Cancellation of Debt and Related Transactions

48 Pages Posted: 11 Feb 2015 Last revised: 11 Mar 2015

Douglas A. Kahn

University of Michigan Law School

Jeffrey H. Kahn

Florida State University - College of Law

Date Written: February 9, 2015

Abstract

If a taxpayer borrows money, the borrowed funds are not included in the taxpayer’s gross income. That treatment is proper even though the taxpayer has increased his assets by the amount he borrowed since he has also has created a corresponding liability to pay back the loan. The taxpayer’s net wealth has not increased. The more difficult and interesting questions arise when the taxpayer fails to repay the loan. At first blush, it would appear that upon cancellation of a loan, the taxpayer should have income for the amount that was canceled. However, the current tax treatment is not that simple. A number of exceptions exist to the straightforward treatment under which the cancellation requires the taxpayer to recognize income. Some of those exceptions reflect an application of normal tax principles while others exist for programmatic purposes. Those exceptions make the tax treatment of cancellation of debt particularly complex.

The goal of this article is to set out the tax treatment of cancellation of debt, including the many exceptions that apply. It reviews the history of the cancellation of debt rules which help explain how we arrived at the current treatment. It covers the current statutory treatment of cancellation of debt as well as the many common law rules (such as the transactional approach and the tax benefit rule) that apply.

Keywords: Cancellation of Debt, Cancellation of Indebtedness, Transactional Approach, COD

JEL Classification: H2, H20, H24, H25, H29

Suggested Citation

Kahn, Douglas A. and Kahn, Jeffrey H., Cancellation of Debt and Related Transactions (February 9, 2015). Tax Lawyer, Forthcoming; U of Michigan Public Law Research Paper No. 441. Available at SSRN: https://ssrn.com/abstract=2562527

Douglas A. Kahn

University of Michigan Law School ( email )

625 South State Street
Ann Arbor, MI 48109-1215
United States
734-647-4043 (Phone)

Jeffrey H. Kahn (Contact Author)

Florida State University - College of Law ( email )

425 W. Jefferson Street
Tallahassee, FL 32306
United States
850.644.7474 (Phone)

HOME PAGE: http://www.law.fsu.edu/faculty/jkahn.html

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