With Great Power Comes Great Responsibility

Partners William E. Russell and Brian A. Smith are the authors of “With Great Power Comes Great Responsibility - Deferring Cancellation of Debt Income For Tax Partnerships,” an update to their prior publication, “New Tax Deferral Election May Lead to Investor Disputes During Loan Workouts,” which was featured in the August issue of Financier Worldwide magazine. 

This article examines one of the most significant hurdles in structuring a suitable debt workout or restructuring arrangement between a lender and a borrower: cancellation of indebtedness (“COI”) income.  In the United States, as is the case in many other countries, when a borrower reduces or cancels its outstanding indebtedness for less than the full amount due, the borrower is deemed to realize taxable income on the amount of the reduction.  This cancellation of COI income is subject to many nuances and exceptions, the primary exceptions being that an insolvent debtor can avoid COI income to the extent it is insolvent.