A few months ago we advised readers that it was time to put pencil to paper and calculate the potential savings in refinancing loans and other obligations ("Taking Advantage of Low Rates," Banking & Capital, December 1992, [Article link]). With attractive interest rates still available, our recommendation stands. But based on a recent U.S. Supreme Court decision and a subsequent proposal announced by the IRS in January, restructuring of debt may not be a free lunch after all.
Under the new guidelines, the refinancing of many business loans of more than $250,000 could be counted as an "event" subject to tax. If recognized as such, businesses refinancing after the effective date would be obliged to pay tax on the resulting difference in income.
Previously, notes Howard Sniderman, a partner in the Pittsburgh office of Deloitte & Touche, the rules governing refinancing were vague. But now that refinancing fever has swept the land, the IRS has proposed a series of new criteria for determining whether a debt modification has tax consequences. According to the IRS proposal FI 189-84 ("Modification of Debt Instruments"), refinancings can be taxable for any one of the following reasons:
cancellation of part of the principal,
rate changes of more than Â¼%,
rate changes from fixed rate to variable rate,
obligation changes from a recourse loan to a nonrecourse loan,
extension of loan maturity by more than five years,
involvement of a new lender,
the pledging of different collateral.
For more information, consult a library for the Internal Revenue Bulletin dated January 19, 1993, or the Federal Register dated December 22, 1992. -- Bruce G. Posner