Recent economic events have led many U.S. corporations to reduce or restructure their outstanding debt. Some U.S. corporations have effected such changes through the bankruptcy process, but others have not. This article reviews certain U.S. federal income tax considerations relevant to debtors and creditors in connection with certain debt restructuring transactions and addresses certain tax advantages to a debtor seeking bankruptcy protection prior to effecting the debt restructuring.
When the capital of a corporation is restructured, one of the creditors’ primary concerns is whether the transactions will result in the current recognition of gain or loss for U.S. federal income tax purposes. Debtors’ U.S. federal income tax considerations commonly relate to whether the restructuring will result in tax liability arising from the recognition of cancellation of debt income (CODI) or an ownership change significantly limiting the future value of their net operating losses (NOLs). Debtors in bankruptcy may avoid negative tax effects of generating CODI or having an ownership change.
Debt Exchanges
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