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DanielleCPA
DanielleCPA, Certified Public Accountant (CPA)
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A C Corp (#1) owns 100% of the stock of another C Corp (#2).

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A C Corp (#1) owns 100% of the stock of another C Corp (#2). They both file taxes as separate corporations. Corp #1 borrowed money from Corp #2 ($600K) structured as arms' length (6 payments of $100K plus market interesr). Corp #2 is paid years and now ows $100K. However, Corp #2 is having cash flow issues and although it still solvent is unable to repay the debt. Corp #2 wants to issue stock to Corp #1 to satisfy the $100K.

Corp #2 basis in the outstanding debt is $100K, which is equal to the amount of the debt.



Will the provisions of Code section 108(e)(6) or Code section 108(e)(8) to this case (cancellation of indebtedness,)

What are the results of applying one code or the other?
Submitted: 10 months ago.
Category: Tax
Expert:  MequonCPA replied 10 months ago.
Hi and welcome to JustAnswer:

Maybe I'm missing something here, but I don't believe this is a cancellation of indebtedness situation. Nothing has been written off. Corporation #2 reduces its debt, but increases its shareholder equity. Corporation #1 no longer has a note receivable but now has an additional investment in Corporation #2.
Customer: replied 10 months ago.
Could you please release the question for someone else to answer it?
Expert:  DanielleCPA replied 10 months ago.
Whether section 108(e)(6) or section 108(e)(8) applies depends on the substance of the transaction.

The situation you describe - where the debtor corporation (Corporation #2) issues additional stock to its creditor stockholder (Corporation #1) falls under section 108(e)(8). Corporation #2 (debtor) would recognize cancellation of debt income to the extent that the fair market value of the stock issued is less than the face value of the debt. The creditor (Corporation #1) could then recognize a loss under section 1001 to the extent their basis in the debt is more than the value of the stock received.

If the fair market value of the additional stock Corporation #2 issues is $100K, then there would be no tax consequences. The stock may be worth that much, but for a small business with cash flow issues, that may not be very realistic. I don't know what an accurate value would be, but for example purposes, let's say the stock in Corporation #2 is worth $50K. That would be mean #2 would recognize $50K in cancellation of debt income and #1 would recognize $50K in loss.

Section 108(e)(6) provides a tax advantage overall because it doesn't result in recognition of cancellation of debt income by the debtor (Corporation #2) to the extent the shareholder has basis in the debt. The creditor's (Corporation #1) capital account is increased but no new stock is issued. Since the basis in the debt is $100K, no cancellation of debt income is recognized by Corporation #2. Corporation #1's basis in Corporation #2's stock is increased by the $100K debt cancelled.
DanielleCPA, Certified Public Accountant (CPA)
Category: Tax
Satisfied Customers: 692
Experience: Years of Experience in Business & Personal Taxes
DanielleCPA and 4 other Tax Specialists are ready to help you
Customer: replied 10 months ago.

Danielle:


 


I'd like to ask you one more question. If satisfy, I'd add a bonus. Do you see a relation between any of the following authorities or cases and the Corp #1 and Corp #2 situation described above?


 


Code Section 61


Code Section 6110


TAM 9830002


Reg. 1-61-12


PLR XXXXXXXXX /p>

National Alfalfa Case


Committe Reports 1081.004 (93)


Bittker 3.13 Contribution in Cap


Bittker 4.25 Debt Discharge


 


Thanks

Customer: replied 10 months ago.

I think my difficulty is understanding form and substance and who is bound by what based on the case.

Expert:  DanielleCPA replied 10 months ago.
Thanks for the follow-up, but unfortunately, the interpretation and application of those regulations and cases falls outside of my expertise. In regards to your follow-up questions, another expert may be better suited. I suggest posting another question so you get the best service possible. Have a wonderful evening!

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