Corporate Tax | Just Tax

Insolvency Reorganization and COD Income (§§ 368(a)(1)(G), 108(a), 108(b))

This checklist guides the analysis of a corporate reorganization in bankruptcy or insolvency, covering the qualification requirements for a Type G reorganization and the exclusion of cancellation-of-indebtedness (COD) income under the bankruptcy and insolvency exceptions, including the mandatory reduction of tax attributes. Use this checklist when a corporate client is undergoing a Chapter 11 restructuring, a receivership proceeding, or an out-of-court workout in which debt is exchanged for stock.

Step 1. The Type G Reorganization Defined

"(G) a transfer by a corporation of all or part of its assets to another corporation in a title 11 or similar case; but only if, in pursuance of the plan, stock or securities of the corporation to which the assets are transferred are distributed in a transaction which qualifies under section 354, 355, or 356." (IRC § 368(a)(1)(G))

• The five statutory elements of a Type G reorganization.
  • A corporation must transfer assets to another corporation. The transferor is typically the debtor-in-possession or a corporation under bankruptcy court jurisdiction. (IRC § 368(a)(1)(G))
  • The transfer must occur "in a title 11 or similar case." This includes proceedings beyond Chapter 11, such as receiverships and foreclosure proceedings in federal or state court. (IRC § 368(a)(3)(A))
  • At least one party to the reorganization must be under the jurisdiction of the court, and the transfer must be pursuant to a plan of reorganization approved by the court. (IRC § 368(a)(3)(B))
  • Stock or securities of the acquiring (transferee) corporation must be distributed in a transaction qualifying under § 354, § 355, or § 356. (IRC § 368(a)(1)(G))
  • Through the back door of § 354(b), the acquirer must acquire "substantially all" of the transferor's assets, and the transferor must fully liquidate and distribute all properties. (IRC § 354(b)(1)(A)-(B))
• Congressional framework and related nonrecognition provisions.
  • The Bankruptcy Tax Act of 1980 eliminated several requirements that apply to other reorganization types. No state merger law compliance is required (unlike a Type A). No solely-for-voting-stock restriction applies (unlike a Type C). No control-by-transferor-shareholders requirement applies (unlike a Type D). (S. Rep. No. 96-1035 (1980), 1980-2 C.B. 620, 623-627)
  • Exclusive characterization as Type G. If a transaction would qualify both under § 368(a)(1)(G) and under any other reorganization subparagraph or under § 332 or § 351, it is treated as qualifying ONLY under subparagraph (G). The sole exception is that § 357(c)(1) still applies as if the transaction were not exclusively a G reorganization. (IRC § 368(a)(3)(C)) CAUTION. A transaction cannot selectively apply more favorable provisions from other reorganization types.
  • The transferor corporation's nonrecognition. § 361(a) provides that no gain or loss is recognized to the transferor on an exchange of property for stock or securities of the acquiring corporation pursuant to a plan of reorganization. § 361(b) provides that gain is recognized on boot only to the extent the boot is not distributed to shareholders or creditors who have a proprietary interest. (IRC §§ 361(a)-(b))

Step 2. The "Title 11 or Similar Case" Requirement

"The term 'title 11 or similar case' means (i) a case under title 11 of the United States Code, or (ii) a receivership, foreclosure, or similar proceeding in a Federal or State court." (IRC § 368(a)(3)(A))

• Title 11 and similar case proceedings.
  • A case under Title 11 of the United States Code qualifies. This includes Chapter 7 (liquidation), Chapter 11 (reorganization), and Chapter 13 (individual adjustment of debts) cases. For corporate reorganizations, Chapter 11 is the standard proceeding. (IRC § 368(a)(3)(A)(i))
  • The statute explicitly extends to receiverships, foreclosure proceedings, and similar proceedings in federal or state court. A proceeding need not be a formal bankruptcy under the Bankruptcy Code. A state-court receivership qualifies if it is "similar" to a Title 11 case in that a court exercises jurisdiction over the debtor's assets for the benefit of creditors. (IRC § 368(a)(3)(A)(ii)) (S. Rep. No. 96-1035, 1980-2 C.B. 620, 624)
  • Federal or state agency receiverships involving financial institutions referred to in § 581 or § 591 are treated as "courts" for this purpose. (IRC § 368(a)(3)(D))
• Jurisdictional requirements and § 363 sales.
  • A transfer is treated as made in a title 11 or similar case if and only if (i) any party to the reorganization is under the jurisdiction of the court in such case, and (ii) the transfer is pursuant to a plan of reorganization approved by the court. (IRC § 368(a)(3)(B)) TRAP. Both prongs must be satisfied. An asset transfer made outside a court-approved plan does not qualify, even if the debtor is in bankruptcy.
  • A § 363 sale of substantially all of a debtor's assets can qualify as a Type G reorganization if the sale is pursuant to a confirmed Chapter 11 plan or an order approving the sale that satisfies the plan requirement. (PLR 201025018 (July 8, 2010)) The General Motors 2009 bankruptcy is the most prominent example. (See H.R. Rep. No. 111-16 (2009))

Step 3. The § 354 Back-Door Requirements

"Section 354(a) shall not apply to an exchange in pursuance of a plan of reorganization within the meaning of subparagraph (D) or (G) of section 368(a)(1) unless (A) the corporation to which the assets are transferred acquires substantially all of the assets of the transferor of such assets; and (B) the stock, securities, and other properties received by such transferor, as well as the other properties of such transferor, are distributed in pursuance of the plan of reorganization." (IRC § 354(b)(1))

• The "substantially all" assets requirement.
  • Although § 368(a)(1)(G) uses the deceptively broad phrase "all or part of its assets," § 354(b)(1)(A) effectively requires that the acquiring corporation acquire "substantially all" of the transferor's assets. (IRC § 354(b)(1)(A))
  • There is no fixed percentage test. Courts examine the percentage of gross assets transferred, whether operating assets are transferred, and whether the transferor retains assets necessary to continue its business. (See S. Rep. No. 96-1035, 1980-2 C.B. 620, 624)
  • The legislative history provides that asset sales to raise cash before the reorganization do not preclude satisfying the "substantially all" test if the purpose is to leave the debtor with manageable operating assets. (S. Rep. No. 96-1035, 1980-2 C.B. 620, 624) TRAP. In CCA 200350016 (Aug. 28, 2003), the IRS concluded that a transaction failed because the transferor retained assets related to its core business and continued to operate through subsidiaries.
• The full liquidation requirement.
  • § 354(b)(1)(B) requires that "the stock, securities, and other properties received by such transferor, as well as the other properties of such transferor, are distributed in pursuance of the plan of reorganization." The transferor must distribute ALL properties it receives from the acquirer AND all of its other properties. It cannot retain assets or continue in corporate existence. (IRC § 354(b)(1)(B)) (CCA 200350016)
  • If immediate liquidation is impractical, consider using a liquidating trust to wind down remaining affairs while still satisfying the distribution requirement.
• The § 354(a) exchange requirement.
  • § 354(a) provides nonrecognition treatment to stockholders and security holders of a party to a reorganization who exchange their stock or securities solely for stock or securities in the reorganized corporation. (IRC § 354(a)(1))
  • For a Type G reorganization to exist, there must be a qualifying exchange under § 354, § 355, or § 356. At least one creditor must qualify as a "security holder." TRAP. If the debtor's stock is worthless and no creditor holds "securities," no one can qualify for § 354 treatment. This is the fatal "no securities" trap discussed in Step 4. (IRC § 368(a)(1)(G))

Step 4. The Securities Requirement and the No-Securities Trap

• The definition of "securities" and the consequences.
  • A creditor who holds only short-term trade debt is NOT a "security holder" and cannot participate in a § 354 exchange. The Supreme Court held that short-term notes payable within a few months are not "securities." (Pinellas Ice & Cold Storage Co. v. Commissioner, 287 U.S. 462 (1933))
  • The rule of thumb is that obligations with terms of less than five years generally are NOT securities, obligations with terms of more than ten years generally ARE securities, and obligations with terms between five and ten years are analyzed based on facts and circumstances. (Neville Coke & Chemical Co. v. Commissioner, 148 F.2d 599 (3d Cir. 1945), cert. denied, 326 U.S. 726) (Rev. Rul. 2004-78, 2004-2 C.B. 108)
• The no-securities trap and the credit bid workaround.
  • In CCA 200350016 (Aug. 28, 2003) (the "Bruno's Transaction" case), the IRS concluded that a transaction did not qualify as a G reorganization because all prepetition stock interests were extinguished and there were no prepetition holders of "securities." The creditors who received stock were neither stockholders nor security holders of the debtor. CCA noted that short-term creditors may be treated as former shareholders for COI purposes but this treatment has NOT been extended to determine status as a shareholder or security holder for purposes of §§ 354 or 355.
  • Where no securities exist, a credit bid structure may achieve G reorganization treatment. Under PLR 201025018 (July 8, 2010), secured creditors credit bid their debt for the debtor's assets, contribute the debt to a newly formed corporation in exchange for stock, and the IRS recasts the transaction as if the debtor transferred assets directly to the acquirer for stock that was then distributed to creditors. This requires sufficient stock issuance to satisfy COI.

Step 5. Continuity of Interest - Creditors as Proprietors

• Foundational authority for creditor continuity of interest.
  • In Helvering v. Alabama Asphaltic Limestone Co., 315 U.S. 179 (1942), the Supreme Court held that creditors of an insolvent corporation who receive stock in the reorganized entity can satisfy COI. The Court stated that creditors who institute bankruptcy proceedings have "effective command over the disposition of the property" and that for practical purposes the shift of ownership from stockholders to creditors "took place not later than the time when the creditors took steps to enforce their demands against their insolvent debtor." (Helvering v. Alabama Asphaltic Limestone Co., 315 U.S. 179, 184-185 (1942))
  • The Senate Finance Committee Report states that "the most senior class of creditor to receive stock, together with all equal and junior classes (including shareholders who receive any consideration for their stock), should generally be considered the proprietors of the insolvent corporation for 'continuity' purposes." (S. Rep. No. 96-1035, 1980-2 C.B. 620, 625)
• The regulatory framework - Treas. Reg. § 1.368-1(e)(6). The final regulations issued as T.D. 9434 (December 11, 2008) provide a comprehensive framework. (Treas. Reg. § 1.368-1(e)(6))
  • A creditor's claim is treated as a proprietary interest if the target is in a title 11 or similar case OR if the target is insolvent immediately before the reorganization. If any creditor receives a proprietary interest in exchange for its claim, then EVERY claim of that class and EVERY claim of all equal and junior classes is treated as a proprietary interest. (Treas. Reg. § 1.368-1(e)(6)(i))
  • For the most senior class to receive stock ("senior claims"), the value of the proprietary interest equals a fraction. The numerator is the aggregate FMV of proprietary interests received for senior claims. The denominator is the sum of money plus the FMV of all other consideration received for senior claims. (Treas. Reg. § 1.368-1(e)(6)(ii)(A))
  • For claims junior to the senior claims, the value of the proprietary interest is the FULL FMV of the junior claim. (Treas. Reg. § 1.368-1(e)(6)(iii))
  • Shareholders retain their proprietary interest notwithstanding that creditors are treated as having a proprietary interest. However, if old shareholders receive only cash, their proprietary interest is not preserved. (Treas. Reg. § 1.368-1(e)(6)(iv))
  • A de minimis rule applies. If only one class of creditors receives stock, such stock must be more than a de minimis amount of the total consideration. (Treas. Reg. § 1.368-1(e)(6)(ii)(B))
• COI calculation and the 40 percent safe harbor.
  • There is 100% continuity of interest if each senior claim is satisfied with the same ratio of stock to nonstock consideration and no junior claim is satisfied with nonstock consideration. The regulations include an example in which COI of 40% is sufficient. (Treas. Reg. § 1.368-1(e)(2)(v), Example 1)
  • EXAMPLE. Target has assets with FMV of $120, senior bank debt of $40, trade debt of $50, and junior notes of $30. The acquirer issues $40 of stock and $80 of cash. The junior notes are the most senior class to receive stock. The value of the proprietary interest in senior claims equals $120 multiplied by $40/$120, which equals $40. COI is $40/$120 or 33.3%. Additional stock consideration may be needed.

Step 6. Continuity of Business Enterprise

"The acquiring corporation must either continue the target corporation's historic business or use a significant portion of the target's historic business assets in a business." (Treas. Reg. § 1.368-1(d)(1))

• The COBE requirement and subsidiary drop-downs.
  • The acquiring corporation must either continue the target corporation's historic business or use a significant portion of the target's historic business assets in its business. COBE generally does not present unique problems in the G reorganization context because the acquirer typically continues the debtor's operations. (Treas. Reg. § 1.368-1(d)(1)) TRAP. If the acquirer significantly changes the business, COBE may fail.
  • A G reorganization will not be disqualified if the acquirer transfers acquired assets to a controlled subsidiary, provided the subsidiary continues the business. (Treas. Reg. § 1.368-2(k)) Transfer of acquired assets to a controlled subsidiary can satisfy COBE.

Step 7. § 108(a)(1)(A) - The Bankruptcy Exclusion

"Gross income does not include any amount which (but for this subsection) would be includible in gross income by reason of the discharge (in whole or in part) of indebtedness of the taxpayer if the discharge occurs in a title 11 case." (IRC § 108(a)(1)(A))

• Scope and requirements of the bankruptcy exclusion.
  • The bankruptcy exclusion is unlimited. If the discharge occurs in a Title 11 case, ALL COD income is excluded from gross income with no dollar limitation. Even a solvent taxpayer in bankruptcy can exclude unlimited COD income. (IRC § 108(a)(1)(A))
  • The discharge must occur in a case under Title 11. The taxpayer must be under the jurisdiction of the court. The discharge must be granted by the court or pursuant to a plan approved by the court. (IRC § 108(d)(2)) TRAP. The bankruptcy court order or confirmation order must specifically reference the discharge of indebtedness. A general discharge order may not suffice.
• Precedence and title 11 case definition.
  • The bankruptcy exclusion takes precedence over all other exclusions. § 108(a)(2)(A) provides that subparagraphs (B), (C), (D), and (E) shall NOT apply to a discharge in a title 11 case. (IRC § 108(a)(2)(A))
  • § 108(d)(2) defines "title 11 case" as a case under title 11 of the United States Code, but only if the taxpayer is under the jurisdiction of the court and the discharge is granted by the court or pursuant to a plan approved by the court. Note that for § 108 purposes, a "title 11 case" is narrower than for § 368 purposes. § 368(a)(3)(A) includes receiverships as "similar cases," but § 108(a)(1)(A) applies only to actual Title 11 cases. For non-Title-11 proceedings, the insolvency exclusion may apply. (IRC § 108(d)(2)) (IRC § 368(a)(3)(A))

Step 8. § 108(a)(1)(B) - The Insolvency Exclusion

"Gross income does not include any amount which (but for this subsection) would be includible in gross income by reason of the discharge (in whole or in part) of indebtedness of the taxpayer if the discharge occurs when the taxpayer is insolvent." (IRC § 108(a)(1)(B))

• The insolvency exclusion scope and limitation.
  • The insolvency exclusion is limited to the extent of insolvency. The amount excluded shall NOT exceed the amount by which the taxpayer is insolvent. (IRC § 108(a)(3)) EXAMPLE. A taxpayer has $500,000 of liabilities and $300,000 of assets immediately before discharge. Insolvency is $200,000. If $350,000 of debt is discharged, only $200,000 is excluded. The remaining $150,000 is taxable COD income.
  • § 108(d)(3) defines "insolvent" as "the excess of liabilities over the fair market value of assets" determined "immediately before the discharge." In Merkel v. Commissioner, 109 T.C. 463 (1997), aff'd, 192 F.3d 844 (9th Cir. 1999), the Tax Court held that contingent obligations such as guarantees are NOT includible liabilities. (IRC § 108(d)(3)) (Merkel v. Commissioner, 109 T.C. 463 (1997))
• Precedence and application to non-Title-11 proceedings.
  • The insolvency exclusion takes precedence over QFII and QRPBI exclusions. However, the qualified principal residence exclusion takes precedence over insolvency unless the taxpayer ELECTS to apply insolvency instead. (IRC § 108(a)(2)(B)-(C)) If a taxpayer has both insolvency and qualified principal residence indebtedness, the taxpayer can elect insolvency if it yields a larger exclusion. The election is made on Form 982.
  • Unlike the bankruptcy exclusion, the insolvency exclusion does not require a Title 11 case. It applies to out-of-court workouts, receiverships, foreclosure proceedings, and direct negotiations. (IRC § 108(a)(1)(B))

Step 9. The Insolvency Calculation Under § 108(d)(3)

• Assets and liabilities included in the insolvency calculation.
  • All assets are included, even exempt assets. In Carlson v. Commissioner, 116 T.C. 87 (2001), the Tax Court held that state law exemptions protect assets from creditors but do NOT exclude those assets from the insolvency calculation. Assets exempt under state law (homestead exemptions, retirement accounts, pension benefits) must be included. (IRC § 108(d)(3)) (Carlson v. Commissioner, 116 T.C. 87 (2001))
  • Nonrecourse liabilities are included. § 108(d)(1) defines "indebtedness" to include any indebtedness "for which the taxpayer is liable, or subject to which the taxpayer holds property." In Commissioner v. Tufts, 461 U.S. 300 (1983), the Supreme Court held that nonrecourse debt is true debt for tax purposes. (IRC § 108(d)(1)(B)) (Commissioner v. Tufts, 461 U.S. 300 (1983))
  • Excess nonrecourse debt is included only to the extent discharged. Rev. Rul. 92-53, 1992-2 C.B. 48, holds that the amount by which nonrecourse debt exceeds the FMV of the securing property is treated as a liability only to the extent the excess is discharged. EXAMPLE. Property worth $800,000 subject to $1,000,000 nonrecourse debt. If the entire debt is discharged, $200,000 excess counts toward insolvency. If only $100,000 is discharged, only $100,000 counts.
• Liabilities excluded and valuation standards.
  • Contingent liabilities may not be included. In Merkel v. Commissioner, 109 T.C. 463 (1997), the Court held that contingent obligations such as guarantees of another entity's debts were NOT includible as liabilities. Include only fixed, determinable liabilities. TRAP. Do not include potential judgments or unquantified obligations. (IRC § 108(d)(3)) (Merkel v. Commissioner, 109 T.C. 463 (1997))
  • FMV standard. Assets are valued at "the price at which property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell." (United States v. Cartwright, 411 U.S. 546 (1973)) For a corporate debtor, going concern value including intangible assets must be included. A formal valuation by a qualified appraiser is strongly recommended.
• Partnership excess nonrecourse debt allocation and recourse liability rules.
  • Rev. Rul. 2012-14 amplifies Rev. Rul. 92-53 by providing that for purposes of measuring a partner's insolvency, each partner treats as a liability an amount of the partnership's discharged excess nonrecourse debt based upon the allocation of COD income to such partner under § 704(b). (Rev. Rul. 2012-14) (Rev. Rul. 92-53, 1992-2 C.B. 48)
  • Recourse debt of the partnership is allocated to partners based on their economic risk of loss under § 752. A partner's share of partnership liabilities affects both the insolvency calculation and the basis of the partner's partnership interest.

Step 10. § 108(e)(8) - Stock-for-Debt and COD Income Mechanics in Type G

"For purposes of determining income of the debtor from discharge of indebtedness, if a corporation issues stock in satisfaction of its indebtedness, such corporation shall be treated as having satisfied the indebtedness with an amount of money equal to the fair market value of the stock." (IRC § 108(e)(8))

• COD income mechanics and nonrecognition in Type G reorganizations.
  • When a debtor corporation in a Type G reorganization issues stock to creditors in satisfaction of debt, § 108(e)(8) treats the debtor as having satisfied the indebtedness for the FMV of the stock. To the extent the adjusted issue price exceeds the FMV of the stock, COD income arises under § 61(a)(12). (IRC § 108(e)(8)) (IRC § 61(a)(12)) EXAMPLE. Debtor has $200,000 of trade debt. In a Type G reorganization, debtor transfers assets (basis $75,000, FMV $100,000) to Acquirer for $100,000 of Acquirer stock and distributes the stock to creditors. COD income of $100,000 arises. This may be excluded under § 108(a)(1)(A). (See H.R. Rep. No. 96-833, at 32-34 (1980))
  • § 354 provides nonrecognition to creditors receiving stock as "security holders." § 361 provides nonrecognition for the transferor on the asset transfer. § 1032 provides nonrecognition for the acquiring corporation on the issuance of its stock. (IRC § 354(a)(1)) (IRC § 361(a)) (IRC § 1032(a))
• Historical development and special stock-for-debt rules.
  • Pre-1980 common law held that issuing stock for debt did not produce COD income. The Bankruptcy Tax Act of 1980 preserved a stock-for-debt exception. The 1986 Amendment limited it to bankrupt and insolvent corporations. The 1993 Amendment (OBRA) rewrote § 108(e)(8) into its current FMV-based rule. (Commissioner v. Motor Mart Trust, 156 F.2d 122 (1st Cir. 1946)) (IRC § 108(e)(8))
  • § 108(e)(8)(B) requires proper adjustment for any amount not included in the creditor's gross income but which would have been included if the indebtedness had been satisfied in full. § 108(e)(8)(C) treats parent corporation stock as stock of the debtor corporation. § 108(e)(8)(D) provides that "debtor corporation" includes a successor corporation. (IRC § 108(e)(8)(B)-(D))

Step 11. § 108(b) Attribute Reduction Ordering

"The amount excluded from gross income under subparagraph (A), (B), or (C) of subsection (a)(1) shall be applied to reduce the tax attributes of the taxpayer as provided in paragraph (2)." (IRC § 108(b)(1))

• Scope and exclusions outside the § 108(b) ordering.
  • The mandatory attribute reduction applies to the bankruptcy, insolvency, and qualified farm indebtedness exclusions. The amount excluded must be applied to reduce tax attributes in the order specified in § 108(b)(2). (IRC § 108(b)(1))
  • The QRPBI exclusion (§ 108(a)(1)(D)) has its own basis reduction mechanism under § 108(c). The qualified principal residence exclusion (§ 108(a)(1)(E)) has its own basis reduction under § 108(h)(1). Neither triggers the § 108(b) ordering rules. (IRC § 108(c)) (IRC § 108(h)(1))
• The § 108(b)(2) ordering of attribute reduction.
  • Attributes are reduced in this mandatory order. (IRC § 108(b)(2))
    1. Net operating losses. Any NOL for the taxable year of discharge and any NOL carryover. Reduction is dollar for dollar. (IRC § 108(b)(2)(A))
    2. General business credits. Any carryover to or from the taxable year of discharge. Reduction is 33 1/3 cents per dollar. (IRC § 108(b)(2)(B))
    3. Minimum tax credits. The amount available under § 53(b) as of the beginning of the taxable year immediately following the year of discharge. Reduction is 33 1/3 cents per dollar. (IRC § 108(b)(2)(C))
    4. Net capital losses. Any net capital loss for the taxable year of discharge and any capital loss carryover. Reduction is dollar for dollar. (IRC § 108(b)(2)(D))
    5. Basis of property. The basis of the property of the taxpayer. Reduction is dollar for dollar, subject to the liability floor in Step 12. (IRC § 108(b)(2)(E))
    6. Passive activity loss and credit carryovers. Loss reduction is dollar for dollar. Credit reduction is 33 1/3 cents per dollar. (IRC § 108(b)(2)(F))
    7. Foreign tax credit carryovers. Reduction is 33 1/3 cents per dollar. (IRC § 108(b)(2)(G))
  • Credits are reduced at 33 1/3 cents per dollar of excluded COD because Congress determined that a partial reduction of credits is equivalent to a full dollar reduction of other attributes. NOLs and capital losses are reduced dollar for dollar.
• Timing rules and residual COD treatment.
  • Reductions are made AFTER the determination of tax for the taxable year of discharge. The taxpayer first computes taxable income, all carryovers and carrybacks are applied, and THEN attribute reduction occurs. Basis of property sold after discharge but in the same tax year is NOT reduced for purposes of computing gain or loss. (IRC § 108(b)(4)(A))
  • "Black hole" COD. Any excluded COD income that remains after all available tax attributes have been reduced to zero is permanently excluded from gross income. This excess does not reduce any attributes and is not later recaptured. (IRC § 108(b)(1))

Step 12. The § 108(b)(5) Election and the Liability Floor

• The § 108(b)(5) election to reduce basis first.
  • A taxpayer may elect to apply any portion of excluded COD income to reduce the basis of depreciable property before reducing other attributes. The election cannot exceed the aggregate adjusted bases of depreciable property held as of the beginning of the taxable year following the year of discharge. Any amount to which the election applies is NOT subject to the § 108(b)(2) ordering rules. (IRC § 108(b)(5)(A)-(C))
  • The election is made on Form 982, line 5, for the taxable year of discharge. Once made, it may be revoked only with the consent of the Secretary. If a timely return was filed without the election, it may be made by filing an amended return within 6 months of the due date (excluding extensions), with "Filed pursuant to section 301.9100-2" written at the top. (IRC § 108(b)(5)) (Treas. Reg. § 1.301-9100-2)
  • Strategic value. This election benefits taxpayers with significant long-lived depreciable property who expect to utilize NOLs quickly. By reducing basis first, NOLs are preserved. The liability floor does NOT apply to basis reductions under this election. EXAMPLE. Taxpayer excludes $100,000 of COD and has $20,000 of NOLs, $100,000 of basis, and $70,000 of liabilities after discharge. Without the election, $20,000 of NOLs is reduced, then basis is reduced by only $30,000 due to the liability floor, and $50,000 becomes black hole COD. With the election, all $100,000 reduces basis first, NOLs are preserved, and there is no black hole COD. (IRC § 108(b)(5))
• The liability floor and § 1017 basis reduction ordering.
  • In a Title 11 case or insolvency, basis reduction under § 108(b)(2)(E) cannot exceed the excess of (i) the aggregate adjusted bases of property held immediately after discharge, over (ii) aggregate liabilities immediately after discharge. This is the "liability floor." CAUTION. The liability floor does NOT apply to basis reductions made under the § 108(b)(5) election. (IRC § 1017(b)(2))
  • Basis is reduced in this order under § 1017. First, real property used in a trade or business subject to depreciation. Second, personal property used in a trade or business subject to depreciation. Third, other property used in a trade or business. Fourth, inventory and stock in trade. Fifth, personal-use property. (Treas. Reg. § 1.1017-1(a))

Step 13. § 108(c) - QRPBI Basis Reduction Election

• The qualified real property business indebtedness exclusion.
  • § 108(a)(1)(D) excludes COD income from the discharge of QRPBI for taxpayers other than C corporations. This does NOT apply if the discharge occurs in a Title 11 case or to the extent the taxpayer is insolvent. (IRC § 108(a)(1)(D)) (IRC § 108(a)(2)(A)-(B))
  • § 108(c)(3) defines QRPBI as indebtedness incurred or assumed in connection with real property used in a trade or business, secured by such real property, incurred before January 1, 1993 or as qualified acquisition indebtedness thereafter, and with respect to which the taxpayer makes an election. "Qualified acquisition indebtedness" means debt incurred to acquire, construct, reconstruct, or substantially improve real property. Refinancing debt qualifies to the extent it does not exceed the refinanced debt. (IRC § 108(c)(3)) (IRC § 108(c)(3)(B))
  • Rev. Rul. 2016-15, 2016-26 I.R.B. 1060, holds that real property developed and held for lease qualifies as "real property used in a trade or business," but real property developed and held primarily for sale does NOT qualify.
• QRPBI limitations and partnership application.
  • Two limitations apply. First, the exclusion cannot exceed outstanding principal minus FMV of the securing property minus other QRPBI secured by the same property. Second, the exclusion cannot exceed aggregate adjusted bases of all depreciable real property held. Property acquired in contemplation of discharge is excluded from the basis calculation. (IRC § 108(c)(2)(A)-(B))
  • The excluded amount reduces the basis of depreciable real property. Under Treas. Reg. § 1.1017-1(c)(1), the taxpayer must reduce the basis of the "qualifying real property" (the property securing the QRPBI) BEFORE other depreciable real property. § 108(d)(6) requires the exclusion to be applied at the PARTNER level with each partner making a separate election. (IRC § 108(c)(1)) (Treas. Reg. § 1.1017-1(c)(1)) (IRC § 108(d)(6))

Step 14. Integration of Type G Reorganization and COD Income Exclusion

• The complete transaction and regulatory framework.
  • In a Type G reorganization with COD income, the following sequence occurs. (See Treas. Reg. § 1.108-7(c)) (H.R. Rep. No. 96-833, at 32-34 (1980))
    1. The transferor corporation transfers assets to the acquiring corporation in exchange for stock or securities. Under § 361(a), the transferor recognizes no gain or loss.
    2. The transferor distributes the acquiring corporation's stock to creditors in satisfaction of their claims.
    3. Under § 108(e)(8), the transferor is treated as having satisfied indebtedness for the FMV of the stock distributed. COD income arises to the extent adjusted issue price exceeds FMV.
    4. The COD income may be excluded under § 108(a)(1)(A) (Title 11 case) or § 108(a)(1)(B) (insolvency).
    5. Excluded COD income triggers § 108(b) attribute reduction on the transferor.
    6. The acquiring corporation takes a carryover basis in transferred assets under § 362(b), subject to § 1017 basis reduction.
    7. The acquiring corporation succeeds to the transferor's reduced tax attributes under § 381(a)(2).
    8. Creditors receiving stock generally recognize no gain or loss under § 354(a).
  • T.D. 9080, 68 FR 42590 (July 18, 2003), provides that if a taxpayer realizes excluded COD income during or before a § 381(a) transaction, all tax attributes to which the acquirer succeeds must reflect the § 108(b) reductions. The basis of stock or securities of the acquiring corporation received by the transferor is NOT available for reduction. (Treas. Reg. § 1.108-7(c))
• Treas. Reg. § 1.108-7(c) and the regulatory example.
  • T.D. 9080, 68 FR 42590 (July 18, 2003), provides that if a taxpayer realizes excluded COD income during or before a § 381(a) transaction, all tax attributes to which the acquirer succeeds must reflect the § 108(b) reductions. Attributes available immediately prior to the transaction (but after tax determination) are available for reduction. The basis of stock or securities of the acquiring corporation received by the transferor is NOT available for reduction. (Treas. Reg. § 1.108-7(c))
  • Example from the regulations. Corporation X (in Title 11 case) has trade debts of $200,000, a depreciable asset with basis of $75,000 and FMV of $100,000, and an NOL carryover of $80,000. X transfers the asset to Corporation Y for Y stock worth $100,000 and distributes to creditors. COD income of $100,000 arises and is excluded under § 108(a)(1)(A). The NOL is reduced by $80,000. Asset basis is reduced by $20,000. Y succeeds to NOL of $0 and takes a basis of $55,000 in the asset. (Treas. Reg. § 1.108-7(c), Example 3)

Step 15. Tax Attribute Carryover and § 382 Limitations

• § 381(a)(2) attribute carryover in Type G reorganizations.
  • In a Type G reorganization, the acquiring corporation succeeds to the transferor's tax attributes under § 381, including NOL carryovers, capital loss carryovers, earnings and profits, and accounting methods. However, the acquirer succeeds only to REDUCED attributes because excluded COD income triggers § 108(b) attribute reduction before carryover. (IRC § 381(a)(2)) (IRC § 381(c)) (Treas. Reg. § 1.108-7(c))
  • The transferor's taxable year ends on the date of transfer. Tax for the year of discharge (including carrybacks) is determined first, then § 108(b) attribute reduction is applied, and then reduced attributes carry over. (IRC § 381(b)(1)) (IRC § 108(b)(4)(A))
• § 382 limitations and bankruptcy exceptions.
  • The acquirer's ability to use the debtor's NOLs may be limited by § 382 if there is an ownership change (greater than 50 percentage point change during a 3-year testing period). An ownership change is highly likely in bankruptcy where creditors become shareholders. The § 382 annual limitation equals the value of the loss corporation before the change multiplied by the long-term tax-exempt rate. (IRC § 382(a)-(g))
  • § 382(l)(5) provides a bankruptcy exception. The § 382 limitation does NOT apply if (i) the old loss corporation was under court jurisdiction in a Title 11 case, (ii) the ownership change was ordered by the court or pursuant to an approved plan, and (iii) old shareholders and creditors retain at least 50% ownership. If § 382(l)(5) applies, NOLs must be reduced by interest deductions claimed during the 3-year period preceding bankruptcy on indebtedness converted to stock. TRAP. If a second ownership change occurs within 2 years, the § 382 limitation is ZERO and all NOLs are lost. (IRC § 382(l)(5)(A)-(D))
  • § 382(l)(6) provides that if § 382(l)(5) does not apply, the value for § 382 purposes reflects the increase in value from the surrender or cancellation of creditors' claims. (IRC § 382(l)(6))

Step 16. Anti-Abuse Doctrines - Step-Transaction and Economic Substance

• The step-transaction doctrine.
  • Courts may collapse formally separate steps into a single transaction if the steps were prearranged. Three tests exist. The binding commitment test (parties bound from the outset). The mutual interdependence test (each step has no independent significance). The end result test (steps are part of a preordained plan). (Commissioner v. Gordon, 391 U.S. 83, 96 (1968)) (Penrod v. Commissioner, 88 T.C. 1415, 1429 (1987)) (Commissioner v. Court Holding Co., 324 U.S. 331 (1945))
  • In the Type G context, the doctrine may collapse pre-bankruptcy planning steps, combine asset transfers and stock distributions, or recharacterize related-party transactions designed to manipulate COD income. CAUTION. Document the genuine business purpose for each step contemporaneously. (Rev. Rul. 67-274, 1967-2 C.B. 141) (Rev. Rul. 2001-46, 2001-2 C.B. 321)
• Economic substance and § 108(e) anti-avoidance.
  • Economic substance is codified at § 7701(o). A transaction has economic substance only if it changes in a meaningful way the taxpayer's economic position apart from tax effects AND the taxpayer has a substantial purpose apart from tax effects. The bankruptcy court's approval of a plan provides strong evidence of business purpose, but individual tax-motivated steps may still be challenged. (IRC § 7701(o)) (11 U.S.C. § 1129(a))
  • § 108(e)(4) provides that if a related person acquires the debtor's indebtedness from an unrelated person, the acquisition is treated as by the debtor. § 108(e)(5) applies ONLY to direct reductions by the seller to the original purchaser and does NOT apply if the debt has been transferred to a third party. In Preslar v. Commissioner, 167 F.3d 1323 (10th Cir. 1999), the Tenth Circuit held that § 108(e)(5) did not apply where the FDIC (not the seller) reduced the debt. (IRC § 108(e)(4)-(5)) (Preslar v. Commissioner, 167 F.3d 1323 (10th Cir. 1999))

Step 17. Entity-Specific Rules - S Corporations, Partnerships, and Consolidated Groups

Step 17A. S Corporation Rules

• Corporate-level application and the override of Gitlitz.
  • § 108(d)(7)(A) requires §§ 108(a), (b), (c), and (g) to be applied at the CORPORATE level for S corporations. Excluded COD income does NOT pass through to shareholders and does NOT increase stock basis. This provision overrules Gitlitz v. Commissioner, 531 U.S. 206 (2001), in which the Supreme Court held (8-1) that excluded COD income passed through to shareholders and increased basis. Under current law, attribute reduction occurs at the corporate level and shareholders receive no basis increase. (IRC § 108(d)(7)(A)) (Gitlitz v. Commissioner, 531 U.S. 206 (2001))
  • Any loss or deduction disallowed under § 1366(d)(1) (because it exceeds the shareholder's basis) is treated as an NOL for § 108(b)(2)(A) attribute reduction purposes. These suspended losses are reduced first. (IRC § 108(d)(7)(B))
• Basis in indebtedness and shareholder debt treatment.
  • For purposes of § 108(e)(6) (shareholder debt contribution to capital), a shareholder's adjusted basis in S corporation indebtedness is determined without regard to adjustments under § 1367(b)(2). (IRC § 108(d)(7)(C))
  • Under § 108(e)(6), when a shareholder contributes debt to capital, the corporation is treated as having satisfied the indebtedness for an amount equal to the shareholder's adjusted basis in the debt. If basis is less than face amount, COD income may arise. This differs from § 108(e)(8) which uses FMV of stock.

Step 17B. Partnership Rules

• Partner-level application and the bankruptcy requirement.
  • § 108(d)(6) requires § 108(a) to be applied at the PARTNER level. Each partner determines insolvency, bankruptcy status, and makes separate elections. One partner may exclude COD while another must include it. COD income is allocated under § 704(b). (IRC § 108(d)(6))
  • In Estate of Martinez v. Commissioner, T.C. Memo. 2004-150, the Tax Court held that partners could exclude partnership COD income where the bankruptcy court discharged them from liability. However, in AOD 2015-01 (2015-6 I.R.B. 579), the IRS nonacquiesced, arguing the bankruptcy exclusion applies only to partners who are debtors in bankruptcy in their individual capacities. The IRS position is the controlling authority for practitioners. (Estate of Martinez v. Commissioner, T.C. Memo. 2004-150) (AOD 2015-01)
• Excess nonrecourse debt allocation and reporting.
  • Rev. Rul. 2012-14 amplifies Rev. Rul. 92-53 by providing that for measuring a partner's insolvency, each partner treats as a liability an amount of the partnership's discharged excess nonrecourse debt based upon the allocation of COD income to such partner under § 704(b). (Rev. Rul. 2012-14) (Rev. Rul. 92-53, 1992-2 C.B. 48)
  • Each partner reports their distributive share of COD income on their individual return and separately determines whether the bankruptcy or insolvency exclusion applies. The partnership must provide Schedule K-1 information sufficient for each partner to make this determination.

Step 17C. Consolidated Group Rules

• Consolidated group attribute reduction and insolvency rules.
  • When a member of a consolidated group realizes excluded COD income, attribute reduction operates in three tiers under Treas. Reg. § 1.1502-28. First, tax attributes attributable to the debtor member are reduced, including basis of assets and SRLY losses, but not subsidiary stock basis below zero. Second, to the extent subsidiary stock basis is reduced, the subsidiary is treated as having recognized excluded COD income (the "push down" rule). Third, any remaining excluded COD reduces the consolidated tax attributes of the group (the "fan out" rule). (Treas. Reg. § 1.1502-28(a)(2)-(4))
  • § 108(a)(1)(A) and (B) is applied separately to each member that realizes excluded COD income. The insolvency limitation is determined based on ONLY the assets and liabilities of the member realizing the COD income. CAUTION. A consolidated group member that is solvent may not exclude COD income even if the group as a whole is insolvent. (Treas. Reg. § 1.1502-28(b))
  • If a subsidiary is disposed of in the year of discharge, complex computational issues arise because the disposition affects both the debtor member's attributes and the look-through calculations. Plan attribute reduction before disposing of subsidiary stock.

Step 18. Earnings and Profits, CAMT, and Advanced Corporate Issues

• Former § 312(l) E&P rules.
  • § 312(l) was repealed by the American Jobs Creation Act of 2004, Pub. L. 108-357, effective for discharges after October 22, 2004. Under the repealed provision, earnings and profits did not include income from discharge of indebtedness to the extent applied to reduce basis under § 1017. COD income applied to reduce NOLs (rather than basis) increased E&P. COD income applied to reduce basis did not increase E&P. Current law does not contain this specific rule. (Former IRC § 312(l)(1)-(2))
  • This distinction mattered for dividend characterization, personal holding company tax, and accumulated earnings tax. The acquiring corporation in a Type G reorganization inherits the transferor's E&P under § 381, but only after the § 108(b) attribute reduction. Practitioners should consult current regulations for E&P treatment of excluded COD income.
• CAMT and other advanced issues.
  • Notice 2025-46 provides interim guidance on CAMT treatment of COD income for financially troubled companies. AFSI is adjusted to exclude COD income if the CAMT entity is in a Title 11 bankruptcy case or to the extent insolvent. For consolidated groups, insolvency is determined on a member-by-member basis. CAMT attributes are reduced in an ordering following § 108(b) logic. (Notice 2025-46)
  • Under GAAP, companies emerging from bankruptcy may apply "fresh start" accounting, restating assets to FMV. For tax purposes, there is NO corresponding step-up in tax basis. The tax basis carries over subject to § 1017 reduction. This creates book-tax differences affecting CAMT, state tax, and future depreciation. TRAP. Do not conflate GAAP fresh start accounting with tax basis.

Step 19. State Tax Conformity

• State conformity framework and federal COD exclusion.
  • States conform through rolling conformity (automatic adoption), static conformity (fixed date), or selective conformity (picking provisions). When a corporation excludes COD income under § 108(a), most conforming states also exclude the income. However, attribute reduction rules follow only in states that specifically conform to §§ 108(b) and 1017. (State tax authorities)
  • Fixed-date conformity states with pre-1980 conformity dates may not have adopted the Bankruptcy Tax Act provisions. Selective conformity states may have specific modifications. Some states decouple from specific attribute reduction provisions or have different NOL carryforward periods.
• Decoupling and multi-state filing considerations.
  • The following states affirmatively decoupled from the § 108(i) deferral provision (now sunset). Connecticut, District of Columbia, Florida, Indiana, Maine, Maryland, Massachusetts, Minnesota, New Jersey, North Carolina, Oregon, and Rhode Island. TRAP. If a client has historical deferred COD income under § 108(i), those states required inclusion in the year of discharge rather than over the deferral period.
  • For multi-state filers, determine the conformity method for each state. Check state-specific decoupling from § 108 provisions. Assess whether state attribute reduction rules differ from federal. Consider the interaction between federal COD exclusion and state tax credit calculations.

Step 20. Documentation, Reporting, and Filing Obligations

• Form 982 and required elections.
  • Form 982 must be filed with the federal income tax return for the year a discharge is excluded from income under § 108(a). Part I requires checking the applicable exclusion box (line 1a for Title 11, 1b for insolvency, 1c for QFII, 1d for QRPBI, 1e for principal residence) and entering the excluded amount on line 2. Part II reports attribute reduction. Each category has its own line. Dollar for dollar for NOLs, basis, and capital losses. Credits are reduced at 33 1/3 cents per dollar. (IRS Form 982 Instructions)
  • The § 108(b)(5) election to reduce depreciable property basis first is made on line 5 of Form 982. The election must include a statement describing the transactions and identifying the property. The QRPBI election under § 108(c)(3)(C) is made on Form 982 and may be revoked only with the consent of the Secretary. TRAP. Failure to file Form 982 can result in the exclusion being denied. (IRC § 108(b)(5)) (IRC § 108(c)(3)(C))
  • Variations from general basis adjustment rules under § 1082 require a corporation to attach a statement showing the precise method and allocation. Consent is effective only if incorporated in a closing agreement under § 7121. (Treas. Reg. § 1.1082-1)
• Other reporting and document retention.
  • Creditors must file Form 1099-C when discharging indebtedness of $600 or more. The debtor must report COD income even if no Form 1099-C was received. Discrepancies should be explained on the return. (IRC § 6050P) (IRS Form 1099-C Instructions)
  • For individuals in bankruptcy, a separate estate is created under § 1398. For corporations, there is no separate estate. The corporation remains the taxpayer. (IRC § 1398) (IRC § 1399)
  • Maintain these records for audit defense. Bankruptcy court orders and confirmed plan. Debt instruments and modification agreements. Stock valuation reports. Insolvency calculation workpapers. Attribute reduction worksheets. Election statements. E&P and CAMT adjustment computations. CAUTION. In Carlson v. Commissioner, 116 T.C. 87 (2001), inadequate documentation of asset values was a significant issue. Retain independent appraisals of stock and assets. (Best practices) (Carlson v. Commissioner, 116 T.C. 87 (2001))