Are you talking to your lender about restructuring or forgiving all or part of your business debt? You may be surprised to learn the outcome of your negotiations could lead to taxable income.
Why? When you no longer have to repay a business debt because it’s been reduced or forgiven, cancellation of debt (COD) income can result. In general, unless your business qualifies for an exception, COD income is taxable.
Exceptions include bankruptcy, insolvency, indebtedness incurred in direct connection with farming, and qualified real property debt.
Note that these exceptions apply only to COD income. Depending on the kind of debt forgiven, restructuring could lead to other types of income. For instance, say you have a nonrecourse loan, where the lender’s only option in the case of default is to take the property back. In this situation, you’ll generally have a gain or loss on a sale instead of COD income.
The form of your business can also affect tax consequences. For example, when you operate as a partnership, the determination of whether the insolvency exception applies is made at the partner level. That means even if your partnership has more liabilities than assets, COD income could be taxable to individual partners.
Other rules may apply, including the possibility of deferring certain COD income you receive in 2010 to later years. Please contact us if you need more information.
