Debt Restructuring and Repurchases: Tax Implications for Borrowers and Lenders

Description

Debt restructurings and workouts are becoming more and more prevalent in the current economic downturn and such transactions may result in significant federal income tax consequences, including CODI for the borrower and original issue discount (OID) income for the lender. Counsel should be aware of structuring alternatives and timing decisions that can affect the tax outcome.

A change in the interest rate, reduction of principal, an extension of the maturity date, or a deferral of interest (among other amendments) that constitutes a "significant modification" is treated as an exchange of the old debt instrument for a deemed new debt instrument, resulting in CODI if the issue price of the new debt is less than the adjusted issue price of the old debt. Similarly, if a borrower repurchases debt for less than the amount owed, it will recognize CODI. A deemed exchange may also result in the conversion of market discount into OID, which can result in "phantom" income for lenders.

Debt restructurings and workouts involving borrowers taxed as partnerships present special CODI concerns. Because of the pass-through tax treatment, a partnership in financial distress may want to consider converting to a corporation so that any bankruptcy or insolvency exclusion will apply at the entity level. Taxpayers should also carefully consider the timing of any restructuring transaction in light of the expanded ability to carryback NOLs under the CARES Act and the 80 percent limitation on the utilization of carryover NOLs (temporarily suspended by the CARES Act).

Listen as our authoritative panel examines the tax implications of restructuring and repurchasing existing debt. The panel will also discuss exclusions available under the tax code and strategies for avoiding or minimizing the tax consequences of these transactions.