1 / 54

Financial Distress Chapter 16 pp. 541-570

Financial Distress Chapter 16 pp. 541-570. 2016 National Income Tax Workbook™. p. 541 Financial Distress . Cancellation-of-Debt Income (CODI) Bad-Debt Deduction Debt-Related Information Returns. p. 542 Cancellation-of-Debt Income .

danielas
Download Presentation

Financial Distress Chapter 16 pp. 541-570

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Financial DistressChapter 16 pp. 541-570 2016 National Income Tax Workbook™

  2. p. 541 Financial Distress • Cancellation-of-Debt Income (CODI) • Bad-Debt Deduction • Debt-Related Information Returns

  3. p. 542 Cancellation-of-Debt Income • Transactions triggering tax consequences: • Transfer of assets triggering recognition of gain or loss • Discharge of debt • Recognition of income • Exclusion of income under §108 with reduction of tax attributes

  4. p. 542 Recognition of Gain or Loss • Repossession, forced sale, voluntary sale • Example 16.1 • Bank loan secured by stock • Bank sold the stock and applied to loan • Excess funds to Lotta • Lotta has gain – sales price less basis

  5. p. 542 Recognition of Gain or Loss • Repossession: Property Held for Sale • Cash basis: postpone income by delaying sale - Financial distress can accelerate • Example 16.2 • Deduct crop costs 2016, to sell in 2017 • Bank sells crop, 2016 income = FMV

  6. pp. 542-543 Recognition of Gain or Loss • Repossession: Property Used in Business • Depreciation recapture – ordinary income • Example 16.3 • § 1231 Gain or Loss • Sale at > original cost → § 1231 gain • Sale at < adjusted basis → § 1231 loss • Example 16.4 • Example 16.5

  7. p. 543Inclusion of COD Income • CODI generally = difference between principal owed & amount accepted • Repossession: FMV = borrower payment • Example 16.6 Personal Use Asset • Truck - $23,000 with $20,000 loan • Repossessed: FMV = $12000, Loan = $15,000 • COD income = $3,000 (15-12) • Loss of $11,000 (12-23) not deductible

  8. p. 544COD Income – Special Rules • Related party acquisition • Relative of debtor acquires debt for < face • Debtor has COD income (CODI) • Family = spouse, parents, children (+ spouses) grandchildren • + any related party under §§ 267(b) & 707(b) • Cancellation as gift → no CODI • Discharge w/o repossession → CODI

  9. p. 544Exceptions to COD Income • Bankruptcy • Discharge while debtor in bankruptcy • Insolvency • Liabilities exceed assets immediately before discharge of debt • Exception limited to insolvency amount • Principal Residence (2007-2016) • Qualified personal residence debt

  10. p. 545Exceptions to COD Income • Deductible if paid • If taxpayer made payment, could deduct • Example 16.7 • Interest obligation for cash basis taxpayer • Installment purchase • Owed to original seller → sale price adjustment • Buyer lowers basis by debt discharge

  11. p. 545Exceptions to COD Income • Qualified farm debt • Debt owed to unrelated lender, • Incurred directly in T or B of farming, & • ≥ 50% taxpayer’s aggregate gross receipts for 3 years prior to discharge are from farming

  12. p. 545Exceptions to COD Income • Qualified Real Property Debt • Debtor not a C corporation • Debt incurred to acquire real property used in a T or B and secured by the real property • Not debt incurred for real property held for sale • Excluded amount not to exceed the excess of • Outstanding debt principal just before over • Property FMV net of other debt the property secures

  13. p. 545Exceptions to COD Income • Qualified Real Property Debt (N/A C corp) • Debt to acquire real property used in a TorB & secured by the real property (not held for sale) • Exclusion not to exceed: • Excess of outstanding debt principal just before over property FMV net of other debt it secures • Aggregate adjusted basis of depreciable property (after any basis reductions)

  14. pp. 545-546Exceptions to COD Income • Grantor Trusts and Disregarded Entities • “Taxpayer” for bankruptcy and insolvency exclusions is the owner (not the entity) • § 108 exceptions apply in prescribed order • Practitioner Note, p. 546 • Can elect to apply insolvency exception before qualified personal residence

  15. p. 546Election to Defer COD Income • Election to defer CODI in 2009 and/or 2010 • Defer the income until 2014 → recognize ratably over 5 year period • When deferred CODI recognized, § 108 exclusions will not apply

  16. p. 546Reduction in Tax Attributes • Tax on CODI deferred by reduction in tax attributes • Reductions shown on Form 982 • No reductions if qualifies for “deductible if paid” or installment purchase exception • Reduction rules differ for various exceptions

  17. p. 547Reduction in Tax Attributes • Principal Residence: Reduce residence basis • Qualified Real Property Debt • Reduce basis in depreciable real property • Reduce at earlier of • End of the tax year of discharge • Immediately before property disposition • Bankruptcy, insolvency, qualified farm debt • 7 attributes to reduce in prescribed order

  18. p. 547Reduction in Tax Attributes • NOL • General business credit • Minimum tax credit • Capital loss carryovers • Basis (may elect to apply first) • Limited to basis at beg’g of next year • PAL and passive credit carryovers • Foreign tax credit carryovers

  19. pp. 547-548Student Loans • Debt cancelation tied to working a certain time period in certain professions not CODI if from • A government entity, • Certain tax-exempt public benefit corps, or • An educational institution • Education loan repayments not taxable if from: • NHSC Loan Repayment Program • State program eligible for funds under PHSA • State program for certain health services

  20. p. 548-551Attribute Reduction • Reduced dollar/dollar of exclusion-credits 1 for 3 • Example 16.8 $1,000,000 debt canceled • $1,500,000 insolvent • Figure 16.1 Tax Attributes • Figure 16.2 Form 982 with attachment • Example 16.9 • Save NOL, Elects depreciable basis first • Figure 16.4 Form 982 with attachment

  21. p. 551Attribute Reduction • Tax attributes to zero, CODI remains • Bankruptcy or insolvency: No recognition • Qualified farm debt: Excess CODI taxable • Personal asset basis not reduced • Limit on Basis Reduction: Bankruptcy, Insolvency • Retain basis = debt remaining after discharge • No limit if elects to reduce depreciable first • (No limit - qualified farm debt basis reduction)

  22. pp. 551-552Attribute Reduction • Example 16.10 Insolvent • $75,000 aggregate basis in assets • $100,000 debt, $40,000 discharged • Basis reduction limit: $15,000 (75-60) • Still excludes full $40,000 for insolvency • Rationale to limitation: To prevent tax if remaining assets sold for debt

  23. p. 552Attribute Reduction • Order of Basis Reduction • Real property used in T or B or held for investment (not held for sale) that secured debt • Personal property used in T or B or held for investment (not inventory, receivables) that secured the debt • Remaining property (not inventory, real property held for sale, receivables)

  24. p. 552Attribute Reduction • Order of Basis Reduction • Inventory, notes receivables, accounts receivables, real property held for sale • Property not used in T or B and not held for investment • Example 16.11 • Figure 16.6 Debt and Security • Figure 16.7 Assets

  25. pp. 552-553Attribute Reduction • Example 16.11 (continued) • $180,000 forgiven – No CODI recognition • Basis reduction: Lesser of $180,000 or $150,000 ($600,000 - $450,000) • Debt was secured by real property – reduce building and land by $100,000 • Equipment also secured debt - $50,000 prorated among the machines (using basis) • Figure 16.8

  26. p. 553Attribute Reduction • Qualified farm debt exception: Only property held for use in T or B (or for production of income) is reduced • Depreciable property • Land held for use in farming • Other qualified property • Basis reduction occurs at the end of the tax year of the discharge

  27. p. 554Income vs Gain on Asset Transfer • Whether property transfer when debt canceled is income or gain depends on type of debt • Example 16.12 $500,000 loan canceled • Building FMV: $400,000 Basis: $350,000 • Nonrecourse: $150,000 gain (500-350) • Recourse: COD $100,000 (500-400) Gain $ 50,000 (400-350)

  28. Qualified Personal Residence Debt(QPRI) p. 554 • Example 16.13 • Basis $250,000 • Loan Balance $235,000 FMV $200,000 • Plans to walkaway, let lender foreclose • Q1: Deductible loss? No, personal asset • Q2: Taxable COD income? • $35,000 debt discharge but may exclude as qualified principal residence indebtedness

  29. pp. 554-556QPRI – Example 16.13 • Q3: Tax consequence to the exclusion? • $35,000 basis reduction at beg’g of next year • No other tax attribute affected – Figure 16.10 • Q4: What if prior home office deduction (including $2,500 depreciation) • Cannot treat as 2 properties, no loss deduction

  30. p. 556QPRI – Example 16.13 • Q5: Does it matter if Jason is insolvent or files bankruptcy? • COD income still excluded • QPRI exclusion takes precedence unless Jason elects to apply insolvency exception • If in bankruptcy, cannot elect the QPRI exclusion in place of the bankruptcy exclusion

  31. p. 556QPRI – Example 16.13 • Q6: What if gain on the deemed sale? • Could qualify for exclusion under § 121 • Would he turn the house over if FMV > debt? • Q7: If loan restructured, $35,000 discharge in 2016, house sold in 2017 for $220,000? • Discharge excluded, basis reduced $215,000 • Gain of $5,000 in 2017 • If office depreciated, $2,500 not excludible

  32. Bad Debt Deduction p. 557Business Bad Debts - Definition • Debts created/acquired in the TP’s T or B or • Debts related to TP’s T or B when worthless • Created or acquired in a business • Same idea as whether a loss is Tor B • Example 16.14 • Sold business, retained 2014 rec’ble • 2016 worthless, business debt

  33. Bad Debt Deduction pp. 557-558Business Bad Debts - Definition • Related to business when worthless • Use of funds not of consequence • Example 16.15 • Ex. 16.14 sold receivable with business • New owner did not create/acquire in T or B but related to business when worthless • Q1 If sold debt to sister? Not business debt • Q2 If business inherited by son? Business debt

  34. Bad Debt Deduction pp. 558-559Business Bad Debts • Common business debts • Loans to clients & suppliers • Debts of a partner • Loans to an employer • Loss = basis in the debt • Cash basis A/R → no basis • Accrual basis A/R → basis • Purchased A/R at < face → loss = cost

  35. Bad Debt Deduction p. 559Business Bad Debts – Timing • Method determines timing of deduction • Specific Charge-Off Method • Deduct in year partially or totally worthless • Partially: if charge off in accounting records • Amend: filing + 3 yrs or payment + 2 yrs • Totally: in year worthless net of earlier partial • Amend: filing + 7 yrs or payment + 2 yrs

  36. Bad Debt Deduction p. 559Business Bad Debts - Timing • Specific Charge-Off Method • Deduct in year partially or totally worthless • Partially: can deduct if charge off in accounting records • Totally: deduct in year worthless net of any earlier partial write-off

  37. Bad Debt Deduction p. 560Business Bad Debts - Timing • Nonaccrual-Experience Method • Accrual taxpayers if • Provide services in specified fields • Average annual GR ≤ $5M all prior years • No accrual of service-related income expected to be uncollectible → no bad debt • Cannot use if for lending money, selling goods, acquiring receivables

  38. Bad Debt Deduction p. 560Business Bad Debts - Reporting • Deduct where income reported • Schedule C, Schedule F • Schedule A-2% if employee loan to employer • Example 16.19 – Business Bad Debt • Figure 16.11 – Sched C, Part V

  39. Bad Debt Deduction p. 561Nonbusiness Bad Debts - Definition • Not: • Debts created/acquired in TP’s T or B or • Debts related to T or B when worthless • Must show intended as loan, not gift • Establish true debtor/creditor relationship • Example 16.20 – Gift • Example 16.21 – Enforceable Loan

  40. Bad Debt Deduction pp. 561-562Nonbusiness Bad Debts - Definition • Common nonbusiness bad debts • Lien on property – owner pays off lien, claim against contractor is nonbusiness debt • Example 16.22 • Deposits for goods or services not in T or B • Example 16.23 • Secondary liability on home mortgage • Buyer assumes mortgage & defaults

  41. Bad Debt Deduction pp. 562-563Nonbusiness Bad Debts – Loss • Loss = basis in debt • Example 16.24 – unpaid wages has no basis • Deducted only when totally worthless • Amend later of filing + 7 yrs or paym’t + 2 yrs • Short-term capital loss – Form 8949 • Statement of specifics of debt, efforts to collect and explanation of why worthless • Example 16.25, Figure 16.12

  42. Bad Debt Deduction pp. 563-564Other Bad Debt Rules • Worthless securities • Sale/exchange, capital asset, last day of year • Amend: later of filing + 7 yrs or paym’t + 2 yrs • Loan guarantees • Entered into as T or B or transaction for profit • Entered into before worthless at all • Reasonable consideration received • Legally enforceable

  43. Bad Debt Deduction p. 564Other Bad Debt Rules • Loan guarantees • Reasonable expectation @ agreement that would not have to pay w/o reimb. from debtor • Reasonable consideration not limited to cash or property • Guarantee: favor, no consideration – no debt • Example 16.26 Business loan guarantee • Example 16.27 Investment loan guarantee

  44. Bad Debt Deduction pp. 564-565Other Bad Debt Rules • Loan guarantees • No bad debt in year of payment if has right to replace lender and collect from debtor • No § 163 (interest) § 165 loss deductions • Proving debt worthless • Debtor(s) financial state, FMV of collateral • Took reasonable steps to collect • Bankruptcy of debtor good evidence

  45. Bad Debt Deduction p. 565Other Bad Debt Rules • Recovery of a bad debt • Include all or part in gross income • Limited to amount of bad debt deduction that reduced taxable income • Report as “other income” • Bad debt in NOL still in carryover treated as having reduced taxable income

  46. p. 566Debt-Related Information Returns • 1099-A: Lender acquires interest in secured property in full/partial satisfaction of debt or know that property abandoned • 1099-C: Anyone in T or B of lending or federal government unit canceling debt in excess of $600 • 1099-C only: Debt canceled w/foreclosure or abandonment during the year

  47. pp. 566-567Debt-Related Information Returns • Example 16.28 Building Foreclosure • $100,000 loan, Property FMV $75,000 • Report sale with $75,000 amount realized • Figure 16.14 – Form 1099-A (still owes $25K) • Example 16.29 $50,000 loan cancelled • Figure 16.15 – Form 1099-C • CODI of $50,000, Form 982 if exclusion • Interest not included – deductible if paid

  48. pp. 567-568Debt-Related Information Returns • Example 16.30 • Bank realized $25,000 won’t be collectible • Canceled entire note @ foreclosure • Figure 16.16 • Identifiable events triggering 1099-C • Treas. Reg. § 6050P-1(b)(2)(i) • List – page 568

  49. p. 568Debt-Related Information Returns • Identifiable events triggering 1099-C • Discharge in bankruptcy • Debt rendered unenforceable in a receivership, foreclosure or similar proceeding in court • Cancellation upon expiration of statute of limitations for collection • Cancellation by foreclosure election by creditor that bars rights to pursue collection

  50. p. 568Debt-Related Information Returns • Identifiable events triggering 1099-C • Cancellation pursuant to probate or similar proceeding • Discharge by agreement for less than full consideration • Discharge by creditor based on creditor policy to discontinue collection & discharge debt • Expiration of 36-month nonpayment test period

More Related