Volume 5 Winter 2011 Number 2 - Charleston Law Review

2011] Tax Aspects—Financially Troubled Entitiesmodification event so that the yield on the debt instrument isreduced to a level below the applicable federal rate, then theissue price of the new debt instrument equates to the imputedprincipal amount. 68 The imputed principal amount is equal tothe sum of the present value of all payments due under the newinstrument, determined by using a discount rate that is equal tothe applicable federal rate, compounded semiannually. 69What if we use the same example but substitute a lower yieldfor a deferral of payments and assume that the principal of thenew debt instrument equals $940,000? On these facts, the lenderis deemed to receive an amount equal to the value of the newdebt instrument, or $940,000, and the lender generates a loss of$60,000. The debtor realizes cancellation of indebtedness incomeof $60,000. The new debt instrument also has original issuediscount of $60,000.C. Contingent Payments on New DebtThe regulations issued under § 1275 provide special rules tocover situations in which there are contingent payments, and therules distinguish between debt issued for publicly tradedproperty and debt issued for non-publicly traded property. 70However, these rules exempt a situation in which there is aremote likelihood that the contingency will occur or that thecontingency will not occur. 71 In addition, the regulations have acarve-out for incidental contingencies. 72 An incidentalcontingency is one in which the potential amount of thecontingency is insignificant when compared to the expectedamount of remaining payments on the obligation. 73If the modified debt instrument falls under the rules forpublicly traded property, then the interest on the contingentpayment debt instrument must be computed using the68. I.R.C. § 1274(a)(2).69. I.R.C. § 1274(b).70. I.R.C. § 1275.71. Treas. Reg. § 1.1275-2(h)(2) (2001).72. § 1.1275-2(h)(3).73. Id.243