Taxes

Question 1

What are the two main tax implications of bankruptcy?

Answer 1

1) Discharge of indebtedness income

2) NOL Carryforwards are lost when ownership changes

Question 2

What is discharge of indebtedness income?

Answer 2

When debt is reduced in a workout, the firm incurs taxable income to the extent of the debt forgiven (in Bankruptcy only NOLs are reduced, but it still hurts)

Question 3

What are the 2 exceptions for discharge of indebtedness income?

Answer 3

In bankruptcy, only NOLs are reduced (the tax hit can’t exceed the value of the NOLs)
Outside of Ch11, exchanges of old debt for new equity does not produce income to the extent of the insolvency

Question 4

What is the incentive effect of discharge of indebtedness income?

Answer 4

Firms may want to wait as long as possible to restructure

Question 5

Are NOLs really lost when ownership changes?

Answer 5

No, the IRS just caps the firm’s ability to use them

Question 6

What is an ownership change?

Answer 6

When prior shareholders or historic creditors continue to own at least 50% or more of the firm’s stock post reorg there is no ownership change

Question 7

What is a historic creditor?

Answer 7

Any creditor that owns <5% of the reorganized company

Any creditor that owns >5% of the reorganized company and acquired its interest at least 18 mo before bankruptcy

Question 8

What are arguments for and against a court enjoining claims trading to preserve NOLs in bankruptcy?

Answer 8

For: NOLs are a valuable asset of the company that the automatic stay should protect
Against: The claims traders are not trying to exercise control or obtain possession of the property of the estate. The claims trading prohibition could be sought strategically to prevent the entry of activist investors