Understanding the Tax Implications of Debt Workouts & Restructurings

Understanding the Tax Implications of Debt Workouts & Restructurings

Ever since the outbreak of the pandemic back in 2020, organizations, as well as individuals, have been finding it increasingly challenging to honor their tax obligations. That explains the rapidly increasing number of applications received for debt workouts and restructuring. While the tax authority offers numerous IRS debt relief provisions to help taxpayers to find their way out of tax liabilities, there could be certain tax implications that the applicants should know before they file their applications, starting with some basics.

Bankruptcy Status

Requests for debt workouts and restructurings can be filed irrespective of whether or not a taxpayer is applying for bankruptcy. The tax implications, however, will partly depend upon whether the applicant has filed for bankruptcy. The structure of the transaction is the second factor that comes into play to decide the tax ramifications. It is, therefore, important to talk to an IRS tax attorney, who can analyze the dynamics at play and devise a suitable plan.

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Income Exclusion

Any income that may stem from the cancellation of debt is not to be included in the gross income of a bankrupt or insolvent individual or organization. In cases of non-bankruptcy, the maximum allowed exclusion is the amount of the taxpayer’s insolvency. If an organization is considered a partner for tax purposes, the insolvency is determined at the “partner” level and not the partnership level. If the owners of an insolvent partnership are financially stable, they may not be able to exclude any COD income realized in the workout of the partnership’s IRS tax debt.

Tax Attributes Reduction

If a bankrupt or insolvent organization excludes any income from cancellation of debt, it is required to reduce the tax attributes. In such cases, the taxpayer can refer to sections 108(b) and 1017 to find out the corresponding rules that govern the reduction of the taxpayer’s basis in the property owned by them at the beginning of the first year after the discharge, which is generally by the amount(s) excluded from the gross income.

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Group Attribute Reduction

If a taxpayer is a “group of corporations”, they need to file consolidated federal income tax returns, complying with an additional set of attribute reduction rules. These rules may result in attribute reduction to not only the member of the consolidated group realizing any income from cancellation of debt, but also to other consolidated group members. In general, consolidated return regulations apply a “look-through and across” rule in determining the applicable attribute reduction.

Wrap Up

When considering debt workouts and restructurings, it is important for taxpayers to understand that the most “tax-efficient” method depends upon their particular circumstances. That is the reason why it is important to rope in an experienced Dallas tax lawyer, who can analyze the dynamics at play and come out with a tailored way out. If you are looking for IRS tax debt relief, look no further than the Law Offices of Nick Nementh. For a no-obligation free consultation, simply call (972) 426-2553.

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