Stock transfer to creditors generated deductions.

• Author: Hitt, JoAnn H.

Many times, an interesting fact pattern in a court case or IRS ruling offers reminders on favorable tax planning concepts. The ruling discussed below is an example. The facts demonstrate that the use of a corporate taxpayer's stock, which creates no taxable result in a Sec. 1032 transaction, can often be bundled to create certain tax deductions. Many tax advisers are familiar with the compensation deduction generated in a Sec. 83 transaction when stock is used to reward employees; in the right circumstances, this approach can create interest deductions as well.

In Letter Ruling (TAM) 200449001, the IRS held that a corporation could deduct as a repurchase premium the excess of the fair market value (FMV) of cash, notes and new common stock it transferred to certain creditors, pursuant to a plan of reorganization, over the amount of each creditor's claims.

Facts

A taxpayer filed a voluntary petition to reorganize under Bankruptcy Code Chapter 11. It submitted a reorganization plan, which was agreed to by its creditors and approved by the bankruptcy court. Under the plan, certain nontrade and nonconvertible debts were allowed in full, including unpaid accrued interest. In year 1, the taxpayer distributed a combination of cash, new debt and common stock in satisfaction of its obligations. Some creditors received distributions with a total FMV in excess of their allowed claims.

Initially, the taxpayer did not deduct these excess payments on its year 1 return, which reported a net operating loss (NOL) carryforward. On an IRS examination of a subsequent year, the taxpayer asserted that it had failed to deduct the excess and made a claim to increase its NOL carryforward. The examining agent rejected the claim.

Law

Regs. Sec. 1.163-4(c)(1) states that when a debt instrument is repurchased by an issuer for a price in excess of its adjusted issue price, the excess is deductible as interest. In Clark Equipment Co., 912 F2d 113 (6th Cir. 1990), the court stated that a repurchase is not limited to an exchange for cash, but includes a reacquisition by money or its equivalent, including shares of stock in the issuing corporation.

Sea 1032(a) provides that a corporation recognizes no...