Bankruptcy & Insolvency Taxation Third Edition Grant W. Newton Robert Liquerman JOHN WILEY & SONS, INC. BANKRUPTCY & INSOLVENCY TAXATION Third Edition BECOME A SUBSCRIBER! Did you purchase this product from a bookstore? If you did, it’s important for you to become a subscriber. John Wiley & Sons, Inc. may publish, on a periodic basis, supplements and new editions to reflect the latest changes in the subject matter that you need to know in order to stay competitive in this ever-changing industry. By contacting the Wiley office nearest you, you’ll receive any current update at no additional charge. In addition, you’ll receive future updates and revised or related volumes on a 30-day examination review. If you purchased this product directly from John Wiley & Sons, Inc., we have already recorded your subscription for this update service. 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Newton, Professor of Accounting, Graziadio School of Business and Management, Pepperdine University, Malibu, California, is the author of Bank- ruptcy and Insolvency Accounting; Practice and Procedure (updated annually) and Corporate Bankruptcy (2003), also published by John Wiley & Sons. He is the Executive Director of the Association of Insolvency and Restructuring Advisors and he developed and teaches the three courses that lead to the Certified Insol- vency and Restructuring Advisor (CIRA) designation. A CPA, CIRA, and CMA, he received a Ph.D. from New York University, a Master’s degree from the Uni- versity of Alabama, and a B.S. Degree from the University of North Alabama. Dr. Newton was a member of the AICPA’s Task Force on Financial Report- ing by Entities in Reorganization Under the Bankruptcy Code that resulted in the issuance of the Statement of Position 90-7. He is coauthor of Consulting Ser- vices Practice Aid 02-1: Business Valuation in Bankruptcy and Providing Bankruptcy & Reorganization Services—Practice Aid, both published by the AICPA. He serves as a consultant and expert witness on issues dealing with financial reporting during and emerging from chapter 11, valuation, terms of plan, tax impact of plan, tax issues related to the bankruptcy estate, and recovery of assets. Robert Liquerman is a principal in KPMG LLP’s Washington National Tax Prac- tice, Corporate Tax Group, specializing in matters under Subchapter C of the Internal Revenue Code. He is an adjunct professor of law in the LL.M. program at the Georgetown University Law Center and previously served as an adjunct professor in the LL.M. program at The College of William & Mary, Marshall- Wythe School of Law. Mr. Liquerman holds an LL.M. in Taxation from New York University School of Law; a J.D. from St. John’s University, School of Law; and a B.S. in Accounting from the State University of New York at Binghamton. He joined KPMG LLP from the Internal Revenue Service Office of the Chief Counsel, Corporate Division. In this position, he drafted treasury regulations, private letter rulings, technical advice memoranda, closing agreements, responses to congressional inquiries, field service advice, and memoranda of law. Prior to his government experience, Mr. Liquerman was a senior tax associ- ate in the mergers and acquisition group and the insurance group in the New York office of Coopers & Lybrand. He is a frequent speaker on bankruptcy and tax issues at various tax insti- tutes and conferences around the country, including Tax Executives Institute, Federal Bar Association, DC Bar Association, and the Association of Insolvency and Restructuring Accountants. Mr. Liquerman is a member of the American Bar Association, Section of Taxation. Although Chapters 2, 5, 6, and 7 reflect the views of Robert Liquerman, they do not necessarily reflect the views of KPMG, LLP. n vi n IMPORTANT NOTE As we go to press, Congress is on the verge of passing new legislation that will affect corporate bankruptcy. Please email Sheck Cho at John Wiley & Sons (scho@wiley.com) to receive information about this new Act. ******************************************** Because of the rapidly changing nature of information in this field, this product may be updated with annual supplements or with future editions. Please phone 1-877-762-2974 or email us at subscriber@wiley.com to receive any current update at no additional charge. We will send on approval any future supplements or new editions when they become avail- able. If you purchased this product directly from John Wiley & Sons, Inc., we have already recorded your subscription for this update service. n vii n Contents Preface xi Chapter One Nature of Bankruptcy & Insolvency Proceedings 1 1.1 Objectives 1 1.2 Alternatives Available to a Financially Troubled Business 3 Chapter Two Discharge of Indebtedness 21 2.1 Introduction 23 2.2 Discharge of Indebtedness Income 23 2.3 Determination of Discharge of Indebtedness Income 24 2.4 Section 108(e) Additions to Discharge of Indebtedness Income 35 2.5 Section 108(e) Subtractions from Discharge of Indebtedness Income 53 2.6 Discharge of Indebtedness Income Exclusions 57 2.7 Consequences of Qualifying for Section 108(A) Exclusions 66 2.8 Use of Property to Cancel Debt 85 2.9 Consolidated Tax Return Treatment 95 2.10 Discharge of Indebtedness Reporting Requirements 112 Chapter Three Partnerships and S Corporations: Tax Impact of Workouts and Bankruptcies 117 3.1 Introduction 118 3.2 Partnerships 118 3.3 S Corporations 140 Chapter Four Taxation of Bankruptcy Estates and Debtors 151 4.1 Introduction 152 4.2 Responsibility for Filing Income Tax Returns 152 4.3 Accounting for the Bankruptcy Estate 156 4.4 Accounting for the Debtor (Individual) 203 4.5 Summary 214 Chapter Five Corporate Reorganizations 217 5.1 Introduction 218 5.2 Elements Common to Many Reorganization Provisions 219 5.3 Overview of Specific Tax-Free Reorganizations Under Section 368 232 5.4 Acquisitive Reorganizations 232 Contents n viii n 5.5 Stock Acquisitions 243 5.6 Single Entity Reorganizations 252 5.7 Divisive Reorganizations 257 5.8 Insolvency Reorganizations 268 5.9 Summary 281 Chapter Six Use of Net Operating Losses 283 6.1 Introduction 284 6.2 I.R.C. Section 381 286 6.3 Restructuring Under Prior I.R.C. Section 382 291 6.4 Current I.R.C. Section 382 293 6.5 I.R.C. Section 383: Carryovers other than Net Operating Losses 346 6.6 I.R.C. Section 384 347 6.7 I.R.C. Section 269: Transactions to Evade or Avoid Tax 351 6.8 Libson Shops Doctrine 357 6.9 Consolidated Return Regulations 358 Chapter Seven Other Corporate Issues 369 7.1 Introduction 370 7.2 Earnings and Profits 370 7.3 Incorporation 374 7.4 Liquidation 377 7.5 I.R.C. Section 338 381 7.6 Other Tax Considerations 394 7.7 Administrative Expenses 397 7.8 Other Administrative Issues 405 Chapter Eight State and Local Taxes 409 8.1 Introduction 409 8.2 Income from Debt Discharge 410 8.3 Net Operating Loss Carryback and Carryover 413 8.4 Bankruptcy Estate 416 8.5 Responsibility for Filing Tax Returns 419 8.6 Stamp Tax 420 8.7 Summary 424 Chapter Nine Tax Consequences to Creditors of Loss from Debt Forgiveness 425 9.1 Introduction 426 9.2 Nature of Losses 426 9.3 Business and Nonbusiness Losses 428 9.4 Determination of Worthlessness 436 9.5 Secured Debt 445 [...]... The first edition of Bankruptcy and Insolvency Taxation was a revision of the authors’ Tax Planning for the Troubled Business, first published in 1983 and revised annually This edition, revising the second edition, will be updated annually or more frequently if needed because of tax law changes Bankruptcy and Insolvency Taxation is one of four books by the author and published by John Wiley & Sons dealing... four books by the author and published by John Wiley & Sons dealing with bankruptcy and insolvency taxation and accounting The others are Bankruptcy and Insolvency Accounting: Practice and Procedure, Bankruptcy and Insolvency Accounting: Forms and Exhibits, and Corporate Bankruptcy Chapter 1 describes the general provisions of the Bankruptcy Code applicable to debtors who have filed a chapter 7 or chapter... the bankruptcy court held that a section 6672 penalty assessed against the debtor for failure to pay the withholding taxes of Meridian Glass did count toward the debt limit The bankruptcy court held that the IRS’s disputed claim is includable in calculating the chapter 13 debt limits under section 109(e) of the Bankruptcy Code 4 5 Id 4.1 159 B.R 587 (Bankr D Idaho 1993) n 17 n Nature of Bankruptcy & Insolvency. .. was established at $12,300 The $12,300 value remains effective until April 1, 2007 n 7 n Nature of Bankruptcy & Insolvency Proceedings (ii) Priorities The 1978 Bankruptcy Code modified to a limited extent the order of payment of the expenses of administration and other unsecured claims Section 507 of the Bankruptcy Code provides for the following priorities: 1 Administrative expenses 2 In an involuntary... claims and interests The court may accept the voting that n 15 n Nature of Bankruptcy & Insolvency Proceedings was done prepetition provided that the solicitation of the acceptance (or rejection) was in compliance with applicable nonbankruptcy law governing the adequacy of disclosure in connection with the solicitation If no nonbankruptcy law is applicable, then the solicitation must have occurred after... reorganization or liquidation in a title 11 bankruptcy case This discussion is intended only to provide the reader with a basic introduction to n 2 n §1.2(a) Out-of-Court Settlements out-of-court and bankruptcy proceedings For a more detailed discussion of the legal aspects of and the accounting for out-of-court settlements and bankruptcy cases, see Newton’s Bankruptcy and Insolvency Accounting: Practice and... Booth and Mary Van Leuven, also in the Washington National Tax Practice of KPMG, LLP, in preparing this edition He also thanks his many other colleagues at KPMG, LLP, for their insights and contributions in preparing this book Robert Liquerman n xii n C H A P T E R O N E 1 Nature of Bankruptcy & Insolvency Proceedings § 1.1 Objectives (a) Introduction (b) Scope of Coverage § 1.2 Alternatives Available... out to the creditors that if legal action is taken, a petition in bankruptcy court will have to be filed.) • The informal composition settlement does not provide a method to resolve individual disputes between the debtor and the creditors • Executory contracts, especially leases, may be difficult to avoid n 5 n Nature of Bankruptcy & Insolvency Proceedings • Certain tax law provisions make it more advantageous... the right to file an involuntary bankruptcy court petition Proceedings brought in the federal courts are governed by the Bankruptcy Code Normally, it will be necessary to resort to such formality when suits have been filed against the debtor and its property is under garnishment or attachment or is threatened by foreclosure or eviction (c) Bankruptcy Court Proceedings Bankruptcy court proceedings are... business community in general Chapter 7 of the Bankruptcy Code covers the proceedings related to liquidation Another alternative under the Bankruptcy Code is to seek some type of relief so that the debtor will have enough time to work out agreements with creditors with the help of the bankruptcy court and be able to continue operations Chapters 11, 12, and 13 of the Bankruptcy Code provide for this type of . Bankruptcy & Insolvency Taxation Third Edition Grant W. Newton Robert Liquerman JOHN WILEY & SONS, INC. BANKRUPTCY & INSOLVENCY TAXATION Third. enquiry@wiley.com.sg Email: brisbane@johnwiley.com.au Bankruptcy & Insolvency Taxation Third Edition Grant W. Newton Robert Liquerman JOHN WILEY & SONS, INC. This book is