Author(s): , Christopher D. Freeman
Published: 03/18/2009
The American Recovery and Reinvestment Act of 2009 ("ARRA"), commonly known as the Stimulus Bill, provides favorable tax benefits for struggling businesses, including:
- Greater flexibility in dealing with Cancellation of Debt ("COD") Income when acquiring outstanding debt
- Better use of net operating losses
Dealing with Cancellation of Debt Income Arising in 2009 and 2010
In general, if a taxpayer acquires his or its own debt at a discount, the taxpayer is required to include the amount of the discount as COD Income. ARRA includes favorable rules for individuals or businesses that reacquire previously issued "applicable debt instruments" at a discount in 2009 or 2010. ARRA allows an irrevocable election by the taxpayer (in the case of corporation or partnership, the election must be made at the entity level) to defer recognition of qualified COD Income until 2015, at which time it is included in income ratably over five years.
Reacquisition of Debt Eligible for Deferral
For these purposes, a "reacquisition" is defined as an acquisition by a debtor, an obligor, or a related person of a debt instrument (any bond, note, debenture, certificate, or other instrument or contract constituting debt and issued in connection with a trade or business) in exchange for many types of consideration, including cash, debt (or modification of the existing debt instrument), and stock. These methods of a reacquisition are liberal and allow considerable flexibility for businesses seeking to diminish outstanding debt. For example, a "reacquisition" would occur when a taxpayer discharges its own promissory note by paying a discounted amount.
If a taxpayer elects to defer recognition of COD Income, acceleration of the deferral could occur in any year in which the taxpayer (1) dies; (2) liquidates or sells substantially all of its assets; (3) ceases to conduct business; or (4) declares bankruptcy, or a similar event occurs. Finally, there are rules specific to pass-through entities regarding allocation of deferred gain among partners and dealing with partners' decrease in their share of liabilities resulting from discharged debt.
Care should be exercised in structuring workouts to take advantage of these rules. If carefully structured, these rules could minimize the tax costs arising from "short sales" of mortgaged real estate, foreclosures or deeds in lieu of foreclosure. In the case of partnerships and limited liability companies seeking to take advantage of these rules, partnership agreements and operating agreements should be reviewed, and perhaps amended, to maximize the benefits these rules provide.
This ARRA provision provides a significant deferral opportunity for businesses seeking to decrease their financial leverage while also creating an opportunity for distressed or troubled businesses to obtain much needed breathing room during tough economic times. To maximize the benefit of this deferral opportunity, businesses should act quickly to identify potential debts that can be restructured or reacquired.
Net Operating Losses – Expanded Carryback
Generally, net operating losses (NOLs) may be carried back to each of the two previous tax years to offset taxable income. If an NOL is not fully utilized by the carryback, it can be carried forward an additional 20 years if necessary. The carryback and carryforward are designed to offset the sometimes harsh results of a taxpayer incurring a large amount of losses in one year and not being able to receive any credit for those losses in other years in which it has paid income taxes on its profits.
Generally, taxpayers will carryback NOLs where possible. However, there are cases where a carryback provides little or no benefit because the taxpayer had no significant tax liability in the carryback years which would give rise to a refund. As a result, many taxpayers are unable to recognize benefits from NOL carrybacks and are forced to, or in fact elect to, carry their losses to future years, where they can hopefully offset that benefit. ARRA has extended the carryback period for these taxpayers to five years. For taxpayers with an history of profitable operations, this change can result in a significant increase in tax refunds as a result of claiming a net operating loss carryback.
To be eligible for the benefit, the taxpayer's average annual gross receipts cannot exceed $15,000,000. It must also have an applicable NOL, which is defined as an NOL for any taxable year ending in 2008, or, if elected by a taxpayer with a non-calendar taxable year, a taxable year beginning in 2008. However, the taxpayer must choose wisely because the extended carryback period is available only with respect to one year.
Several planning issues arise for taxpayers who may wish to use the extended NOL carryback. For example:
1. Non-calendar year taxpayers should determine whether they want to use their year ended in 2008 or 2009 for the year from which a net operating loss may be carried back. (Remember, they can only use one year.)
2. If a taxpayer wishes to carryback from a year ending in 2008 and the taxpayer has already filed its return, the taxpayer only has until April 18, 2009 to elect to carry the losses back for the extended carryback period and whether to revoke a prior election to forego a net operating loss carryback.
3. Taxpayers are not required to carry their losses back the full five years. In some cases, a greater benefit will be derived by a taxpayer from carrying the losses back three or four years, and taxpayers should carefully evaluate how far back they wish to carry available losses.
Adam Weitzel is an associate in RJ&L's Colorado Springs office. His practice focuses on business and nonprofit organizations in a variety of legal matters, including real estate, general corporate law, business transactions, taxation and finance, and other general contractual matters. Mr. Weitzel can be reached at 719-386-3006 or by e-mail at aweitzel@rothgerber.com
Christopher Freeman is an assoicate in RJ&L's Denver office. He has a Masters in Taxation from New York University School of Law, and represents individual and corporate clients in all aspects of tax planning, and controversy resolution. Mr. Freeman can be reached at 303-628-9596 or by e-mail at cfreeman@rothgerber.com
For additional business taxation issues, please contact:
James R. Walker, Denise D. Hoffman, or H. William Mahaffey.