Election promises major impact on debt restructuring


The candidates lay out contrasting futures for bankruptcy and distressed debt


The coming months may bring major tax changes to bankruptcy and distressed debt transactions.

President Donald Trump and Democratic nominee Joe Biden have laid out deeply contrasting visions for the future of tax policy, and regardless of who wins in November, the tax implications are likely to be significant. The IRS may also finalize regulations on built-in gains or losses after a Section 382 change in ownership. Together, these developments have the potential to dramatically alter the tax impact of debt restructuring. The following provides an overview of the possible changes and discusses how they might affect bankruptcy and distressed debt transactions.




Potential future tax changes



Tax plans of the presidential candidates


Trump has not yet released a formal tax plan, but he and his administration have long indicated a desire to expand upon the Tax Cuts and Jobs Act (TCJA), the president’s signature legislative achievement. Biden, on the other hand, has a robust tax platform that continues to expand and evolve even with the election just weeks away. The chart below compares key proposals that could impact bankruptcy and distressed debt transactions.



tax insights impact table chart



Proposed regulations


The IRS proposed regulations under Section 382 in September 2019 that, if finalized, could also have significant impacts on bankruptcy and distressed debt transactions.

Comparison of tax effect of sale based on various rate scenarios chart

Potential effects of future changes


The proposed changes under the presidential plans and the proposed Section 382 regulations may impact the tax consequences of bankruptcy and distressed debt transactions. It is difficult to predict the scope of the changes in the aggregate, but we can look at specific pieces that may be affected as a result of the changes.



Tax cost of debt workouts


In debt workouts, the debtor often realizes cancellation of debt (COD) income. In cases of Chapter 11 bankruptcy, the debtor can exclude the full amount of COD income from taxable income. For out-of-court workouts, however, the debtor can only exclude COD income from taxable income to the extent the debtor was insolvent prior to the cancellation. Even in the most severe cases, it is not uncommon that an insolvent debtor may recognize some taxable COD income in an out-of-court workout. In either a Chapter 11 bankruptcy or out-of-court workout, the debtor may recognize taxable income on the sale of assets. Assuming a debtor anticipates recognizing taxable income in a debt workout, the Biden plan is likely more costly given the increased corporate tax rates.

Additionally, under the Biden plan, debtors may be subject to alternative minimum taxes (AMT) on “book profits” greater than $100 million. Key details of the proposal have likely not yet been considered. However, if book profits are defined to include COD income, debt workouts (especially those above the $100 million threshold) may be more costly under the Biden plan, regardless of whether all or most of the COD income is excludable. The debtor may be able to offset AMT with NOLs, although, absent additional details, it is unclear how this offset would work in the connection with a debt workout. It is also possible that an exclusion for COD income would be made for AMT purposes.



Bruno’s Transaction


A Bruno’s Transaction generally involves the taxable sale of a debtor’s assets (for more details on Bruno’s Transactions, see our prior coverage and see CCA 200350016 for the IRS treatment of such a transaction). There can be significant tax benefits for the debtor to structure its emergence as a Bruno’s Transaction, but only in the right set of circumstance, which requires detailed analysis and consideration. As a result of the proposed changes under the presidential plans and the proposed Section 382 regulations, the levers of the analysis of a Bruno’s Transaction versus other debt for equity transactions could be significantly impacted. For example, the amount of tax basis step-up and usability of tax attributes post-transaction are parameters of the analysis that could be altered under the proposed changes.


Post-transaction tax attributes


Generally, taxpayers may want to avoid transactions that trigger ownership changes subject to Section 382 under the proposed taxpayer-unfavorable rules. In particular, distressed companies with built-in losses in their assets that have an ownership change may be significantly and negatively affected by the proposed Section 382 regulations’ changes to rules including the calculation of net-unrealized built-in gains or losses and the treatment of COD income. As of a result of these changes, the usability of a corporation’s tax attributes may be severely limited in a debt workout, which could create undue tax burdens post-emergence. Additionally, loss corporations with severe Section 382 limitations may want to consider a Bruno’s Transaction to recognize gains and utilize net operating losses prior to an ownership change.


Next steps


The proposed changes under the presidential tax plans and the proposed Section 382 regulations could have significant impacts on bankruptcy and distressed debt transactions. However, neither are final, and both could be subject to significant changes. Campaign proposals in particular tend to evolve considerably between election and enactment, if they are ever enacted at all. And regardless of who wins in November, any tax bill will face immense legislative and political hurdles. Still, companies should proactively consider the proposed policies and rules as they prepare future tax plans and potential debt workouts. They should also stay apprised of the latest developments as the election approaches and final regulations are promulgated.

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