Insights

Debt Restructuring in Troubled Times - Watch for Tax Traps

Firm Thought Leadership

In the current economic climate, prudent businesses are considering whether to adjust or restructure their debt in order to preserve and maximize cash flow. Debt restructuring raise the risk of increased tax liability for the borrower by creating cancellation of indebtedness income (“CODI”), even in circumstances when the debt is not completely cancelled or forgiven. For the majority of taxpayers who restructure their debt, the tax consequences can be a very unwelcome side effect if not properly planned for. This alert will help readers (i) recognize circumstances in which CODI can arise, including debt buybacks or redemptions, debt-for-debt and stock-for-debt exchanges and less obvious triggers, including amendments and modifications to debt terms and lender forbearance and (ii) understand potential exceptions or planning options to mitigate CODI risks. By keeping the tax consequences front-of-mind when considering changes to debt, the best (or the least-bad) course of action can be selected.

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