Final Regulations for Cancellation of Debt Income Involving Partnerships with Disregarded Entities and Grantor Trusts as Partners
Treasury recently finalized regulations clarifying the application of the bankruptcy and insolvency exceptions to cancellation of debt income involving a debtor partnership with one or more partners that are disregarded for income tax purposes. Section 108(a)(1)(A) and (B) exclude cancellation of debt from income if the cancellation or discharge occurred in a bankruptcy case or to the extent the taxpayer is insolvent. Where the debtor is a tax partnership, these exceptions are applied at the partner level instead of at the partnership level. Where a partner is a disregarded entity or grantor trust, the final regulations clarify that the bankruptcy and insolvency exceptions are applied by looking through the disregarded entity or grantor trust to the ultimate owner for income tax purposes. Consequently, the insolvency analysis is applied to the ultimate owner of the disregarded entity or grantor trust, and not to the disregarded entity or grantor trust itself. Similarly, in order for the bankruptcy exception to apply, the ultimate owner of the disregarded entity or grantor trust must be subject to a bankruptcy court’s jurisdiction.
The final regulations can be found here: https://www.federalregister.gov/articles/2016/06/10/2016-13779/guidance-under-section-108a-concerning-the-exclusion-of-section-61a12-discharge-of-indebtedness