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Clarity on Cancellation of Debt Rules

Saul Brenner, CPA, J.D., LL.M. 08.03.2016 | eVisor

The IRS has finalized regulations1 for determining who is the "taxpayer" in applying the insolvency and bankruptcy exceptions to discharge-of-indebtedness rules to a grantor trust or disregarded entity. A disregarded entity is a business entity that elects to be disregarded as separate from the business owner for federal tax purposes.

Internal Revenue Code Sections 108 (a) (1) (A) and (B) exclude discharged debt from a taxpayer's income if the discharge occured in a bankruptcy case or to the extent the taxpayer is insolvent when the discharge occurs. The regulations provide that, for a grantor trust or a disregarded entity, the "taxpayer" means the owner of the grantor trust or disregarded entity and not the trust or entity itself. In the case of partnerships, the owner rules apply to the partners to whom the discharge-of-indebtedness income is allocated. If any partner is itself a grantor trust or a disregarded entity, the rules require that ultimate owner of the partner be identified and would be the taxpayer.

The final regulations emphasize that case law treating the partnership as the party whose bankruptcy is relevant 2 have not been adopted by the IRS. The regulations clarify that the insolvency exception is available only if the owner is insolvent. The insolvency of the grantor trust or the disregarded entity is not taken into account.

T.D. 9771

Gracia, T.C. Memo. 2004-147

Questions: Contact your Berdon advisor or Saul Brenner, Berdon LLP, New York accountants

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