On August 17, 2009, the Internal Revenue Service issued Revenue Procedure 2009-37, which, among other things, details the procedures that taxpayers must follow to elect to defer recognition of cancellation of debt (COD) income under the American Recovery and Reinvestment Act of 2009 (the Stimulus Act). The other key element of the Revenue Procedure is that it allows for a partial election option, which may be particularly useful for partnerships.
Mechanics for Making Deferral Election
Section 108(i) of the Internal Revenue Code, which was enacted as part of the Stimulus Act to offer tax relief for struggling businesses, provides for an election to defer for up to five years the recognition of COD income from the reacquisition of a debt instrument in 2009 or 2010.1 Taxpayers must then include the COD income in their gross income ratably over the next five years.
The Revenue Procedure specifies that, to elect to defer COD income with respect to a debt instrument, an eligible taxpayer must attach a statement providing required information about the debt instrument to a timely filed Federal income tax return for the taxable year in which the reacquisition of the debt instrument occurs. The Revenue Procedure grants an automatic 12-month extension of this deadline for making the election, however.
Taxpayers are also permitted to make a protective Section 108(i) election if they are unsure whether a particular transaction will result in the realization of COD income but do not want to miss the filing deadline if it does. Partial Election Option The Revenue Procedure also allows taxpayers to make a partial election to defer any portion of COD income.
The ability to make a partial election may be particularly useful to a partnership with partners who have differing tax situations. The Stimulus Act provides that the election must be made at the partnership level, even though partners may have divergent interests as to the benefits of the election. As a result, Section 108(i) appeared potentially problematic for partnerships when the Stimulus Act was first passed. The allowance of a partial election should make the Section 108(i) election more appealing and more practicable. If a partnership elects to defer less than all of the COD income realized from the reacquisition of a debt instrument, the partnership may allocate the deferral on a partner-by-partner basis – i.e. one partner may recognize that partner’s share of COD income currently, while another partner defers that partner’s share. For a partnership that realizes COD income during 2009 or 2010, it will now make sense to solicit from each partner that partner’s individual preference regarding whether and to what extent the COD income allocable to that partner should be deferred.
The Revenue Procedure indicates that the flexibility for a partnership to determine how to allocate COD income among its partners will extend to each partnership in a tiered partnership structure.
In contrast, an S corporation, while having the option of a partial election, must allocate its deferred COD income ratably among its shareholders.
Further IRS Guidance
In the Revenue Procedure, the IRS says that it intends to issue additional guidance under Section 108(i), that may include future regulations, which could modify the procedures set forth in the Revenue Procedure.