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The Treatment of Payments on Distressed Debt Instruments  

Author:  John Kaufmann.

Source: Volume 26, Number 01, Fall 2008 , pp.13-49(37)

Journal of Taxation of Investments

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The current rules for accounting for payments on debt instruments are not well-suited for the treatment of payments on distressed debt instruments. These include the rules for accruals of interest and OID under Reg. 1.451-1(a) and Sections 1272 to 1275 and the regulations thereunder, the rules for accounting for market discount under Sections 1276 to 1278, and the rules for allocating payments to interest and principal under the “interest first” rules of Regs. 1.446-2(e) and 1.1275-2(a). This article examines the applicability of the foregoing rules to distressed debt obligations, as well as the potential for treating pools of distressed debt obligations as single mass assets. The article notes the need for regulatory guidance in this area, and ends with a suggestion regarding the proper treatment of “distress” in this context. The article first examines whether owners of distressed debt are required to accrue coupon interest and OID on obligations that are substantially certain never to pay these amounts. Second, the article examines whether payments on distressed debt obligations should be treated wholly or in part as market discount.


Affiliations:  1: PricewaterhouseCoopers.

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