Partnership Taxation: Restructuring Partnership Debt - Life is Change

Abstract:     
With the economy slowly recovering from recession, the restructuring and discharge of partnership debt continue to generate important tax questions. US versus Kirby Lumber Co. (1931), which established the principle that income is realized to the extent a debt is discharged without payment, has been routinely cited for the proposition that cancellation of indebtedness income (COD) must be recognized because the debt relief frees assets of the taxpayer for other uses. The Kirby holding was codified as section 61(a)(12) of the Internal Revenue Code, and exceptions to COD found in section 108 were overhauled with the Bankruptcy Tax Act of 1980. The Code quite properly makes a partnership insolvency calculation at the partner level, giving the partners ultimate responsibility for partnership debt to the extent of personal liability. On the other hand, the exception to COD for purchase price adjustments improperly looks to the partnership entity when calculating insolvency, often yielding inconsistent results.

Number of Pages in PDF File: 56

Keywords: partnership debt, partnership taxation, U.S. v. Kirby Lumber, Bankruptcy Tax Act of 1980, COD, partnership insolvency

JEL Classification: K29, K34, H25, H29

Accepted Paper Series