REVENUE RULE 92-52

1992-2 C.B. 34, 1992-27 I.R.B. 6.

Internal Revenue Service
Revenue Ruling

DISCHARGE OF INDEBTEDNESS

Published: June 16, 1992

Section 61.  Gross Income Defined, 26 CFR 1.61-12: Income from discharge of indebtedness.

(See Also Section 108.)

Discharge of indebtedness. Guidance is provided for determining discharge of indebtedness income and tax attribute reduction when an insolvent debtor outside of a title 11 case issues its stock and cash or other property for indebtedness.

ISSUES

(1) To what extent does the stock-for-debt exception or section 108(a)(1)(B) of the Internal Revenue Code apply when an insolvent debtor outside of a title 11 case issues its stock and cash or other property for an indebtedness held by a single creditor?

(2) To what extent does the stock-for-debt exception or section 108(a)(1)(B) of the Code apply when an insolvent debtor outside of a title 11 case issues its stock for an indebtedness held by one creditor and issues cash or other property for an indebtedness held by another creditor?

FACTS

In both situations described below, corporations X and Y each have 10 shares of common stock outstanding, assets with a fair market value of $40,000, and unsecured indebtedness of $90,000. X and Y are each insolvent (under section 108(d)(3) of the Code) to the extent of $50,000 but are not in a title 11 case. Upon completion of each transaction, X and Y each have a net worth of $30,000, and the stock held by the original shareholders has a fair market value of $10,000. The payment of indebtedness owed by X and Y would not have resulted in a deduction. The stock issued is not de minimis under section 108(e)(8), and the stock is not disqualified stock under section 108(e)(10)(B)(ii).

SITUATION 1

X owes an unsecured indebtedness with an adjusted issue price of $90,000 to a creditor that is unrelated to X. In 1992, X issues its debt instrument with an issue price of $10,000 and its common stock with a fair market value of $20,000 to the creditor in exchange for the indebtedness.

SITUATION 2

Y owes an unsecured indebtedness to A with an adjusted issue price of $30,000 and an unsecured indebtedness to B with an adjusted issue price of $60,000. A and B are unrelated to Y. In 1992, Y issues its debt instrument with an issue price of $10,000 to A in exchange for the indebtedness held by A. In a related transaction, Y subsequently issues its common stock with a fair market value of $20,000 to B in exchange for the indebtedness held by B.

LAW

Section 61(a)(12) of the Code provides that gross income includes income that a debtor realizes by discharging its indebtedness for less than the amount owed. Section 108(e)(11) provides that a debtor issuing a debt instrument in satisfaction of its indebtedness is treated as satisfying the indebtedness with an amount of money equal to the debt instrument's issue price (determined under sections 1273 and 1274).

Sections 108(a)(1)(B) and 108(a)(3) of the Code provide that, in the case of an insolvent debtor outside of a title 11 case, discharge of indebtedness is excluded from gross income but only to the extent of the debtor's insolvency. Under sections 108(b) and 1017, the debtor must reduce certain tax attributes on account of the income so excluded.

The courts have formulated an exception (the "stock-for-debt exception") to the realization of discharge of indebtedness income if the debtor exchanges its stock for its indebtedness. E.g., Commissioner v. Motor Mart Trust, 156 F.2d 122 (1st Cir. 1946). Section 108(e)(10) of the Code limits the stock-for-debt exception to a debtor in a title 11 case or to an insolvent debtor outside of a title 11 case to the extent of the debtor's insolvency. If the stock- for-debt exception applies to prevent the debtor's realization of discharge of indebtedness income, no corresponding reduction of the debtor's tax attributes is required under sections 108(b) and 1017. S. Rep. No. 1035, 96th Cong., 2d Sess. 11, 1980-2 C.B. 620, 625. Under section 108(e)(10)(A), if the debtor is neither in a title 11 case nor insolvent and thus the stock-for-debt exception does not apply, the debtor is treated as satisfying the indebtedness with an amount of money equal to the fair market value of the stock issued in exchange therefor.

ANALYSIS

SITUATION 1

In the transaction, X has $60,000 of discharge of indebtedness ($90,000 indebtedness less the sum of the $10,000 issue price of X's new debt instrument and the $20,000 fair market value of X's stock). See sections 108(e)(10) and (11) of the Code. However, because X is insolvent by $50,000 immediately before the discharge, X includes only $10,000 as discharge of indebtedness income. See sections 108(a)(3) and 108(e)(10)(B)(i).

In discussing the stock-for-debt exception, the legislative history to the 1980 Bankruptcy Tax Act states that "[i]f a corporate debtor issues a package of stock and other property in cancellation of debt, the cash and other property are to be treated as satisfying an amount of debt equal to the amount of cash and the value of other property, and the stock is to be treated as satisfying the remainder of the debt." S. Rep. No. 1035 at 17, 1980-2 C.B. at 629. If the other property issued by a corporate debtor is a new debt instrument, the new debt instrument is treated as satisfying an amount of indebtedness equal to the issue price of the new debt instrument. See section 108(e)(11) of the Code. For purposes of allocating the discharge of indebtedness attributable to its insolvency, X is treated as issuing its new debt instrument of $10,000 in exchange for $10,000 of indebtedness and its stock with a $20,000 fair market value in exchange for the remainder of the indebtedness. Thus, the $50,000 of discharge of indebtedness attributable to X's insolvency is allocated to the stock-for-debt exchange, and X is not required to reduce its tax attributes under sections 108(b) and 1017.

SITUATION 2

In the debt-for-debt exchange with A, Y has $20,000 of discharge of indebtedness ($30,000 indebtedness owed to A less the $10,000 issue price of Y's new debt instrument). See section 108(e)(11) of the Code. In the stock-for- debt exchange with B, Y has $40,000 of discharge of indebtedness ($60,000 indebtedness owed to B less the $20,000 fair market value of Y's stock). See section 108(e)(10). In total, Y has $60,000 of discharge of indebtedness. However, because Y is insolvent by $50,000 immediately before the discharge, Y includes only $10,000 as discharge of indebtedness income. See sections 108(a)(3) and 108(e)(10)(B)(i).

When determining the potential tax attribute reduction required of an insolvent debtor outside of a title 11 case, the discharge of indebtedness attributable to insolvency is first allocated to stock- for-debt exchanges (other than exchanges involving a de minimis amount of stock under section 108(e)(8) of the Code or disqualified stock under section 108(e)(10)(B)(ii)). Any remaining discharge of indebtedness attributable to insolvency is allocated to any other exchanges.

Therefore, the first $40,000 of Y's $50,000 of discharge of indebtedness attributable to its insolvency is allocated to the stock-for-debt exchange with B. Because Y is issuing stock for the indebtedness held by B, the stock-for- debt exception, and not section 108(a)(1)(B) of the Code, applies to the exchange with B. Y is not required to reduce its tax attributes under sections 108(b) and 1017 with respect to that exchange. The remaining $10,000 of Y's discharge of indebtedness attributable to its insolvency is allocated to the debt-for-debt exchange with A. Because Y is not issuing any stock for the indebtedness held by A, section 108(a)(1)(B), and not the stock- for-debt exception, applies to the exchange with A. Y is required to make a corresponding reduction of tax attributes under sections 108(b) and 1017.

Because the exchanges with A and B are related, the sequence of these exchanges does not affect the foregoing analysis.

HOLDINGS

(1) When an insolvent debtor outside of a title 11 case issues stock (other than a de minimis amount of stock under section 108(e)(8) of the Code or disqualified stock under section 108(e)(10)(B)(ii)) and cash or other property for an indebtedness held by a single creditor, the discharge of indebtedness attributable to the debtor's insolvency is allocated by treating the cash and other property as satisfying an amount of indebtedness equal to the amount of cash and the value of the other property. The stock is treated as satisfying the remainder of the indebtedness. Thus, the stock-for-debt exception, and not section 108(a)(1)(B), applies to the entire amount of the discharge of indebtedness attributable to the debtor's insolvency, and no tax attribute reduction is required under sections 108(b) and 1017.

(2) When an insolvent debtor outside of a title 11 case issues stock (other than a de minimis amount of stock under section 108(e)(8) of the Code or disqualified stock under section 108(e)(10)(B)(ii)) for an indebtedness held by one creditor and cash or other property for an indebtedness held by another creditor, the discharge of indebtedness attributable to the debtor's insolvency is first allocated to the stock-for-debt "exchange with the remaining amount being allocated to the other exchange. With respect to the stock-for-debt exchange, the stock-for-debt exception applies to the extent that the discharge of indebtedness attributable to the debtor's insolvency is allocated to that exchange, and no tax attribute reduction is required under sections 108(b) and 1017. With respect to the exchange involving cash or other property, section 108(a)(1)(B) applies to the extent that the discharge of indebtedness attributable to the debtor's insolvency is allocated to that exchange, and a corresponding reduction of tax attributes is required under sections 108(b) and 1017.

DRAFTING INFORMATION

The principal author of this revenue ruling is Keith Engel, Office of Chief Counsel, who can be contacted at (202) 566-6442 (not a toll-free call).

Rev. Rul. 92-52, 1992-2 C.B. 34, 1992-27 I.R.B. 6.