Proposed Reg. § 1.108-9, 76 FR 20593-01 (4/13/2011)

In general, income from the discharge of indebtedness is includible in gross income. A limited exception applies under IRC Section 108 which provides that an amount that normally would be includible in gross income by reason of the discharge of indebtedness of the taxpayer is excludible if the discharge occurs in (1) a Title 11 bankruptcy case or (2) to the extent the taxpayer is insolvent when the discharge occurs.

This proposed regulation would treat the grantor as the taxpayer with respect to amounts owed by a grantor trust, to determine whether the discharge of those debts is excluded from gross income because the debtor is bankrupt or insolvent. Under the proposed regulations, the grantor, rather than the grantor trust, would have to be bankrupt or insolvent in order to avoid current income. The proposed regulations would also treat the owner of a disregarded entity, such as a single member LLC, as the taxpayer for similar purposes.