Section 108(i) was enacted on February 17, 2009.1 Where available, Section 108(i) permits taxpayers to elect to defer for a period of up to five years the recognition of COD income arising from repurchases, exchanges or modifications (“reacquisitions”) of outstanding debt (“applicable debt instruments”) that occur during 2009 and 2010. Under Section 108(i), if a debt instrument having original issue discount (“OID”) is issued in exchange for an applicable debt instrument, deductions for the OID on the new instrument are disallowed during the deferral period to the extent such OID does not exceed the COD income realized but deferred in the exchange. After the expiration of the deferral period, the deferred OID deductions may be claimed ratably over the fiveyear period during which the COD income must be included.
On August 17, 2009, the IRS issued Revenue Procedure 2009-37, which, in addition to providing detailed administrative procedures for making the Section 108(i) election, clarifies certain ambiguities in the statute. Significantly, it also permits “partial elections” as discussed below. Here we provide a summary of some of the more important aspects of the new guidance.
Partial Elections. The revenue procedure makes clear that a taxpayer may make an election for all or any portion of COD income realized from the reacquisition of any applicable debt instrument. Thus, for example, if a taxpayer realizes $100 of COD income from the reacquisition of an applicable debt instrument, the taxpayer may elect to defer only $40 of the $100 of COD income. The remaining portion may be excluded under other Section 108 exceptions (e.g., the insolvency exception), if applicable. The procedure also clarifies that a taxpayer may make an election in respect of different portions of COD income arising from different applicable debt instruments (whether or not part of the same issue). In addition, a partnership that makes a partial election may specifically allocate the deferred amount to specific partners, allowing the partnership flexibility in tax planning for each partner.2
Pass-Through Entities. Under Section 108(i), certain events accelerate the deferral of COD income. These events include the death of, liquidation of, or other similar event with respect to, a taxpayer. In addition, certain dispositions of interests in partnerships, S corporations, or other “passthrough” entities cause acceleration. Importantly, clarifying an ambiguity in the statute, the revenue procedure provides that regulated investment companies (“RICs”) and REITs are not pass-through entities for purposes of Section 108(i).
Impact on Earnings and Profits. The revenue procedure provides that the IRS intends to issue regulations that generally will provide that deferred COD income increases earnings and profits in the taxable year that it is realized and not in the taxable year or years that the deferred COD income is includible in gross income. OID deductions deferred under Section 108 generally will decrease earnings and profits in the taxable year or years in which the deduction would be allowed without regard to Section 108(i). However, in the case of RICs and REITs, COD income deferred under Section 108(i) generally increases earnings and profits in the taxable year or years in which the deferred COD income is includible in gross income and not in the year that the deferred COD income is realized and OID deductions deferred under Section 108(i) generally decrease earnings and profits in the taxable year or years that the deferred OID deductions are taken into account.
Transition Rules. A previous election that does not comply with the revenue procedure will not be effective unless the taxpayer files an amended return that complies with the requirements of the revenue procedure on or before November 16, 2009. In addition, a taxpayer that filed a Section 108(i) election on or before September 16, 2009 may modify that election by filing an amended return on or before November 16, 2009.