Tax Attributes: Definition, Mechanisms, and Examples

Tax attributes refer to specific economic benefits, including tax credits and losses, that undergo adjustment due to the exclusion of canceled debt from a taxpayer’s gross income. When a taxpayer encounters insolvency or declares bankruptcy, tax attributes are subject to modification to accommodate the exclusion of debt cancellation.

Taxpayers facing insolvency or bankruptcy are relieved from including forgiven debt as part of their taxable gross income, providing a measure of financial respite during challenging times. Section 108 of the Internal Revenue Code (IRC) exempts gains from forgiven debt from being factored into taxable income, offering relief to individuals and businesses navigating financial distress.

However, the exclusion of income under section 108 necessitates the reduction of certain tax attributes. Taxpayers offset future income by decreasing specific tax attributes dollar-for-dollar or by predefined proportions as stipulated by the IRS.

The IRC delineates a specific order in which taxpayers must reduce seven tax attributes, including net operating losses, general business credit carryover, and capital losses, among others. Taxpayers utilize irs form 982: reduction of tax attributes due to discharge of indebtedness to facilitate this reduction process.

Suppose a taxpayer has $5,000 in debt forgiven. in this scenario, the taxpayer may opt to reduce the basis (cost price) of their rental property by $5,000, thereby deferring the tax until the property’s eventual sale. Reducing the cost basis of an asset means that the taxpayer will recognize a higher taxable gain (or smaller loss) upon the asset’s sale. If the property is sold for a gain, $5,000 of that gain will be taxed as ordinary income.

Tax attributes play a crucial role in bankruptcy proceedings as they are adjusted to accommodate the exclusion of canceled debt from a taxpayer’s gross income. This adjustment allows taxpayers facing financial distress to receive favorable tax treatment while offsetting certain economic benefits.

While forgiven debt is generally excluded from taxable gross income under certain circumstances such as insolvency or bankruptcy, taxpayers must adhere to specific rules outlined in the Internal Revenue Code (IRC). Failure to comply with these rules may result in adverse tax consequences.