Final Regs. issued on deferral of COD income and OID deductions.

• Author: Yu, David
• Position: Cancellation of debt, original issue discount

On July 2, 2013, the IRS issued final regulations (T.D. 9622) on the application of Sec. 108(i), providing guidance to C corporations regarding the accelerated inclusion of deferred cancellation of debt (COD) income and accelerated deduction of deferred original issue discount (01D). The regulations also cover the calculation of earnings and profits (E&P) as a result of a Sec. 108(i) election.

As a general rule, a taxpayer realizes income from discharge of indebtedness by the payment or purchase of its own obligations at less than face value (Regs. Sec. 1.61-12(a)). Sec. 108(1) was added to the Code by the American Recovery and Reinvestment Act of 2009, P.L. 111-5, which was enacted on Feb. 17, 2009, as part of an economic stimulus package in response to the Great Recession.

Sec. 108(i)(1) provides an election for deferral of the inclusion of COD income arising in connection with the reacquisition of an applicable debt instrument after Dec. 31, 2008, and before Jan. 1,2011. An applicable debt instrument is one issued by a C corporation or any other person in connection with the conduct of a trade or business by that person (Sec. 108(i)(3)(A)). If an election is made, a taxpayer's deferred COD income is generally includible in gross income ratably over a five-tax-year period, beginning with the taxpayer's fourth or fifth tax year following the tax year of the reacquisition.

Sec. 108(i)(2) provides that if, as part of a reacquisition to which Sec. 108(i) (1) applies, a debt instrument is issued in exchange for the applicable debt instrument, and there is any OID with respect to the newly issued debt instrument, then no deduction is allowed to the issuer of the debt instrument for the portion of the OID that:

* Accrues before the first tax year in the five-tax-year period in which the COD income attributable to the reacquisition of the debt instrument is includible; and

* Does not exceed the COD income from the reacquisition of the debt instrument.

However, the aggregate amount of deductions disallowed is deductible ratably over the five-tax-year period in which the COD income attributable to the reacquisition of the debt instrument is includible.

A debt instrument is treated as issued in exchange for an applicable debt instrument if its proceeds are used directly or indirectly by the issuer to reacquire the applicable debt instrument. If only a portion of the proceeds from a debt instrument is used to reacquire an applicable debt instrument...