There’s a push for lawmakers to help companies avoid taxes on canceled debts as they restructure—something congressional staff say they’re considering—as the pandemic has thrown oil and gas, retail, restaurant, and other sectors into a tailspin.
When loans are canceled or significantly amended, the forgiven debts or modifications can trigger taxes for the borrower, with exceptions for those that are insolvent or bankrupt, among others. The forgiven portions of the $660 billion in small-business loans provided by the third coronavirus response law (Public Law 116-136) won’t be subject to tax, but many companies that restructure after the crisis are likely to face taxes on what’s known as cancellation of debt income, tax and financial professionals say.
“I personally think that Congress is going to need to take a look at this and possibly remedy this, and I certainly know that they are at least thinking about it,” said Todd Maynes, a partner at Kirkland & Ellis and a member of the National Bankruptcy Conference. “For companies to survive, they’re going to need to restructure their debt, and if you can’t restructure your debt without triggering a big cash tax—then you sort of defeat the whole point.”
Airlines, hotels, and restaurant chains are most likely to be restructuring, and ending up with cancellation of debt income, in the wake of this crisis, Maynes said.
The National Bankruptcy Conference—an organization of judges, professors, and lawyers—asked congressional leaders to reenact tax code Section 108(i), which provided a deferral of cancellation of debt income in the aftermath of the 2008 financial crisis.
“It enabled companies to restructure out of court during the Great Recession, and we believe it can do so again in the face of the pandemic,” conference Chair Jane Vris wrote in an April 23 letter to party leaders in both chambers of Congress. “A significant increase in corporate bankruptcy filings resulting from covid is likely unavoidable, but we believe that a reenacted Section 108(i) can reduce that number.”
Already, commercial Chapter 11 filings rose 48% in May compared with the same month last year, according to the American Bankruptcy Institute.
Hill Staff ‘Taking a Look’
Maynes said he had heard that “the Senate Finance Committee is very positively inclined to either enact a new section 108(i), or actually fix the problem on a more permanent basis with a permanent solution,” calling it “very much on the table.”
Sarah Schaefer, a Democratic senior tax policy adviser on the committee, noted in an American Bar Association webcast Wednesday that Congress has used the measure before.
“There are proposals that have come up,” she said. “We’re reviewing those and it’s definitely something that we’re looking at.”
Randell Gartin, chief Republican tax counsel on the House Ways and Means Committee, who also spoke on the webcast, echoed Schaefer’s remarks.
“It was an important tool” back in 2009, he said. “People have come in and discussed that with us and we’re taking a look at that and seeing how, in this environment, it’s an appropriate relief measure as well.”
Earlier, a spokesperson for Senate Finance Committee Chairman Chuck Grassley (R-Iowa) said he “hasn’t weighed in on what specific policy proposals should be included in any future potential coronavirus legislation.” A spokesperson for House Ways and Means Committee Chairman Richard Neal (D-Mass.) said committee Democrats remained focused on a messaging bill known as the HEROES Act, as well as their part of a Democratic infrastructure package.
Ryan McCormick, senior vice president and counsel at the Real Estate Roundtable, said the group has been communicating the issue to tax committee leadership staff. Their effort stems from concerns that real estate businesses are and will be unable to pay their debts as tenants can’t pay their rents.
Lawmakers “are quite aware of the issue,” McCormick said, adding that he couldn’t speak to the likelihood that a related relief measure would make it into a future bill. “In all of our conversations, there’s a recognition that it’s an issue that should be considered, and that they might need or want to address.”
Rather than a deferral, McCormick said, the real estate group wants lawmakers to take a different approach—forcing companies to reduce the value of investment, or basis, in their property, or to lower the value of certain tax offsets, like losses and credits, rather than sticking them with upfront cancellation of debt income taxes. The approach would effectively push off the tax to when companies are better equipped to pay it.
For smaller borrowers, like small businesses and students, the group is also pushing for a universal annual exclusion of $250,000 in canceled debt from taxable income over three years starting March 13, 2020, McCormick said.
The Real Estate Roundtable also urged Treasury and IRS officials to delay by up to one year taxes on any income from cancellation of debt between March 1 and Aug. 31, 2020, under agencies’ authority to extend deadlines when there is a presidentially declared emergency. This, CEO Jeffrey DeBoer wrote, “will give time for the Congress and Administration to consider legislation or regulations that would provide tax rules for COD income that would apply after the one-year delay and that would reflect the current emergency situation, tax policy considerations, and general economic conditions.”
The lobbying group described the issue as one of its “remaining tax policy priorities” in April and said it broached it to Neal’s chief tax counsel, Andrew Grossman, at a virtual event earlier this month.
Companies with sufficient losses can offset their debt-cancellation income, said Jeff Schwarcz, managing director at Alvarez & Marsal Taxand in New York.
The third Covid-19 response law made that easier by temporarily lifting a cap on the amount of interest payments that companies can write off as a percentage of taxable income, as well as by temporarily relaxing a cap on the amount of income corporations can shield from tax using losses. Insolvent companies, despite not facing cancellation of debt income tax liability, may still have to reduce their tax offsets, which “may lead to more tax bills down the road,” Schwarcz told Bloomberg Tax.
“This becomes a modeling exercise,” he said, adding that companies that were doing well prior to the pandemic and don’t have a lot of losses to offset their tax liabilities are more likely to be stuck with cancellation of debt income they can’t write off.
Lobbyists at the Ready
Lobbyists familiar with the 2009 American Recovery and Reinvestment Act’s deferral of cancellation of debt income have been eyeing it as a potential relief measure for their clients in the current crisis.
In an April 12 policy analysis, lawyers and lobbyists at the firm Akin Gump Strauss Hauer & Feld LLP acknowledged the relaxed interest write-off limit in the third Covid-19 response law but said, “many companies were hoping that lawmakers would go farther” by suspending it outright.
“We understand that resurrecting Section 108(i) is coming up on calls between companies and policy advocates,” they wrote. “We would not be surprised if these discussions coalesce in an effort to include the provision in a future relief package.”
Amy Elliott, an Akin Gump senior practice attorney and one of the authors of the report, declined to comment on the analysis.
An April 1 presentation from the law firm DLA Piper listed the 2009 deferral as a “coronavirus-related market observation.”
“DLA Piper’s government affairs group is uniquely situated to advocate for similar provisions in upcoming legislation where our clients can make the case that such relief is necessary,” the presentation said. Three transactions tax partners at the firm, who were listed on the presentation, didn’t respond to requests for comment.
—With assistance from Siri Bulusu.