New Favorable Guidance on Elections to Defer COD Income from Debt Repurchases

On August 17, 2009, the Internal Revenue Service issued Revenue Procedure 2009-37, which provides guidance for making the election to defer cancellation of indebtedness income (CODI) from repurchases of debt in 2009 or 2010 (attached below). The election permits a taxpayer to defer CODI for up to five taxable years and recognize it ratably over the following five years. A detailed discussion of the CODI deferral election is provided in our Alert Memorandum dated February 19, 2009. In addition to detailed administrative procedures for making the election, the revenue procedure provides clarifications regarding the election that should significantly enhance its usefulness to taxpayers. These are summarized below.

• Partial election is allowed. The revenue procedure allows a taxpayer to elect how much CODI it wants to defer and how much it wants to include in income. Thus, instead of potentially facing an “all or nothing” proposition, a taxpayer will have the ability to defer any portion of the CODI realized on the repurchase of a qualifying debt instrument. Moreover, a taxpayer may defer different portions of CODI realized in different repurchases, even if the repurchased debt is part of the same issue. This flexibility allows a taxpayer to combine the benefits of the election with the use of its other tax attributes or allowances potentially resulting in significantly larger tax savings than otherwise would be the case. To illustrate, assume a corporation realizes $100 of CODI on a qualifying debt repurchase. If the corporation is insolvent in the amount of $30, it could elect to defer $70 of CODI and take advantage of the separate “insolvency” exception to CODI to exclude the remaining $30. Absent this clarification, the taxpayer might have been forced to choose between the benefits of a $70 deferral or a permanent exclusion of $30, in either case resulting in a current tax cost. Similarly, if a corporation has an expiring NOL of $30, it could elect to defer $70 and use its NOL to offset the remaining CODI.
  
  
• Partnerships may specially allocate deferred CODI to partners. Primarily of interest to real estate and other operating partnerships, the revenue procedure permits a partnership that makes a partial election to allocate the deferred portion of CODI disproportionately among the partners, thereby allowing the partnership to maximize the benefits of the deferral for some partners without impairing other partners’ tax planning.
  
  
• E&P impact. The Service intends to issue regulations that would provide that an election to defer CODI generally would not affect the computation of the taxpayer’s earnings and profits. This rule may have a negative impact on a taxpayer or, alternatively, create planning opportunities, such as with respect to foreign tax credit utilization.
  
  
• Automatic extension to make the election. The Service has granted an automatic 12-month extension to make the election, which generally must be included with the timely filed original return (including extensions) for the taxable year in which the repurchase occurred. This should provide ample time for an analysis of whether an election is advisable, since a calendar-year corporation would not be required to make elections for 2009 debt repurchases until September 15, 2011 and for 2010 debt repurchases, until September 15, 2012.
  
  
• Amendment of elections already filed. Taxpayers that already filed elections that do not conform to the requirements provided by the revenue procedure must amend the elections on or before November 16, 2009. The revenue procedure also permits a taxpayer to change the amounts of deferred CODI. Therefore, taxpayers who previously have taken positions less favorable than those permitted by the revenue procedure should consider amending their elections.

Please feel free to contact any of your regular contacts at the firm or any of our partners and counsel listed under Tax in the “Practices” section of this website if you have any questions.