Nature of payments

Fact Situation

C Corp redeemed 48% shareholders stock for a note. Corp was to pay S/H interest only on the note for 5 years and then principal and interest on the note for five years. Corp completed the 1st 6 years of payments and then filed a Chapter 11 bankruptcy. S/H was classified as an unsecured creditor and was awarded an amount equal to 28 percent of pre-petition liability, paid monthly for three years without interest. What is the tax nature of the payment now - just principal? Or for tax purposes is interest imputed. Thanks Bill

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Reply to
Bill Lentz
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Principal only.

ChEAr$, Harlan Lunsford, EA n LA

Reply to
Harlan Lunsford

probably only principal

also, you may have a change in your installment sale profit %

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-----> real address on hobokeni or hobokenx

Reply to
Benjamin Yazersky CPA

With respect to the question concerning a shareholder who lent $ to his corporation, and who was granted a post-petition amount equal to 28% of the pre-petition liability, to be paid monthly for three years without interest. There does not appear to be an exemption from the OID rules or the unstated interest rules for post-petition debt recieved in payment of a pre-petition debt. Thus, for federal tax purposes, you will either have unstated interest under Sec. 483, or original issue discount under Secs.

1272-1275. In addition, under Code Sec. 7872, this should be treated as a shareholder to corporation loan (unless the corporation was dissolved, in which case it is a loan from the shareholder to whomever now has liability for the post-petition debt), and, because there is no stated interest, as a below-market loan. Thus, assuming the corporation is still extant, you should be regarded as having made an additional capital contribution to the corporation in an amount equal to the net present value of the interest that would have been paid by the corporation over the life of the debt if the debt had borne stated interest equal to the Applicable Federal Rate at the time the debt was issued (there are some wrinkles to determining that amount, so you should check with someone who knows the rules). This should be the correct characterization under Sec. 7872 because you were a shareholder at the time of the original debt transaction, and thus under the principles of Arrowsmith and the Origin of the Claim doctrine, the character of the post-petition debt should be traced back to the original pre-petition debt. As a result, you will have to include in income for each month the amount of the imputed interest the corporation is deemed to have paid to you from out of the constructive additional capital contribution you are deemed to have made. Alternatively, if there is a good reason to take the position that Sec. 7872 does not apply (I haven't comprehensively researched the issue - I'm not getting paid, after all - so there may be a case or a ruling that excludes you from 7872 because the initial debt was received in redemption of your stock), then you will have to recharacterize a portion of each payment you receive as interest income under either the unstated interest rules of Sec. 483 or the OID rules of Secs. 1272-1275. Under either scenario, the corporation will probably be entitled to a deduction for interest paid. In addition, if Sec. 7872 does not apply (because that section creates imputed interest out of whole cloth, instead of merely recharacterizing a portion of the payments received as income), then the effect of recharacterizing a portion of each payment as interest may be to increase the amount of any worthless debt deduction you may be allowed to claim because the net effect is that, instead of being paid 28% of your pre-petition debt in satisfaction thereof, you would be treated as having received only the deemed or unstated principal amount in satisfaction of your debt, which would be that 28% amount, less the net present value of the recharacterized interest payments. For example, if the amount you received post-petition was $280 (i.e., $1,000 pre-petition debt), and the effect of the imputed interest rules resulted in imputed interest with a net present value of $80, then for tax purposes you should be treated as having received a payment of $200 ($280 less $80 NPV of imputed interest), which would increase any available bad debt deduction from $720 to $800.
Reply to
Shyster1040

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