The recently enacted American Recovery and Reinvestment Act of 2009 (commonly referred to as the “Recovery Act”) significantly amended some of the rules governing the recognition of cancellation of indebtedness (“COD”) income in response to the current economic crisis. In brief newly adopted Section 108(i) permits certain taxpayers recognizing COD income in 2009 and 2010 to elect to defer the recognition of that income until 2014 and beyond. The new Section 108(i) election is discussed in detail below.
One of the basic tenets of federal income taxation is that gross income includes income from the discharge of indebtedness. See Internal Revenue Code ("IRC") § 61(a)(12). The recognition of COD income can result from a wide variety of transactions, such as the conveyance of property in satisfaction of a debt, the cancellation or modification of a debt instrument, the acquisition of debt by a related party, and the contribution of debt to capital. Although IRC § 108 provides various circumstances in which COD income can be excluded from a taxpayer's gross income (for instance, exclusions apply if the debt is discharged in a Title 11 bankruptcy case or while the taxpayer is insolvent), if one of the IRC § 108 exclusions does not apply, taxpayers are required to recognize the COD income in the year the debt is discharged.
In order to reduce the economic hardship associated with the recognition of COD income, the Recovery Act amended IRC § 108 in order to allow taxpayers to elect to defer the recognition of certain COD income, that would otherwise be recognized in 2009 and 2010, until 2014. Pursuant to IRC § 108(i)(1), eligible taxpayers can elect to include COD income resulting from the "reacquisition" of an "applicable debt instrument" during the 2009 and 2010 taxable years ratably over the five-tax-year period beginning in the 2014 taxable year.
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