Businesses interested in realigning their balance sheets may be eligible for help under the American Recovery and Reinvestment Act of 2009.

Normally, a business that is able to buy back at a discount or otherwise reduce its debt is subject to income tax on "cancellation of indebtedness" (COD) income. Current law provides statutory exclusions if the COD income is incurred by a taxpayer who is in bankruptcy or is insolvent or whose debt constitutes farm indebtedness or qualified real property business indebtedness. The act gives businesses (including individuals who have incurred business debt) an additional option of delaying taxes.

Under the act, businesses will have the option of deferring the tax on COD income arising from the purchase or restructuring of business debt, including debt represented by bonds, debentures, notes, certificates or other instruments and contractual arrangements "constituting indebtedness" for tax purposes during 2009 or 2010. Regardless of the year in which the COD income is triggered, it is deferred through 2013. The deferred COD income is then included in income in five equal annual installments, beginning in 2014.

Eligible debt reduction transactions include:

  • Acquisition for cash.
  • Debt-for-debt exchanges (including debt instrument modifications).
  • Exchange for stock or a partnership interest.
  • Contribution of the debt to the issuer's capital
  • Complete forgiveness.
The relief will require careful tax planning by businesses, based on their assessment of their future business environment and on their ability to take advantage of the current statutory exclusions for COD income listed above. If deferral is chosen, those statutory exclusions will not be available to the business. For example, a business that realizes COD income from restructuring qualifying realty debt secured by long-life depreciable realty may find that the statutory exclusion for qualifying realty debt provides a more effective tax deferral result — potentially over 30 or more years — than the four- or five-year deferral and five-year inclusion provided by the American Recovery and Reinvestment Act. If new obligations having original issue discount (OID) are issued in a restructuring, deductions for some of the OID will also be deferred. Finally, some events will accelerate recognition of the deferred income, including cessation of business, disposal of a partnership interest and death.