gross income tax

7/28/2019 Gross Income Tax

1/18

Chapter 3DLOANS AND

THE CANCELLATION OF DEBT

Federal Income Taxation of IndividualsSamuel A. Donaldson

Donald B. Tobin


2/18

Loans and the Cancellation of DebtNeither a borrower nor a

lender be,

For loan oft loseth bothitself and friend.And borrowing dulls the

edge of husbandry.Hamlet, Act I, Scene iii


3/18

$12,000,000

United States v. Kirby Lumber

$1,000,000


4/18

$12,000,000

Kirby Lumber

$1,000,000

Kirby now owes bondholders$12 million


5/18

$12,000,000

Kirby Lumber

$1,000,000

Kirby now purchasesone bond back

for $862,000.

$138,000 Taxable?


6/18

Why would bond go down in value?

Ex. Bond issued when Kirby had

good credit. FM interest

rate was 8%. So Kirby can issue

a $1 million bond that pays $80,000

a year.

1,000,000 * .08 = 80,000

@ 8%


7/18

$1,000,000 * .08 = 80,000

@ 8%8%

10%

$800,000 * .10 = 80,000

If interest rates go up to 10%, would

you buy a 1,000,000 bond that paid

you $80,000?

I hope not. You either want a

$1,000,000 bond paying you$100,000 or an $800,000 bond

paying you $80,000.*

@ 10%

In real bond pricing, you would also build into the price the face amount of the bond. For more accurate

bond pricing see thisbond price calculator.www.spreadsheetconverter.com/calculate/html/financial/Bond_Price_Calculator/Bond_Price_Calculator.htm
http://www.spreadsheetconverter.com/calculate/html/financial/Bond_Price_Calculator/Bond_Price_Calculator.htmhttp://www.spreadsheetconverter.com/calculate/html/financial/Bond_Price_Calculator/Bond_Price_Calculator.htm


8/18

$1,000,000 * .08 = $80,000

@ 8%8%

10%

$800,000 * .10 = $80,000

Since the payout amount is

fixed at $80,000, only the

price of the bond can change.

The market rate for the bond,

thus becomes less than

its face value.

@ 10%

(The exact amount the bond will decrease is complicated because the face amount of the bond remains

constant. The price will reflect demand for the bond, which includes the interest rate of the bond and

the confidence buyers have in the issuers ability to repay the principal. This is a very simplified

summary of how bond prices react to changes in interest rates.)


9/18

$1,600,000 * .05 = $80,000

@ 5%

8%

5%

$1,000,000 * .08 = $80,000

The same thing would happen in

reverse if interest rates went down.

@ 8%


10/18

United States v. Kirby Lumber Co.

The cancellation of debt isgross income to theborrower.

FREEING OF ASSETS SYMMETRY

Loan proceeds not

included in gross income

upon receipt because of

obligation to repay.

Cancellation of obligation

to repay removes the

reason for excluding the

proceeds from income.


11/18

COD Income

INCLUDECOD income

[61(a)(12)]

EXCLUDE if

it occurs in

title 11 case

[108(a)(1)(A)]

EXCLUDE if

it occurs

when TPinsolvent

[108(a)(1)(B)]

EXCLUDE if

it is qualifiedfarm

indebtedness

[108(a)(1)(C)]

EXCLUDE if

it is qualified

real propertybusiness debt

[108(a)(1)(D)]

Must reduce

tax attributesas payment for

exclusion.

[108(b)(1)-(2)]


12/18

COD Income

INCLUDECOD income

[61(a)(12)]

EXCLUDE if

it occurs in

title 11 case

[108(a)(1)(A)]

EXCLUDE if

it occurs

when TPinsolvent

[108(a)(1)(B)]

EXCLUDE if

it is qualifiedfarm

indebtedness

[108(a)(1)(C)]

EXCLUDE if

it is qualified


[108(a)(1)(D)]

Must reduce

tax attributesas payment for

exclusion.

[108(b)(1)-(2)]


13/18

COD Income

INCLUDECOD income

[61(a)(12)]EXCLUDE if

it is qualified


[108(a)(1)(D)]

Must reducebasis aspayment forexclusion.

[108(c)(1)(A)]

108(c)(2)(A):

PRINCIPAL BALANCE

LESS BUSINESS REAL ESTATE EQUITY

MAXIMUM AMOUNT EXCLUDABLE

108(c)(2)(B):

Exclusion cannot exceed theaggregate bases of the taxpayers

depreciable real property held

immediately before discharge


14/18

Problem 3-16(b)

$50,000

$35,000

b) No income, insolvent 108(a)(1)(B)

Assets = ($40,000)


15/18

Problem 3-16(c)

$50,000

$35,000

c) $10,000 income

Assets Liabilities = ($5,000)


16/18

Problem 3-16(d)

$50,000property

$10,000 cash$40,000 debt


17/18

Hey! Thatpropertywas only

worth$42,000.

OK. Illreduce thenote from$40,000 to

$30,000

d) No gross income. Section 108(e)(5) provides that a reduction inprice shall be treated as a purchase price adjustment and not as thecancellation of debt.


18/18

Zar in v . Comm issioner

gross income tax

Documents