Guarantor Does Not Have COD Income Upon Discharge Of Guaranty

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In Howard Mylander (T.C. Memo 2014-191, September 17, 2014), Judge Vasquez had before the court the correct tax treatment of a guarantor of a debt in a situation where the guaranty became due and payable and was then reduced as a result of a negotiation between the parties.

Citing pertinent case law Hunt (T.C. Memo 1990-248 and Landreth (50 T.C. 803 (1968))), the Tax Court held that since the guarantor would not have an accession to wealth due to the cancellation of the guaranty-meaning that the guarantor did not receive any nontaxed loan proceeds-the cancellation of the guaranty did not generate cancellation of indebtedness income.

This opinion is clearly correct when you think about it because the guarantor ends up with a balance sheet that is not increased by a prior receipt of untaxed cash or property. The guarantor may end up with a balance sheet that is not decreased from what it was before the guaranty was entered into but the guaranty transaction itself did not result in an untaxed accession to wealth.

This case did not involve partnerships. And yes, it is true that a guarantee by a partner of a partnership can result in the partner obtaining tax basis for a guaranty if properly structured without an outlay of cash upfront. But unless the partner as guarantor uses that tax basis to offset either distributions from the partnership or loss allocations from the partnership, the partner will not have income under sections 752(b) and 731(a) if the guaranty was cancelled.

However, the use of the tax basis generated by the guarantee will result in income to the partner when the guaranty is cancelled (under the prior code sections and assuming that no other transaction intervenes to change that result). Thus, if the tax basis is used by the guarantor partner, it is no different than an untaxed accession to wealth. And so the tax rules in the partnership world and outside of that world appear to be in sync.

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