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C corporation cancellation of debt

Technical topics regarding tax preparation.
#1
Eduardo  
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Need to make sure that I'm thinking this through correctly. Facts - taxpayer is a C corporation in the software development business. Has NOL carryforward from 2018 of $950,000. There was $1,100,000 of nonrecourse debt that the creditors elected to forgive (these were former preferred shareholders who converted their preferred stock to debt a couple of years ago, evidenced by notes and other documentation). All notes were forgiven on the same day. Without factoring in any exclusions (specifically the insolvency exclusion), and assuming that taxable income excluding COD income is zero for the sake of simplicity, this means that the corporation has $150,000 of taxable income.

Now let's say that it's determined that the amount of insolvency immediately before the debt is canceled is $550,000. The amount of the insolvency thus reduces taxable income before the NOL to $550,000. The insolvency amount also is used to reduce the NOL from $950,000 to $400,000. This leaves us in the same place - $150,000 of taxable income.

Am I missing something? The client obviously wants to mitigate the tax effect of the debt cancellation, but I can't think of any way to do this (the purchase price exception doesn't apply in this case).
 

#2
lckent  
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Reg Sec 1.108-7, I think you take the NOL deduction first, if not all used, the remaining balance is reduced.
 

#3
LW25  
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lckent wrote:Reg Sec 1.108-7, I think you take the NOL deduction first, if not all used, the remaining balance is reduced.


Exactly.

$1,100,000 of debt discharge income (before considering section 108 exclusion).

Assumes no other current year income and no current deductions.

Excluded debt discharge income amount is $550,000

So, the REALIZED debt discharge income (after considering the exclusion) is the difference of $550,000 ($1,100,000 minus $550,000 = $550,000).

The NOL carryover from prior years to current year was given to be $950,000.

The current year realized debt discharge income of $550,000 minus the $950,000 NOL carryover from prior years = current year net loss of $400,000, which of course is equal to the tentative NOL carryover from the current year to next year.

But, this tentative $400,000 NOL carryover is reduced to zero by $400,000 of the aforementioned $550,000 exclusion, with the $150,000 excess simply disappearing. No income effect -- a taxpayer freebee!

See IRC section 108(b)(4), subparagraphs (A) and (B).
 


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