[Federal Register Volume 81, Number 112 (Friday, June 10, 2016)]
[Rules and Regulations]
[Pages 37504-37507]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 2016-13779]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Part 1

[TD 9771]
RIN 1545-BJ14


Guidance Under Section 108(a) Concerning the Exclusion of Section 
61(a)(12) Discharge of Indebtedness Income of a Grantor Trust or a 
Disregarded Entity

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulation.

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SUMMARY: This document contains final regulations relating to the 
exclusion from gross income of discharge of indebtedness income of a 
grantor trust or an entity that is disregarded as an entity separate 
from its owner. These final regulations provide rules regarding the 
term ``taxpayer'' for purposes of applying the exclusion from gross 
income of discharge of indebtedness income of a grantor trust or a 
disregarded entity. These final regulations affect grantor trusts, 
disregarded entities, and their owners.

DATES: Effective Date: These regulations are effective on June 10, 
2016.
    Applicability Date: These regulations apply to discharge of 
indebtedness income occurring on or after June 10, 2016.

FOR FURTHER INFORMATION CONTACT: Frank J. Fisher or Amy Chang, (202) 
317-6850 (not a toll-free number).

SUPPLEMENTARY INFORMATION: 

Background

    These final regulations contain amendments to the Income Tax 
Regulations (26 CFR part 1) under section 108 of the Internal Revenue 
Code (Code). Section 61(a)(12) provides that income from the discharge 
of indebtedness is includible in gross income. However, such income may 
be excludable from gross income under section 108 in certain 
circumstances. Section 108(a)(1)(A) and (B) exclude from gross income 
any amount that would be includible in gross income by reason of the 
discharge of indebtedness of the taxpayer if the discharge occurs in a 
title 11 case or when the taxpayer is insolvent. Section 108(d)(1) 
through (3) provide the meaning of the terms ``indebtedness of the 
taxpayer,'' ``title 11 case,'' and ``insolvent,'' for purposes of 
applying section 108, and each definition uses the term ``taxpayer.'' 
Section 7701(a)(14) defines ``taxpayer'' as any person subject to any 
internal revenue tax.
    On April 13, 2011, the Treasury Department and the IRS published in 
the Federal Register (76 FR 20593) a notice of proposed rulemaking 
(REG-154159-09) (the proposed regulations) to provide rules under 
section 108(a) regarding the term ``taxpayer'' for purposes of applying 
section 108 to the discharge of indebtedness income of a grantor trust 
or an entity that is disregarded as an entity separate from its owner 
(disregarded entity). The proposed regulations provide that, for 
purposes of applying section 108(a)(1)(A) and (B) to the discharge of 
indebtedness income of a grantor trust or a disregarded entity, the 
term ``taxpayer,'' as used in section 108(a)(1) and (d)(1) through (3), 
refers to the owner of the grantor trust or the disregarded entity. The 
proposed regulations also provide that, in the case of a partnership, 
the owner rules apply at the partner level to the partners to whom the 
discharge of indebtedness is allocable. For example, if a partnership 
holds an interest in a grantor trust or a disregarded entity, the 
applicability of section 108(a)(1)(A) and (B) to the discharge of 
indebtedness income is tested by looking to each partner to whom the 
income is allocable. Lastly, the proposed regulations clarify that, 
subject to the special rule for partnerships under section 108(d)(6), 
the insolvency exclusion is available only if the owner is insolvent 
and the bankruptcy exclusion is available only if the owner is under 
the bankruptcy court's jurisdiction.
    The Treasury Department and the IRS received written comments 
responding to the notice of proposed rulemaking. The comments are 
available for public inspection at www.regulations.gov. No public 
hearing was requested or held. The comments are discussed in this 
preamble.

Summary of Comments and Explanation of Revisions

    After consideration of all the comments, the final regulations 
adopt the proposed regulations as modified by this Treasury decision. 
The purpose and scope of the proposed regulations and these final 
regulations are primarily limited to defining the term ``taxpayer'' for 
purposes of applying the bankruptcy and the insolvency exclusions from

[[Page 37505]]

gross income, under section 108(a)(1)(A) and (B), to the discharge of 
indebtedness income of a grantor trust or a disregarded entity. These 
final regulations are not intended to address section 108 in general 
and are not intended to address liabilities in general.

1. Other Exclusions Under Section 108(a)

    Two commenters recommended that the final regulations apply the 
provisions of the proposed regulations to all exclusions in section 
108(a), not only to the bankruptcy and the insolvency exclusions. 
Guidance on the other exclusions in section 108(a) is beyond the scope 
of these regulations.

2. Whether, Under Section 108(d)(2), the Owner Is ``Under the 
Jurisdiction'' of the Court in a Title 11 Case

    Section 108(a)(1)(A) provides, in part, that gross income does not 
include any amount which would be includible in gross income by reason 
of the discharge of the indebtedness of the taxpayer if the discharge 
occurs in a title 11 case. Section 108(d)(2) defines ``title 11 case'' 
as a case under title 11 of the United States Code (relating to 
bankruptcy), but only if the taxpayer is under the jurisdiction of the 
court in such case and the discharge of indebtedness is granted by the 
court or is pursuant to a plan approved by the court.
    Consistent with the proposed regulations, these regulations provide 
that the bankruptcy exclusion is available only if the owner of the 
grantor trust or the owner of the disregarded entity is under the 
jurisdiction of the court in a title 11 case. It is insufficient for 
the grantor trust or the disregarded entity to be under the 
jurisdiction of the court in a title 11 case. These regulations further 
clarify that the owner of the grantor trust or the owner of the 
disregarded entity must be under the jurisdiction of the court in a 
title 11 case of that owner as the ``debtor,'' as that term is defined 
in title 11 of the United States Code (the title 11 debtor).
    The commenters suggested that section 108(d)(2) does not require 
that the taxpayer be a title 11 debtor to be considered under the 
jurisdiction of the court in a title 11 case. One commenter recommended 
that an owner of a grantor trust or a disregarded entity be considered 
under the jurisdiction of the court in a title 11 case when that owner 
is indirectly liable for the debt of the grantor trust or the 
disregarded entity and the court in a title 11 case eliminates the 
owner's liability in conjunction with the cancellation of the debt of 
the grantor trust or disregarded entity. Another commenter recommended 
that an owner of a grantor trust or a disregarded entity be considered 
under the jurisdiction of the court in a title 11 case when either the 
owner has taken affirmative actions, such as filing a proof of claim or 
a proof of interest, that place the owner under the court's 
jurisdiction in a title 11 case, or the court otherwise asserts 
jurisdiction over the owner in connection with a title 11 case. A third 
commenter recommended that the owner of a disregarded entity be 
considered under the jurisdiction of the court in a title 11 case when: 
(1) The court asserts jurisdiction over that owner during the title 11 
proceeding of the disregarded entity; (2) the owner's liability on the 
discharged debt had been previously established (by contract or 
otherwise); (3) the owner is liable for all, or substantially all, of 
the discharged debt; and (4) qualifying for the bankruptcy exclusion 
was not a principal purpose of the owner's undertaking of such 
liability.
    The Treasury Department and the IRS have not adopted these 
recommendations because extending the bankruptcy exclusion to the owner 
of a grantor trust or a disregarded entity when that owner is not 
itself in bankruptcy would be inconsistent with the intended purpose of 
section 108(a)(1)(A), as reflected in the legislative history of that 
provision. Congress added the bankruptcy exclusion to the Code to allow 
insolvent debtors a ``fresh start'' after they have liquidated their 
assets to pay off creditors. S. Rep. No. 1035, 96th Cong., 2d Sess. 9-
10 (1980), 1980-2 CB 620, 624, provides:

    The rules of the [Bankruptcy Tax Act of 1980, Public Law 96-589, 
94 Stat. 3389 (1980)] concerning income tax treatment of debt 
discharge in bankruptcy are intended to accommodate bankruptcy 
policy and tax policy. To preserve the debtor's ``fresh start'' 
after bankruptcy, the bill provides that no income is recognized by 
reason of debt discharge in bankruptcy, so that a debtor coming out 
of bankruptcy (or an insolvent debtor outside bankruptcy) is not 
burdened with an immediate tax liability.

Here, Congress was referring to ``debtor'' as that term is defined in 
title 11. See 11 U.S.C. 101(12) (1980) (defining ``debtor'' as a person 
or municipality concerning which a case under title 11 has been 
commenced).

    The Bankruptcy Tax Act of 1980 was enacted to supplement the 
Bankruptcy Reform Act of 1978, Public Law 95-598, 92 Stat. 2549 (1978). 
See S. Rep. No. 1035, 96th Cong., 2d Sess. 9 (1980), 1980-2 CB 620, 
624. As indicated in the legislative history of the Bankruptcy Reform 
Act of 1978, the debtor's ``fresh start'' is conditioned upon the 
debtor committing all of its nonexempt assets to the jurisdiction of 
the bankruptcy court, either for sale by the trustee or to determine an 
appropriate plan to repay creditors. See H.R. Rep. No. 595, 95th Cong., 
1st Sess. 118, 125-26, 176 (1977). Congress did not intend that a 
solvent, non-debtor owner of a grantor trust or a disregarded entity, 
which has committed some but not all of its nonexempt assets to the 
bankruptcy court's jurisdiction, have an exclusion from discharge of 
indebtedness income merely by virtue of having some of its assets 
subject to the jurisdiction of the bankruptcy court.
    The commenters' recommendations are thus inconsistent with the 
Congressional intent underlying the Bankruptcy Tax Act of 1980 because 
those recommendations would provide a non-debtor owner that conducts 
only some of its activities through the grantor trust or disregarded 
entity with an unwarranted benefit when that owner is not a title 11 
debtor and is able to pay its tax liability.
    Accordingly, these regulations clarify that the owner of the 
grantor trust or disregarded entity must itself be under the 
jurisdiction of the court in a title 11 case as the title 11 debtor to 
qualify for the bankruptcy exclusion.

3. The Gracia Cases and the Application of the Bankruptcy Exclusion at 
the Partner Level

    A commenter noted uncertainty under existing law as to whether the 
holding in certain case law would be followed by the IRS. See Gracia v. 
Commissioner, T.C. Memo. 2004-147; Mirarchi v. Commissioner, T.C. Memo. 
2004-148; Price v. Commissioner, T.C. Memo. 2004-149; Estate of 
Martinez v. Commissioner, T.C. Memo. 2004-150 (collectively, the Gracia 
Cases). Because the bankruptcy court had asserted jurisdiction over 
non-debtor partners for certain matters, the Tax Court in the Gracia 
Cases upheld the application of the bankruptcy exclusion to the 
partners of a partnership that was a title 11 debtor, despite the fact 
that the partners were not title 11 debtors. The IRS's position is that 
the Gracia Cases failed to interpret correctly the limited scope of 
section 108(a)(1)(A), which applies only to partners that are also 
title 11 debtors. See Action on Decision 2015-01 (2015-6 IRB 579) 
(nonacquiescence in the Gracia Cases).
    These regulations provide that, in the case of a partnership that 
holds an interest in a grantor trust or a disregarded entity, the owner 
rules

[[Page 37506]]

apply at the level of the partners to whom the income is allocable. 
These regulations provide that the owner must be under the jurisdiction 
of the court in a title 11 case as the title 11 debtor to qualify for 
the bankruptcy exclusion. Accordingly, when the owner of the grantor 
trust or disregarded entity is a partnership, the partner to whom the 
income is allocable must be under the jurisdiction of the court in a 
title 11 case of that partner as the title 11 debtor to qualify for the 
bankruptcy exclusion.

4. Whether a Grantor Trust Can Be a Debtor in a Title 11 Case

    One commenter noted that a trust cannot generally be a debtor in a 
title 11 case. On the other hand, a business trust can be a debtor in a 
title 11 case but is generally treated as a business entity for both 
bankruptcy and Federal tax purposes. As such, the commenter noted 
uncertainty as to whether these regulations concerning the bankruptcy 
exclusion could ever apply to the bankruptcy of a grantor trust.
    These regulations account for the possibility that a trust that is 
treated as a grantor trust for Federal tax purposes may be treated as a 
business trust for purposes of eligibility to be a debtor in a title 11 
case. To provide comprehensive guidance, the Treasury Department and 
the IRS have retained references in these regulations to grantor trusts 
in the provisions concerning the bankruptcy exclusion.

5. Multiple-Owner Grantor Trusts

    A grantor trust is any portion of a trust that is treated, under 
subpart E of part I of subchapter J of chapter 1, as being owned by a 
grantor or another person. One commenter recommended that future 
guidance specify how a grantor's share of a multiple-owner grantor 
trust's liability should be determined for purposes of determining 
insolvency under section 108(d)(3). Specifically, that commenter 
recommended that future guidance or tax forms provide that a grantor 
trust is required to report the owner's share of the trust's 
liabilities. These regulations do not address these issues but the 
Treasury Department and the IRS invite comments regarding the 
application of section 108(d)(3) to the owners of a multiple-owner 
grantor trust. Submissions should be submitted to:
    In the case of submissions to the IRS submitted by U.S. Mail: 
Internal Revenue Service, Attn: Frank J. Fisher, CC:PSI:1, P.O. Box 
7604, Ben Franklin Station, Washington, DC 20044.
    In the case of submissions to the IRS submitted by a private 
delivery service: Internal Revenue Service, Attn: Frank J. Fisher, 
CC:PSI:1, 1111 Constitution Ave. NW., Washington, DC 20224.

6. Extent to Which Indebtedness of a Grantor Trust or a Disregarded 
Entity Is Treated as Indebtedness of the Owner, Whether Indebtedness Is 
Recourse or Nonrecourse Debt of the Owner, and the Effect on Insolvency

    For purposes of section 108, section 108(d)(1) defines the term 
``indebtedness of the taxpayer'' as any indebtedness for which the 
taxpayer is liable or subject to which the taxpayer holds property. One 
commenter recommended that the final regulations clarify that, for 
purposes of section 108(d)(1), indebtedness of a disregarded entity is 
indebtedness of the owner. In addition, a commenter recommended that 
the Treasury Department and the IRS clarify whether debt of a 
disregarded entity should be treated as recourse or nonrecourse debt of 
the owner for purposes of determining the amount of cancellation of 
debt income realized by the owner. That commenter suggested that the 
Treasury Department and the IRS issue guidance, in the form of an 
example in a regulation or a revenue ruling, as to whether the 
indebtedness of a grantor trust or a disregarded entity is recourse or 
nonrecourse indebtedness of the owner.
    In addition, commenters recommended approaches for determining the 
extent to which liabilities of a grantor trust or a disregarded entity 
are taken into account in measuring the owner's insolvency under 
section 108(d)(3) for purposes of the insolvency exclusion under 
section 108(a)(1)(B), including applying the principles of Revenue 
Ruling 92-53 (1992-2 CB 48). For purposes of the insolvency exclusion, 
section 108(d)(3) defines ``insolvency'' as the excess of liabilities 
over the fair market value of assets. Revenue Ruling 92-53 provides 
that the amount by which a nonrecourse debt exceeds the fair market 
value of the property securing the debt (excess nonrecourse debt) is 
taken into account in determining whether a taxpayer is insolvent 
within the meaning of section 108(d)(3) only to the extent that the 
excess nonrecourse debt is discharged.
    Comprehensive guidance on these issues is beyond the scope of these 
regulations. However, the Treasury Department and the IRS are of the 
view that indebtedness of a grantor trust or a disregarded entity is 
indebtedness of the owner for purposes of section 108(d)(1); assuming 
the owner has not guaranteed the indebtedness and is not otherwise 
liable for the indebtedness under applicable law, such indebtedness 
should generally be treated as nonrecourse indebtedness for purposes of 
applying the section 108(a)(1)(B) insolvency exclusion; and accordingly 
the principles of Revenue Ruling 92-53 apply to determine the extent to 
which such indebtedness is taken into account in determining the 
owner's insolvency under section 108(d)(3). The Treasury Department and 
the IRS continue to study these issues and anticipate publishing 
additional guidance providing further clarification. Accordingly, the 
Treasury Department and the IRS invite comments on these issues. 
Submissions should be submitted to:
    In the case of submissions to the IRS submitted by U.S. Mail: 
Internal Revenue Service, Attn: Seoyeon Sharon Park, CC:ITA:5, P.O. Box 
7604, Ben Franklin Station, Washington, DC 20044.
    In the case of submissions to the IRS submitted by a private 
delivery service: Internal Revenue Service, Attn: Seoyeon Sharon Park, 
CC:ITA:5, 1111 Constitution Ave. NW., Washington, DC 20224.

7. Valuation Discounts for Purposes of Section 108(d)(3)

    One commenter requested that the Treasury Department and the IRS 
clarify whether valuation discounts, if applicable to the owner's 
interest in a disregarded entity, could apply to the valuation of the 
assets and liabilities held by a disregarded entity for purposes of 
determining insolvency under section 108(d)(3). Guidance on this issue 
is beyond the scope of these regulations.

8. Effective/Applicability Date

    These final regulations apply to the discharge of indebtedness 
income occurring on or after the date these final regulations are 
published in the Federal Register.
    Some commenters requested that the Treasury Department and the IRS 
permit taxpayers to apply the final regulations retroactively to 
taxable years for which the period of limitations remain open. Another 
commenter requested that the final regulations specifically provide 
that the IRS will not challenge positions taken by taxpayers that apply 
the rules in the proposed regulations. The proposed regulations and 
these regulations are consistent with the existing statute. 
Accordingly, the IRS will not challenge return positions consistent 
with the proposed regulations, as clarified in these final regulations, 
for the period prior to the effective/applicability date of these final 
regulations.

[[Page 37507]]

Availability of IRS Documents

    For copies of recently issued Revenue Procedures, Revenue Rulings, 
notices, and other guidance published in the Internal Revenue Bulletin, 
please visit the IRS Web site at http://www.irs.gov.

Special Analyses

    Certain IRS regulations, including this one, are exempt from the 
requirements of Executive Order 12866, as supplemented and reaffirmed 
by Executive Order 13563. Therefore, a regulatory impact assessment is 
not required. It has also been determined that section 553(b) of the 
Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to 
these regulations, and because the regulations do not impose a 
collection of information on small entities, the Regulatory Flexibility 
Act (5 U.S.C. chapter 6) does not apply. Pursuant to section 7805(f) of 
the Code, these regulations have been submitted to the Chief Counsel 
for Advocacy of the Small Business Administration for comment on its 
impact on small business, and no comments were received.

Drafting Information

    The principal authors of these regulations are Frank J. Fisher and 
Amy Chang, Office of the Associate Chief Counsel (Passthroughs and 
Special Industries). However, other personnel from the Treasury 
Department and the IRS participated in the development of these 
regulations.

List of Subjects in 26 CFR Part 1

    Income taxes, Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR part 1 is amended as follows:

PART 1--INCOME TAXES

0
Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *


0
Par. 2. Section 1.108-9 is added to read as follows:


Sec.  1.108-9  Application of the bankruptcy and the insolvency 
provisions of section 108 to grantor trusts and disregarded entities.

    (a) General rule--(1) Owner is the taxpayer. For purposes of 
applying section 108(a)(1)(A) and (B) to discharge of indebtedness 
income of a grantor trust or a disregarded entity, neither the grantor 
trust nor the disregarded entity shall be considered to be the 
``taxpayer,'' as that term is used in section 108(a)(1) and (d)(1) 
through (3). Rather, for purposes of section 108(a)(1)(A) and (B) and 
(d)(1) through (3) and subject to section 108(d)(6), the owner of the 
grantor trust or the owner of the disregarded entity is the 
``taxpayer.''
    (2) The bankruptcy exclusion. If indebtedness of a grantor trust or 
a disregarded entity is discharged in a title 11 case, section 
108(a)(1)(A) applies to that discharged indebtedness only if the owner 
of the grantor trust or the owner of the disregarded entity is under 
the jurisdiction of the court in a title 11 case as the title 11 
debtor. If the grantor trust or the disregarded entity is under the 
jurisdiction of the court in a title 11 case as the title 11 debtor, 
but the owner of the grantor trust or the owner of the disregarded 
entity is not, section 108(a)(1)(A) does not apply to the discharge of 
indebtedness income.
    (3) The insolvency exclusion. Section 108(a)(1)(B) applies to the 
discharged indebtedness of a grantor trust or a disregarded entity only 
to the extent the owner of the grantor trust or the owner of the 
disregarded entity is insolvent. If the grantor trust or the 
disregarded entity is insolvent, but the owner of the grantor trust or 
the owner of the disregarded entity is solvent, section 108(a)(1)(B) 
does not apply to the discharge of indebtedness income.
    (b) Application to partnerships. Under section 108(d)(6), in the 
case of a partnership, section 108(a)(1)(A) and (B) applies at the 
partner level. If a partnership holds an interest in a grantor trust or 
a disregarded entity, the applicability of section 108(a)(1)(A) and (B) 
to the discharge of indebtedness income is tested by looking to each 
partner to whom the income is allocable.
    (c) Definitions--(1) Disregarded entity. For purposes of this 
section, a disregarded entity is an entity that is disregarded as an 
entity separate from its owner for Federal income tax purposes. See 
Sec.  301.7701-2(c)(2)(i) of this chapter, the Procedure and 
Administration Regulations. Examples of disregarded entities include a 
domestic single-member limited liability company that does not elect to 
be classified as a corporation for Federal income tax purposes pursuant 
to Sec.  301.7701-3 of this chapter, a corporation that is a qualified 
REIT subsidiary (within the meaning of section 856(i)(2)), and a 
corporation that is a qualified subchapter S subsidiary (within the 
meaning of section 1361(b)(3)(B)).
    (2) Grantor trust. For purposes of this section, a grantor trust is 
any portion of a trust that is treated under subpart E of part I of 
subchapter J of chapter 1 of subtitle A of title 26 of the United 
States Code as being owned by the grantor or another person.
    (3) Owner. Notwithstanding any other provision of this section to 
the contrary, neither a grantor trust nor a disregarded entity shall be 
considered an owner for purposes of this section.
    (4) Title 11 debtor. For purposes of this section, a title 11 
debtor is a debtor in a case under title 11 of the United States Code, 
as defined in 11 U.S.C. 101(13).
    (d) Applicability date. The rules of this section apply to 
discharge of indebtedness income occurring on or after June 10, 2016.

John Dalrymple,
 Deputy Commissioner for Services and Enforcement.
    Approved: May 25, 2016.
Mark J. Mazur,
Assistant Secretary of the Treasury (Tax Policy).
[FR Doc. 2016-13779 Filed 6-9-16; 8:45 am]
 BILLING CODE 4830-01-P