premium

c. Exchange of Debt for Stock

(1) The Repealed Stock-for-Debt Exception

(a) In General

(b) Apportionment Between Cash and Stock

(c) Token or Nominal Shares

(d) Ratio Test

(e) G Reorganizations

(f) Triangular Reorganizations

(2) Stock Exchanged for Debt after Repeal of the Stock-for-Debt Exception

(3) State and Local Taxes

d. Debt Cancellation as a Contribution to Capital

e. Carryover of Tax Attributes

f. Net Operating Loss Carryovers

(1) Background

(2) Section 382

(a) Changes Made by the Tax Reform Act of 1986

(b) The § 382 Limitation

(c) Definition of Ownership Change

(i) In General

(ii) Owner Shift

(iii) Equity Structure Shift

(iv) Testing Period

(v) Percentage of Stock Owned

(vi) Stock

(vii) 5-percent Shareholder

(viii) Worthless Stock Rule

(ix) Constructive Ownership

(x) Options

(xi) Excluded Transfers

(d) Controlled Groups

(e) Treatment of Built-In Gains

(f) Treatment of Built-In Losses

(g) Continuity of Business Enterprise

(h) Bankrupt Corporations

(i) Regulations

(3) Section 383

(4) Section 384

(5) Section 269

(6) Consolidated Return Regulations

(a) Former § 382

(b) Consolidated Return Change of Ownership

(c) New § 382

(d) SRLY

(e) Section 108

(7) Libson Shops

g. S Corporations

h. Earnings and Profits

(1) Section 312(l)(1)

(2) Basis Adjustments

(3) Section 312(l)(2)

i. Personal Holding Company Tax

j. Deduction for Accrued but Unpaid Interest

2. Shareholders

a. Loss Deduction

b. Exchange of Stock for Stock or Other Property

3. Creditors

a. Bad Debt or Other Loss Deduction

b. Exchange of Old Debt for New Debt

(1) Determination of Creditor's Amount Realized

(2) Recognition of Gain or Loss

(3) Market Discount

(4) Excess Principal Amount Rule

(5) Original Issue Discount

c. Allocation to Accrued but Unpaid Interest

d. Exchange of Debt for Stock

V. Partners and Partnerships

A. No Separate Taxable Entity

B. Transfer of Partnership Interest to the Bankruptcy Estate

C. Taxable Years of a Bankrupt Individual Partner and the Bankruptcy Estate

D. Discharge of Indebtedness

1. Prior Law

2. Bankruptcy Tax Act

a. In General

b. Timing of § 752(b) Deemed Distributions

c. Substantial Economic Effect

d. Partnership Equity-for-Debt Exception

e. Nonrecourse Debt

f. Basis Reduction

(1) In General

(2) Section 1017(b)(3)

g. Recapture Under § 108(e)(7)(E)

h. Applicability of Purchase-Price Reduction Exception to a Bankrupt or Insolvent Partnership

i. Partner Debt

E. Proceedings to Determine Partnership Income

VI. Procedure


WORKING PAPERS

Working Papers

Table of Worksheets

Worksheet 1 Bankruptcy Tax Act of 1980 (P.L. 96–589)

Worksheet 2 The Bankruptcy Reform Act of 1978 (P.L. 95–598)

Worksheet 3 Tax Provisions of the Financial Institutions Reform, Recovery and Enforcement Act (P.L. 101–73)

Worksheet 4 Provisions of the Omnibus Budget Reconciliation Act of 1990 (P.L. 101–508) Relating to the Issuance of Debt or Stock in Satisfaction of Indebtedness, Amending § 108 and § 1275

Worksheet 5 Provisions of the Omnibus Budget Reconciliation Act of 1993 (P.L. 103–66) Relating to the Exclusion from Gross Income for Income from Discharge of Qualified Real Property Business Indebtedness Under § 108

Worksheet 6 House Explanation of Amendments to § 108, § 1017 and Other Provisions and Enactment of § 1398 and § 1399: H.R. Rep. No. 833, 96th Cong., 2d Sess. (1980)

Worksheet 7 Senate Explanation of Amendments to § 108, § 1017 and Other Provisions and Enactment of § 1398 and § 1399: S. Rep. No. 1035, 96th Cong., 2d Sess. (1980)

Worksheet 8 House Discussion of Amendments to 11 U.S.C. § 362 Relating to Stay of Certain Tax Collection Actions: Excerpt from 124 Cong. Rec. 32412–32418 (Sept. 28, 1978)

Worksheet 9 Treatment of FSLIC Payments to Financially Troubled Financial Institutions Under § 597, § 368 and § 382: Excerpt from H.R. Rep. No. 101–54 (II), 101st Cong., 1st Sess. (1989) (FIRRE Act)

Worksheet 10 Sec. 108(c) Exclusion from Income of Qualified Real Property Business Indebtedness; Excerpt from WMCP: 103–11, 103d Cong., 1st Sess. (1993) (OBRA 1993)

Worksheet 11 Application of § 108 and § 1398 to Individual Bankruptcy Situation

Worksheet 12 Application of § 108 and § 1017 to Corporate Bankruptcy Situation

Worksheet 13 Publication 908 (Bankruptcy Tax Guide)

Bibliography

OFFICIAL

Statutes:

Public Laws:

Treasury Regulations:

Committee Reports/Legislative History:

Treasury Rulings:

Internal Revenue Service Announcements and Notices:

Cases:

UNOFFICIAL

Books and Treatises:

Periodicals:

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