We thought it would be useful to provide our clients and friends with a brief update on some important tax provisions in the stimulus package that is working its way through Congress. The Senate version of the bill, reported out today by the Finance Committee, includes a provision that would generally reduce, on a present value basis, the tax cost of recognizing cancellation of debt (COD) income. The proposal would defer recognition of COD income realized in 2009 or 2010 from a cash repurchase of debt by an issuer or a related person and then require recognition of the income over an 8-year period, generally starting in 2011.  

A few key points to bear in mind:  

  • The Senate Finance Committee bill is limited to transactions in which the issuer or a related party purchases the debt. In its current form, it would not apply to debt for debt exchanges, including deemed exchanges resulting, for example, from modification of debt terms. There is some sentiment in the Senate to expand the provision to cover exchanges, but there is also concern that doing so will prohibitively increase the cost to the government.
  • There are also competing proposals, including another proposal in the Senate for a gross income exclusion for a portion (up to 50%) of the COD income. This may well be viewed as adding too much to the cost of the legislation, but a corresponding attribute reduction proposal (similar to current provisions relating to COD in a bankruptcy context) could mitigate that problem.
  • There are no details yet on a number of technical issues, such as issues relating to the post-acquisition treatment of related party acquisitions and whether there may be different rules for issuers with NOLs (for whom the spread might not be beneficial under certain circumstances).

IRS Circular 230 disclosure: To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing or recommending to another party any transaction or matter that is contained in this document.

Most importantly, it should be noted that there is no COD provision in the House version of the bill (also reported out of committee today), and thus it is not clear what the final bill will provide, if anything. The issue is expected to be dealt with in conference, but it is possible that the COD income relief will be viewed as costing too much and will be left out of the final legislation. We are continuing to monitor developments.  

On another issue, it seems quite likely that Congress will allow NOL carrybacks for up to 5 years (instead of 2 under current law). Both the House and Senate bills include this change with a limited carve out relating to recipients of TARP funds. The House version of this provision imposes a 10% reduction in NOLs on any corporation that elects the extended carryback, while the Senate version has the same extended carryback, but does not impose a 10% haircut on NOLs.