Have you renegotiated a business note or loan? Paid the note holder a lower amount than the principal balance currently owing in satisfaction of the note? This could be a great tip to postpone the tax impact. Yes, I said tax impact. Under normal circumstances the amount of loan that was “extinguished” without being paid should be “Cancellation of Debt” income to you. This applies whether you are operating as a corporation or as an individual. Well the 2009 Recovery Act has come to your rescue. Under the new law if you reacquire business debt you can elect to postpone the payment of tax. This is where it gets good. You get to spread the effects over five years! Not good enough? How about this? The five years doesn’t start until 2014! That means you could postpone the tax on a cancelled debt until 2014 then spread it over five years! So you get the benefit of the reduced debt in 2009 and pay tax on it in equal increments in 2014, 2015, 2016, 2017, and 2018! If the cancellation occurs in 2010 it is also pushed to 2014 through 2018. After that it goes back to the same old treatment. If you have business debt cancelled on January 1, 2011 or later the COD income is taxable in that year.

Let’s go through an example. You currently have a $500,000 business note outstanding. You are able to negotiate an early payoff with the creditor in the amount of $350,000. The creditor might agree to this if they aren’t happy with their rate of return or are hungry for cash. Under the status quo, you would include the $150,000 difference as cancellation of debt (COD) income on your 2009 income tax return. (This applies to corporations and “any person in connection with the conduct of a trade or business by that person.” (clear as mud, I don’t write these laws, just report on them). Under the new regime, you report no COD income in 2009. In 2014 through 2018 you report $30,000 each year ($150,000 / 5 years). This is a much better answer. You postpone the tax payments and have plenty of time to plan how you will pay them. It also gives struggling businesses a breather to get back on their feet.

There is an important election that you must include with the 2009 tax return. You must tell the IRS you are electing to defer the taxable income. The IRS hasn’t issued guidance or regulations on what you need to include in your election. It will be very important to get it right. The IRS can be very picky about what seem like minor details. When it is time to file your tax return be sure to check the IRS web site and other sources for information on this important election. If you fail to include an election with the appropriate tax return the entire COD income is taxable in the current year.

UPDATE: Click here to see my post regarding the state tax implications of this matter.

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