SPECIAL REPORT. tax notes. Surprise! New Rules Require Reporting of Debt Modifications. By Lee G. Zimet

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2 Surprise! New Rules Require Reporting of Debt Modifications By Lee G. Zimet Lee G. Zimet Lee G. Zimet is a principal at Berdon LLP. In this report, Zimet discusses new information reporting rules under section 6045B that require issuers to disclose debt modifications and other debt transactions on Form The new rules have received little public notice and will surprise many tax practitioners. Table of Contents I. Introduction II. Description of Statute and Regulations A. Organizational Action B. Specified Security C. Filing Requirements and Exemptions D. Effective Date E. Filing Form F. Exempt Recipients G. Penalties III. Application to Debt Instruments A. Issuer B. Organizational Action C. Specified Security D. Effective Date IV. Conclusion I. Introduction On January 1, 2014, the information reporting requirements of section 6045B were expanded to cover transactions regarding specific types of debt instruments. Thus, issuers are required to report transactions concerning specified debt instruments to the IRS (and the holders) on Form This new filing obligation for debt instruments came about with little notice or publicity. The change resulted from the delayed effective date for debt instruments under the section 6045B regulations issued in early SPECIAL REPORT tax notes The IRS has not issued any announcement reminding practitioners and the public of the change and has not issued any guidance on how section 6045B will apply to debt instruments. Adding to the confusion, the Form 8937 instructions have not been updated to take into account the increased number of transactions subject to the new filing requirements. Those instructions could lead one to believe that only corporate issuers of stock need to file Form We understand that the IRS is in the process of updating the instructions. II. Description of Statute and Regulations Under section 6045B, an issuer of a specified security must file an information return on Form 8937 if the issuer takes an organizational action that affects the adjusted basis of the security. 1 Generally, the issuer must file Form 8937 with the IRS and furnish a copy of the form (or a written statement) to each security holder (other than exempt holders). Section 6045B is generally effective for organizational actions regarding corporate stock that occur on or after January 1, Section 6045B was recently expanded by regulation to apply to organizational actions that affect the basis of specific types of debt instruments if the action occurs on or after January 1, A further expansion of section 6045B s reach will occur for organizational actions regarding debt instruments currently exempt from reporting under section 6045B to the extent that the action occurs on or after January 1, A. Organizational Action A key determinant of whether Form 8937 must be filed is whether an organizational action has occurred. Form 8937 is required only if the organizational action affects the security s adjusted basis. Unfortunately, the term organizational action is not defined by the tax code or applicable regulations. The regulations include only a few examples of organizational actions, all involving corporate stock. They include a distribution of property (whether in stock or cash), a stock split, and a redemption. 3 The legislative history indicates that a 1 Section 6045B(a); reg. section B-1(a)(1). 2 Sections 6045(g)(3)(C), 6045B(d); reg. section B-1(j). 3 Reg. section B-1(a)(2), (g), (h)(2). TAX NOTES, June 8,

3 COMMENTARY / SPECIAL REPORT merger or acquisition transaction would also constitute an organizational action. 4 B. Specified Security Section 6045B applies only to organizational actions regarding specified securities. A specified security generally includes (i) a share of stock issued by a corporation, (ii) a debt instrument, (iii) an option (or similar interest), and (iv) a securities futures contract. 5 A financial instrument will generally be considered a debt instrument for specified security purposes if the instrument (including a contractual arrangement) constitutes debt under general tax principles. 6 Also, a financial instrument will be considered to be a debt instrument if it is treated as debt under a specific code provision (for example, a regular interest in a real estate mortgage investment conduit). If the issuer has classified a financial interest as debt for federal income tax purpose, the interest will be treated as debt for specified security purposes. 7 Some debt instruments are exempted from the definition of specified security. They include: a regular interest in a REMIC; a qualified mortgage held by a REMIC; a debt instrument under which the principal is subject to acceleration (that is, the payments may be accelerated by prepayments of other obligations securing the instrument or other events); any pool of debt instruments the yield of which may be affected by prepayments or other events; and a debt instrument that has a fixed maturity date of one year or less from the date of issue (that is, a short-term obligation). 8 C. Filing Requirements and Exemptions If an organizational action occurs that affects the adjusted basis of a specified security, the issuer generally must file Form 8937 with the IRS and furnish a copy (or written statement) to all holders (other than exempt holders, discussed below). If all holders of a specified security are exempt holders (as reasonably determined by the issuer), an issuer is not required to file Form Because that exception will not apply if even one holder is 4 Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in the 110th Congress, JCS-1-09, at 367 (Mar. 18, 2009). 5 Sections 6045(g)(3)(B), 6045B(d); reg. sections (a)(14), B-1(a)(1). 6 Reg. sections (d), (a)(17). 7 Reg. section (a)(17). 8 Section 1272(a)(2)(C), (6)(C); reg. section (a)(14)(ii). 9 Reg. section B-1(a)(4). not exempt, it will not apply very often. One situation in which it will generally apply concerns wholly owned subsidiaries. Corporations are generally exempt holders, so a stock distribution by a wholly owned subsidiary to a parent corporation will meet this exception. Generally, the issuer of the specified security is the person responsible for filing Form 8937 and furnishing copies to holders. The filing requirement applies to foreign issuers of specified securities, as well as domestic issuers. 10 However, foreign issuers do not have a filing requirement regarding debt instruments for organizational actions before January 1, An acquiring or successor entity of an issuer must satisfy the issuer s reporting obligations to the extent that the issuer fails to satisfy them. This responsibility applies for both the obligation to file Form 8937 with the IRS and the obligation to furnish Form 8937 (or a written statement) to the holders. If neither party complies, they are jointly and severally liable for any penalties. 11 The applicable regulations do not offer guidance on when an entity is considered to be an acquiring or successor entity. The applicable regulations permit an issuer to use an agent to satisfy the section 6045B reporting requirements. Using an agent generally will not relieve the issuer from penalties. 12 D. Effective Date Section 6045B is generally effective for organizational actions that occur on or after January 1, The filing requirements of the provision went into effect in four stages, as follows for organizational actions that occur: on or after January 1, 2011 shares of corporate stock (other than stock in a regulated investment company); on or after January 1, 2012 shares of stock in a RIC; on or after January 1, 2014 specific types of debt instruments and options (and similar interests) and securities futures contracts; and on or after January 1, 2016 remaining debt instruments. 13 The original effective date for debt instruments, options (and similar interests), and securities futures contracts was for organizational actions on or after January 1, The IRS and the Treasury 10 IRS, Instructions for Form 8937, at 1 (rev. Dec. 2012). 11 Reg. section B-1(e). 12 Reg. section B-1(f). 13 Reg. sections (m)(2)(ii), B-1(j). 14 Sections 6045(g)(3)(C)(iii), 6045B(d) TAX NOTES, June 8, 2015

4 Department received numerous comments requesting postponement of that date. In May 2012 the IRS postponed the effective date until January 1, After receiving further comments requesting extensions, the effective date was postponed in the final regulations until January 1, 2016, for more complicated debt instruments. However, the IRS retained the January 1, 2014, effective date for relatively straightforward debt instruments, options (and similar interests), and securities futures contracts. The January 1, 2014, effective date generally applies to: debt instruments that provide for a single fixed payment schedule (or alternate payment schedules) for which the yield and maturity can be determined under the original issue discount rules; or debt instruments that provide for a fixed yield (even though one or more possible payments are contingent). 16 The section 6045B filing requirements are deferred until January 1, 2016, for the following (even if also described in the previous paragraph) 17 : debt instruments that provide for more than one rate of stated interest, including stepped interest rates (other than a penalty interest rate or adjustment to the stated interest rate upon an event of default or similar event); 18 a debt instrument that is convertible into equity of the issuer or a related party, the debt of a related party, or cash (or other property) in an amount that approximates the value of that equity or debt; 19 a stripped bond (that is, a bond when there is a separation in ownership between the principal and interest before the interest is due) or stripped coupon; 20 a foreign currency denominated debt instrument (that is, an instrument that requires a payment of principal or interest in a currency other than the U.S. dollar); 21 a debt instrument that entitles a holder to a tax credit (at one or more times in the future); 22 a debt instrument that provides for a paymentin-kind (PIK) feature (that is, the holder is COMMENTARY / SPECIAL REPORT entitled to additional debt instruments payable as interest or principal); 23 a debt instrument issued by a non-u.s. issuer; 24 a debt instrument issued as part of an investment unit (that is, a debt instrument and an option, security, or other property issued together as a unit); 25 or a debt instrument evidenced by a physical certificate unless the certificate is held (directly or indirectly through a nominee, agent, or subsidiary) by a securities depository or clearing organization. 26 The section 6045B filing requirements apply to all debt instruments that are specified securities for organizational actions that occur on or after January 1, The expansion covers the instruments described in the previous paragraph as well as (i) variable rate debt instruments, (ii) inflation-indexed debt instruments, and (iii) contingent payment debt instruments. 27 Remote and incidental contingencies are ignored for purposes of determining whether a debt instrument is subject to either the 2014 or 2016 effective date. 28 E. Filing Form 8937 An issuer of a specified security that must report a transaction on Form 8937 must include on the return information described in the statute, applicable regulations, and Form 8937 instructions. This generally includes (i) the issuer s name, taxpayer identification number, and contact information; (ii) information about the security (including identifying information and a description); and (iii) information about the organizational action (including a description of the transaction) and the tax treatment to the holders of the security. Also, the issuer must disclose the quantitative effect on the adjusted basis of the security in the hands of a hypothetical domestic taxpayer as an adjustment per share or as a percentage of old basis, including a description of how the calculation was determined, the data supporting the calculation (for example, market values and valuation dates), and any other information necessary for a hypothetical investor to implement the adjustment. 29 Form 8937 is signed by a representative of the issuer, as well as any paid preparer. 30 The requirement of having the paid preparer sign the form is 15 Notice , C.B Reg. sections (b)-(d), (n)(2)(i), B- 1(j)(3). 17 Reg. sections (n)(2)(ii), B-1(j)(3) and (4). 18 Reg. section (n)(2)(ii)(A), (iv). 19 Reg. sections (e), (n)(2)(ii)(B). 20 Section 1286(e); reg. section (n)(2)(ii)(C). 21 Reg. section (n)(2)(ii)(D). 22 Reg. section (n)(2)(ii)(E). 23 Reg. section (n)(2)(ii)(F). 24 Reg. section (n)(2)(ii)(G). 25 Section 1273(c)(2); reg. section (n)(2)(ii)(I). 26 Reg. section (n)(2)(ii)(J). 27 Reg. sections (n)(3), B-1(j)(4). 28 Reg. section (n)(2)(iii). 29 Section 6045B(a); reg. section B-1(a)(1). 30 IRS, Form 8937, at 2 (rev. Dec. 2011). TAX NOTES, June 8,

5 COMMENTARY / SPECIAL REPORT especially controversial because the return is an information return going to third parties. Other information returns (for example, Form 1099) are not signed by a paid preparer. CPAs and attorneys that sign Form 8937 as paid preparers can expect to receive calls directly from recipient holders because the firm s phone number will appear on the form. Form 8937 generally must be filed 45 days after the date of the organizational action. However, for organizational actions that occur in December, Form 8937 must be filed by January 15 of the following calendar year. 31 If the due date for filing Form 8937 falls on a Saturday, Sunday, or legal holiday, the due date is extended until the next day that is not a Saturday, Sunday, or legal holiday. 32 In many cases, all the facts necessary to determine the quantitative effect of the organizational action on adjusted basis may be unknown (or unknowable) at the time Form 8937 is due. In that case, the issuer may make reasonable assumptions regarding the facts. When this procedure is applied, the issuer must file a corrected Form 8937 within 45 days of determining facts that affect the calculation of the quantitative effect on adjusted basis. 33 It does not appear that the 45-day filing requirement is shortened to January 15 of the following calendar year when the facts are determined in December. An issuer may file Form 8937 before the organizational action occurs if the quantitative effect on basis can be determined beforehand. 34 An issuer might want to file Form 8937 before the transaction occurs (for example, with an offering document) to avoid having to separately mail information to holders after the transaction. For determining the Form 8937 due date regarding a redemption, the redemption is treated as occurring on the last day that a holder may redeem a security. 35 Thus, if there is a 60-day window for holders to redeem their shares or notes, Form 8937 generally would not be due until 45 days after the window closes. That rule helps issuers avoid having to make multiple filings for the same redemption offer. An issuer can avoid filing Form 8937 with the IRS if the issuer posts the form on its website in a readily accessible format by the return s due date. To meet that exception, the form must be posted on the issuer s primary public website in an area dedicated to this purpose. The public must be able to access the return for at least 10 years on the issuer s (or successor organization s) primary public website. 36 If Form 8937 is available on the issuer s primary public website, the issuer can electronically sign the return. In that case, the electronic signature must identify the individual attesting to the declaration. 37 A Form 8937 filed with the IRS also generally must be furnished (for example, mailed) by the issuer to each holder of the security (or the holder s nominee) by January 15 of the calendar year following the organizational action. 38 An issuer can choose to furnish to the holders and nominees a written statement with the same information that is in Form 8937 (instead of furnishing the form itself). The written statement must indicate that the information is being furnished to the IRS. 39 As with filing Form 8937, an issuer may furnish a holder with a copy of the form or a statement before the organizational action occurs if the quantitative effect on basis is determinable beforehand. For purposes of determining the due date for furnishing a holder with a copy of a form or statement regarding a redemption, the redemption is treated as occurring on the last day a holder may redeem a security. 40 If the issuer posts Form 8937 on its public website (instead of filing the return with the IRS), the issuer is deemed to have furnished the form to all its holders and nominees. 41 In that case, the issuer will not be required to physically furnish forms or statements to the holders and nominees. It appears that this alternative procedure can be used only if the form is posted within 45 days of the organizational action (even though the due date for furnishing copies of forms or statements to holders is not until January 15 of the calendar year following the action). If an issuer files a corrected Form 8937 with the IRS, a copy of the corrected form (or a revised written statement) must be furnished to the holders and nominees by the later of (i) the due date for furnishing copies of forms or statements to holders (that is, January 15 of the calendar year following the organizational action) or (ii) 45 days after the issuer determined the appropriate facts. 42 The issuer must generally furnish a separate copy of Form 8937 (or written statement) to each 31 Section 6045B(b); reg. section B-1(a)(2)(i), (g), Example (1)(ii). 32 Section 7503; reg. section (a). 33 Reg. section B-1(a)(2)(ii). 34 Reg. section B-1(a)(2)(i). 35 Id. 36 Section 6045B(e); reg. section B-1(a)(3), (g), Example 1(iii). 37 Reg. section B-1(a)(3). 38 Section 6045B(c); reg. section B-1(b)(1), (2). 39 Reg. section B-1(b)(1), (g), Example (1)(ii). 40 Reg. section B-1(b)(2). 41 Reg. section B-1(b)(4). 42 Reg. section B-1(b)(2) TAX NOTES, June 8, 2015

6 holder of record of the security (other than exempt recipients), as of the date of the organizational action. A copy of a form or statement must also be furnished to each subsequent holder of record (up to the date that the issuer furnishes the form or statement to holders). 43 Thus, it may be advantageous to furnish the forms or statements to holders before the January 15 deadline to avoid having to determine who the subsequent holders of record are. If a security is shown on the issuer s books as held by a nominee, the issuer must generally furnish the copy of Form 8937 (or written statement) to the nominee, instead of the holder. However, the copy of the form or statement should be furnished to the holder if the nominee of record is the issuer, the issuer s agent, or a plan operated by the issuer. 44 F. Exempt Recipients An issuer is not required to (but may) furnish a copy of Form 8937 (or written statement) to an exempt recipient (or its nominee). For this exemption to apply, the issuer must have actual knowledge that the holder is an exempt recipient or has received a properly completed exemption certificate from the holder under the backup withholding rules (generally on Form W-9). 45 An exemption certificate received from a corporation can be used to establish the corporation s exempt recipient status only if the certificate asserts that the filer is not an S corporation. 46 An exempt recipient is: a C corporation (domestic or foreign); a tax-exempt organization (including a charitable organization); a qualified pension, profit-sharing, or stock bonus plan of an employer; an IRA (including IRAs, Archer medical savings accounts, and health savings accounts); the United States, a state, the District of Columbia, or a possession of the United States (including a political subdivision or wholly owned agency or instrumentality of one or more of the foregoing or a pool or partnership composed exclusively of any of the foregoing); a foreign government (or political subdivision thereof) or international organization (or wholly owned agency or instrumentality of the foregoing); a foreign central bank of issue; 43 Reg. section B-1(b)(3). 44 Reg. section B-1(b)(3), (g), Example (3). 45 Reg. sections (h)-3, B-1(b)(5)(i); IRS, Instructions for Form 8937, at 2 (rev. Dec. 2012). 46 Reg. section B-1(b)(5)(ii)(C). COMMENTARY / SPECIAL REPORT a dealer in securities or commodities that is registered as such under U.S. or state law; a futures commission merchant registered as such with the Commodity Futures Trading Commission; a real estate investment trust; an entity registered (at all times during the tax year) under the Investment Company Act of 1940 (for example, a RIC); a common trust fund maintained by a bank; or a banking institution (for example, a bank, mutual savings bank, savings and loan association, building and loan association, cooperative bank, homestead association, credit union, industrial loan association or bank, or similar organization 47 ). 48 An S corporation cannot qualify as an exempt recipient regarding organizational actions that take place on or after January 1, There also does not appear to be an exemption for domestic partnerships, trusts, and estates (even if all partners, grantors, and beneficiaries are exempt recipients). The regulations regarding information returns for interest and OID provide for rules that allow issuers to treat some holders as exempt recipients (without having to collect withholding certificates) based on specific indicators. The section 6045B regulations largely incorporate those rules (with some modifications) and can be found in reg. section (c)(1)(ii)(A) through (M). 50 Under the information return rules for interest and OID, an issuer may treat as an exempt organization a payee whose name contains an unambiguous expression of corporate status such as Inc. or Corp. 51 The section 6045B regulations did not adopt that aspect of the rules (for organizational actions that occur on or after January 1, 2012). 52 Thus, a C corporation can generally qualify as an exempt recipient only if it provides a Form W-9 to the issuer. An issuer may treat a banking institution holder (foreign or domestic) as an exempt recipient (without requiring the holder to supply an exemption certificate) if the person s name reasonably indicates that it is a banking institution (for example, the name contains the words Bank, Banco, or Banque ). In the case of a foreign person, an issuer may also treat a person as an exempt recipient if it is on a list of banking institutions published or 47 Reg. section (c)(3)(i)(B)(11). 48 Reg. sections (c)(3)(i)(B), B-1(b)(5)(i); IRS, Instructions for Form 8937, at 1 (rev. Dec. 2012). 49 Reg. sections (c)(3)(i)(B)(1), B-1(b)(5)(ii)(C). 50 Reg. section B-1(b)(5)(i). 51 Reg. section (c)(1)(ii)(A)(1). 52 Reg. section B-1(b)(5)(ii). TAX NOTES, June 8,

7 COMMENTARY / SPECIAL REPORT approved by the IRS (for example, the Thomson Bank Directory or a list approved by the Federal Reserve Bank). 53 The above described exempt recipients do not include foreign holders (other than foreign governments, organizations, and central banks). Despite the omission, there appears to be a broad exemption for foreign holders. The Form 8937 instructions state that the requirement to file Form 8937 applies to both domestic and foreign issuers of securities if the security is owned by U.S. taxpayers. 54 The instructions later include foreign holders in a list of holders that are exempt recipients. 55 The instructions do not define the terms U.S. taxpayer or foreign holder. It appears that the omission of foreign holders from the list of exempt recipients was inadvertent. Other parts of the regulations provide rules for documenting that a foreign beneficial owner is an exempt recipient. Generally, an issuer may treat a foreign beneficial owner as an exempt recipient if specific requirements are met and the issuer has no actual knowledge that the holder is not an exempt recipient. An issuer may treat a foreign corporate holder as an exempt recipient (without requiring the holder to supply an exemption certificate) if the holder is listed as a per se corporation under reg. section (b)(8)(i). 56 An issuer can also treat a foreign corporate holder as an exempt recipient if the issuer receives a withholding certificate under the foreign taxpayer withholding rules (generally on Form W-8BEN-E) that includes a certification that the person is a foreign corporation. 57 An issuer may treat a foreign noncorporate holder as an exempt recipient if the issuer has received a certification of foreign status from the holder (before the transaction) under the foreign withholding rules (generally on Form W-8BEN or similar form). In some cases, the issuer may presume that the holder is a foreign holder if the presumption is also used for purposes of the rules for foreign withholding or information reporting of interest and OID. 58 Under the foreign withholding and information reporting rules, the exempt status of a foreign partnership (or other foreign flow-through entity) is generally determined based on the status of the partners (or ultimate owners if a partner is itself a partnership or flow-through entity). 59 Thus, it appears that the exempt status of all the ultimate owners of a foreign partnership (or other foreign flow-through entity) must be determined in assessing whether an organizational action is exempt from the filing requirement. G. Penalties The code imposes a relatively small penalty on an issuer that fails to file Form 8937 (or fails to file the form on time with all the required correct information). The penalty is generally $100 per Form 8937 that is not filed timely and correctly, but the penalties can be reduced or increased based on timing and level of compliance. 60 There are also penalties on an issuer that fails to timely furnish a correct Form 8937 (or written statement) to a holder. The penalty is the same amount as it is for failures to file timely correct Forms 8937 with the IRS. 61 There are limitations on the amount of the penalties for failure to furnish a timely correct form or statement to a holder. These limitations can be important because the penalty of $100 (or other amount) can be imposed per holder. (There are similar limitations on the penalties for failure to file a timely, correct Form 8937 with the IRS, but they are likely irrelevant because the penalty is so small.) The general limitation is $1.5 million per calendar year (but it can be reduced or increased based on timing and level of compliance). 62 The penalties described above (both for Form 8937 and for the form or statement that must be furnished to holders) can be waived if the failure is attributable to reasonable cause and not to willful neglect. 63 If an acquiring entity or a successor entity is required to meet an issuer s reporting obligations under section 6045B, that entity and the issuer are jointly and severally liable for any penalties. 64 An issuer can hire an agent to satisfy its reporting obligations, but that does not relieve the issuer of liability for penalties (unless the failure is attributable to reasonable cause and not to willful neglect) Reg. sections B-1(b)(5)(i), (c)(1)(ii)(M). 54 IRS, Instructions for Form 8937, at 1 (rev. Dec. 2012). 55 Id. 56 Reg. sections B-1(b)(5)(ii)(B), (c)(1)(ii)(A)(1). 57 Reg. sections (e)(2)(i), B-1(b)(5)(ii)(D); (c)(1)(ii)(A)(4). 58 Reg. section B-1(b)(5)(iii). 59 Reg. sections (c)(6)(ii), -5(c) through -5(e); reg. section T(c) through -5T(e). 60 Sections 6721(a), 6724(d)(1)(B)(iv). 61 Sections 6722(a), (b), (e), 6724(d)(2)(J). 62 Section 6722(a)(1). 63 Section 6724(a). 64 Reg. section B-1(e). 65 Reg. section B-1(f) TAX NOTES, June 8, 2015

8 III. Application to Debt Instruments There is significant uncertainty about the application of section 6045B to debt instruments, because the IRS has not issued any guidance and the instructions for Form 8937 have not been updated. It appears that debt issuers have failed to comply with section 6045B, ostensibly because they lack knowledge of the change. Many Form 8937 filers comply with section 6045B by posting the form (or an equivalent) on the filer s website. This is a preferred way to comply because it avoids the cost of sending a copy of Form 8937 to all the holders. I have not found a single instance in which Form 8937 for a debt transaction has been posted on a public website (except for stock-for-debt transactions, which were subject to section 6045B before January 1, 2014). Of course, it is possible that issuers filed the forms with the IRS instead of posting them. It is also possible that there were fewer debt modifications in 2014 than in prior years. Despite those possibilities, I would have expected to find a small number of public filings of Form 8937 regarding debt transactions. Because of the lack of guidance, many issues are unresolved. The following discussion analyzes some significant ones. A. Issuer Under section 6045B, an issuer of a specified security must file an information return on Form 8937, if the issuer takes an organizational action that affects the adjusted basis of the security. The term issuer is not defined in the code or applicable regulations. In most cases, determining who has issued a debt instrument (and the person responsible for filing Form 8937) will not be difficult. Under general tax principles, the issuer of a debt instrument is the person that issued the instrument to the holders. In most cases, the issuer is the borrower (that is, the person that received cash or property from the holders and is the primary obligor of the debt instrument as opposed to having a secondary obligation, such as a guarantor). Determining who issued the instrument can be a conceptual problem when there are joint obligations. In some cases in which there is a third-party guarantee, the guarantor has been treated as the issuer under general tax principles. 66 Presumably, in that case, the guarantor would be the correct person to file Form Section 6045B does not have rules providing exemptions to specific issuers (or class of issuers). 66 E.g., Plantation Patterns Inc. v. Commissioner, 462 F.2d 712, (5th Cir. 1972). COMMENTARY / SPECIAL REPORT Thus, section 6045B could apply to issuers and transactions for which one would expect an exemption. There is uncertainty about whether an individual (that is, a natural person) who issues a debt instrument can be treated as an issuer that must file Form Individuals are exempt from the requirement to issue Form 1099 for interest; 67 a similar exemption for Form 8937 would make sense, but the regulations do not appear to explicitly provide any such exemption. It is possible that individuals are generally exempt, because it might be difficult to describe an individual s action as an organizational action. However, if a single-member limited liability company that is owned by an individual issues a debt instrument, it is possible that the LLC s action regarding the instrument could be considered an organizational action requiring the individual to file Form To end some of the uncertainty, it would be helpful for the IRS to clarify whether individuals need to file Form It appears that partnerships and trusts can be an issuer for purposes of the Form 8937 filing requirement. Equity is considered to be a specified security only if it is stock in a corporation. The statute does not make a similar reference to corporations regarding whether a debt instrument is a specified security, so the type of issuer is not relevant for debt. There appears to be no exemption for debt issued by a governmental organization. Governmental organizations are exempt from the requirement to issue Form 1099 for interest. That exemption includes the United States, a state (or political subdivision thereof), the District of Columbia, a foreign government or an international organization (or agency or instrumentality thereof), or a foreign central bank. 68 Unlike for individuals, it might be more difficult to infer an exemption for governmental organizations based on the meaning of the term organizational action, although an exemption for Form 8937 would make sense. It seems that a foreign person can be an issuer for purposes of the Form 8937 filing requirements. 69 However, the effective date for a non-u.s. issuer (that is, a foreign issuer) has been delayed until January 1, The regulations do not define the term non-u.s. issuer, but it presumably includes an issuer that is a foreign entity (corporation, partnership, trust, or estate) or a nonresident alien Section 6049(b)(2)(A); reg. section (b)(1). 68 Section 6049(b)(2)(C)(i), (ii); reg. section (a)(2)(i). 69 Reg. sections (n)(2)(ii)(G), (3), B-1(j)(3), (4); IRS, Instructions for Form 8937, at 1 (rev. Dec. 2012). 70 Reg. sections (n)(2)(ii)(G), (3), B-1(j)(4). 71 See section 7701(a)(30). TAX NOTES, June 8,

9 COMMENTARY / SPECIAL REPORT Several unresolved issues will be relevant in 2016, when debt instruments issued by foreign issuers become subject to the section 6045B requirements. There appears to be no exemption for debt instruments issued outside the United States that are marketed only to foreign persons. Thus, it is possible that a foreign issuer could be required to file Form 8937 for an organizational action regarding a debt instrument that is issued outside the United States and not available for purchase in the United States. That situation could arise if a single U.S. individual, partnership, or trust (or a foreign partnership with a single U.S. partner) acquired some of the debt. To make matters more challenging from a compliance standpoint, some foreign issuers have bearer bonds outstanding, and it may not be possible for them to determine if all the holders are exempt owners. One hopes the IRS and Treasury will issue further guidance regarding foreign issuers before the end of There does not appear to be an exemption for small or de minimis transactions. Thus, it is possible that an organizational action regarding a debt instrument with a small face amount (for example, $1,000) will require filing Form Smaller transactions have been exempted from complicated rules. For example, debt instruments with a stated principal amount of $100 million or less are exempt from the need to determine if the instrument is publicly traded under the OID rules. 72 Based on the complexity of preparing Form 8937, a similar exemption may be warranted. Section 6045B was meant to provide adjusted basis information to brokers, so they could meet their reporting obligations under section 6045(g). Thus, one would expect to see an exemption for debt instruments unlikely to involve a broker. There is also no exception for debt instruments not of a type offered to the public. The registration-required obligation rules have had an exemption for debt instruments that is not of a type offered to the public since the 1980s, 73 so adding a similar exemption to section 6045B would not require writing complicated rules. It may also be appropriate to create an exemption for transactions between related parties or for debt instruments with a limited number of holders. B. Organizational Action A key determinant for whether Form 8937 must be filed is whether an organizational action has 72 Reg. section (f)(6). 73 Section 163(f)(2)(A)(ii); reg. sections 5f.103-1(b)(1), 5f.163-1(b)(2), (f), examples 1-5. occurred. As noted above, organizational action is not defined by either the code or applicable regulations. The regulations include two examples of organizational actions. Both examples involve stock issued by a corporation. They include a distribution of property by a corporation (whether in stock or cash) and a stock split. 74 The legislative history indicates that a merger or acquisition transaction would also constitute an organizational action. 75 Form 8937 is required only if the organizational action affects the adjusted basis of the security. A stock split or stock distribution will generally meet that requirement because the adjusted basis of the shares must be allocated between existing and new shares. 76 A cash distribution by a corporation will not affect the stock s adjusted basis if the amount of cash distributed is less than or equal to the issuer s earnings and profits. However, the adjusted basis will be affected if the distribution exceeds E&P. 77 Thus, whether Form 8937 is needed to report a cash distribution will depend on whether the cash distributed exceeds the amount of E&P. 78 The Form 8937 instructions provide useful information on which transactions are organizational actions that affect adjusted basis. Normally there would be uncertainty about whether a taxpayer could rely on the form instructions. However, section 6045B requires an issuer of a specified security to make a return and furnish statements to holders according to the forms or regulations prescribed. 79 This could indicate that the forms themselves are IRS guidance on which taxpayers may rely. The Form 8937 instructions indicate that a form must be filed only if the organizational action affects the adjusted basis of all the holders of the security (or all holders of a class of a security). For example, Form 8937 is not required if an option holder exercises an option to purchase stock for cash. That transaction affects only the adjusted basis of the exercising holder (not other stockholders). 80 A question arises whether an issuance of a security is an organizational action. The instructions to Form 8937 indicate that the form does not need to Reg. section B-1(g), examples 1-3, (h)(2), examples 1, 75 See JCS-1-09, supra note Reg. section B-1(g), examples 1, Section 301(c)(2). 78 Reg. section B-1(g), Example Section 6045B(a), (c). 80 IRS, Instructions for Form 8937, at 1 (rev. Dec. 2012) TAX NOTES, June 8, 2015

10 be filed for an initial public offering. 81 Many practitioners have interpreted this statement as meaning that an issuance of a specified security for cash is not an organizational action that affects basis. That exemption would make sense from a policy standpoint because a holder that purchases property for cash can generally determine the basis of the property with ease. Some practitioners have read the statement as implying that an issuance of a specified security for property is an organizational action. For example, an issuance of stock in a section 351 transaction is considered by many to be an organizational action that requires a filing. 82 Regarding which transactions involving debt instruments are organizational actions, the preamble to the section 6045B regulations states: A number of comments were received concerning returns relating to issuer actions affecting the basis of securities under section 6045B. Several commentators asked whether certain types of events would be reportable under section 6045B, including the issuance of a debt instrument, a reissuance of a debt instrument, and a reorganization in bankruptcy when new debt instruments are issued for old debt instruments. Section 6045B only applies to an issuer action that affects basis. The issuance of a debt instrument generally is not an issuer action affecting the basis of a debt instrument. Accordingly, in many cases, the issuance of a debt instrument is not subject to section 6045B. The legislative history, however, indicates that reorganizations, such as mergers and acquisitions, are among the organizational actions that can trigger reporting under section 6045B. Thus, for example, the issuance of a debt instrument in a recapitalization, including a recapitalization resulting from a significant modification or a bankruptcy reorganization, can be an issuer action affecting the basis of a debt instrument for purposes of section 6045B. 83 Based on that language, there appears generally to be a position to not report an issuance of a debt obligation, even if the debt was issued in exchange for property (other than debt). However, if the debt instrument was issued in exchange for debt for example, a recapitalization or corporate reorganization the transaction appears be an organizational action that must be reported. 81 Id. 82 Deloitte, Organizational Action Reporting by Corporate Issuers Frequently Asked Questions, M&A Insights, at 2 (Dec. 2013). 83 T.D COMMENTARY / SPECIAL REPORT If a holder acquires a debt instrument that has OID, the holder generally must include in gross income the accrued OID for each day the holder owns the debt instrument. 84 In that case, the holder s adjusted basis in the debt instrument increases by the amount of OID included in income. 85 Thus, the daily accrual of OID is an event that affects the adjusted basis of a debt instrument. A question arises whether the daily accrual of OID is an organizational action that requires the filing of Form 8937; no guidance on this point has been issued. There would be a valid argument that the mere accrual of OID under the original terms of the debt instrument is not an action taken by the issuer and cannot be an organizational action. That the accrual of OID is independently subject to information reporting on Form 1099-OID supports that position. 86 Reg. section provides rules for the modification of debt instruments. A modification includes a physical exchange of one debt instrument for another, as well as an alteration of a legal right or obligation, regardless of form. If the modification of the debt instrument is not a significant modification, the transaction is not treated as an exchange of one debt instrument for another, and the modification generally does not have any tax consequences. 87 If a modification is not significant, it would appear that an organizational action did not occur. If a modification is significant, both holder and issuer are treated as exchanging the original debt instrument for a modified debt instrument. 88 The preamble includes a recapitalization resulting from a significant modification as an example of a transaction that could be an organizational action for which a filing is required. A recapitalization generally includes an exchange of debt issued by a corporation for debt issued by the same issuer. 89 It is interesting that a recapitalization frequently does not result in a significant modification of debt (unless the yield or the timing of payments changes by more than a de minimis amount). 90 Because a recapitalization is only an example of an organizational action, it appears that a significant modification of debt issued by a partnership or trust would also qualify as an organizational action. 84 Section 1272(a)(1); reg. section (a)(1), (b)(1). 85 Section 1272(d)(2); reg. section (g). 86 Section 6049(d)(6)(A)(i). 87 Reg. section (a)(1), (b), (c)(1). 88 Reg. section (b). 89 Rev. Rul , C.B. 28; Rev. Rul , C.B. 311, obsoleted on other issues, T.D. 9182; Rev. Rul , C.B. 309; Rev. Rul , C.B Reg. section (e). TAX NOTES, June 8,

11 COMMENTARY / SPECIAL REPORT Based on the above analysis, many significant modifications of debt will be treated as organizational actions for which a filing is required. However, it may be possible to treat as an exempt transaction a significant modification in which the issuer, the issue price, and the number of bonds or notes does not change in the transaction. For example, A Corp. had issued 1,000 notes with an 8 percent interest rate (payable annually) for an issue price of $1,000 dollars per note. A Corp. then negotiates with the lenders an extension of the time to repay in exchange for an increase in the interest rate to 9 percent. (That change results in a significant modification of the debt because the yield increased by more than 5 percent of the original yield. 91 ) If the old and new debt instruments are not actively traded, the issue price of the new debt instrument would equal $1,000 per note (the same as the adjusted issue price of the old debt instrument). 92 Although the exchange could be either a taxable exchange or a tax-deferred recapitalization, it might be possible to avoid filing Form 8937, because the transaction is unlikely to affect the basis of the holders. In a taxable exchange, the new debt instrument s basis would generally equal its issue price. 93 In a tax-deferred recapitalization, the new debt instrument s basis would equal the basis of the old debt instrument for which it is exchanged. 94 Thus, for most of the original holders of the debt, the adjusted basis of the old debt and the basis of the new debt would equal $1,000 for each note. There is little reason to believe that a holder described in the previous paragraph would be surprised that the transaction did not affect the debt s basis, because only the interest rate changed. For subsequent purchasers of that debt, the transaction would affect the adjusted basis if the modification is a taxable exchange. The existence of subsequent holders may not affect the viability of the position, because the regulations allow filers to make reasonable assumptions of facts in determining the quantitative effect of an organizational action on an adjusted basis, 95 and it seems reasonable to assume that the holders for which the filing is made are the original holders. Support for the exemption described in the previous paragraph can be found in the section 6045B regulations regarding whether Form 8937 must be filed regarding an option for which the underlying stock is subject to a stock split. Form 8937 is required only if the number of option contracts changes as a result of the stock split. 96 For example, if there is a two-for-one stock split and the holder of a call option receives two option contracts to replace the previous single option contract, Form 8937 is required. Conversely, filing is not required when the terms of a call option to purchase 100 shares at $110 are altered to reflect a two-for-one stock split to 200 shares at $ A significant modification can also result from a change in the obligor. For example, a modification occurs when a debt instrument is assumed by a third party. A change in obligor generally does not result in a significant modification of debt when the obligor changes because of a corporate reorganization or an asset acquisition (that is, when the new obligor acquires substantially all the assets of the original obligor). 98 Thus, it may be unnecessary to file Form 8937 in those situations. A significant modification would occur if the obligor changed as a result of other sales of assets. For example, if a buyer purchases a parcel of real estate and assumes the seller s existing secured debt, the transaction would be treated as a significant modification if the debt had been recourse to the seller. 99 There is uncertainty whether an assumption of debt that is a significant modification is an organizational action that requires a filing, as well as uncertainty about which party has a filing obligation (the buyer, seller, or both). A deemed modification of debt occurs when a person that is related to the issuer of a debt instrument acquires debt (directly or indirectly) from a holder that is not related to the issuer (if as a result, the issuer realizes cancellation of debt income). 100 The applicable regulations provide that the related holder does not recognize gain or loss on the deemed exchange and the holder s adjusted basis in the acquired debt is unaffected by the deemed exchange. 101 It would appear that the issuer does not need to file Form 8937 to report the transaction because the action regardless of whether it was an organizational action by the issuer did not affect the holder s adjusted basis. There is much uncertainty about which payments that an issuer makes to a holder are organizational actions that require Form It seems clear that payments of qualified stated interest (QSI) are not required to be reported on Form Reg. section (e)(2)(ii). 92 Section 1274(a)(1); reg. sections (d)(1), (b)(1). 93 Reg. sections (g)(1), (a). 94 Section 358(a)(1). 95 Reg. section B-1(a)(2)(ii). 96 Reg. section B-1(h)(1). 97 Reg. section B-1(h)(2), Example (2). 98 Reg. section (e)(4)(i). 99 Reg. section (e)(4)(i), (ii), (g), examples 5(ii), (6)(ii). 100 Section 108(e)(4)(A); reg. section (a), (g)(1). 101 Reg. section (g)(2) TAX NOTES, June 8, 2015

12 because those payments do not affect the adjusted basis of the underlying debt instrument. A payment by an issuer to a holder regarding a debt obligation is generally allocated first to accrued QSI and then to accrued OID, and the remainder is allocated to principal. The allocation applies to payments required under the terms of the debt instrument and to unscheduled prepayments. 102 The amount of the payment allocable to accrued OID or principal reduces the holder s basis in the debt instrument (but not below zero). 103 It is uncertain whether a payment of OID or principal is an organizational action that requires filing Form The equivalent corporate stock transaction would be the payment of a cash distribution in excess of E&P. Such a payment results in a reduction in the holder s basis in the stock (but not below zero). 104 The regulations generally require that an issuer file Form 8937 to report a cash distribution that reduces the adjusted basis of the holder. 105 This suggests that a payment allocated to principal or OID would also require the issuer to file Form It might be possible to take a position that a payment that is legally required to be made by the terms of the debt instrument is not an organizational action. Such a position could avoid a requirement to file Form 8937 to report scheduled payments under a debt instrument. It would be more difficult to argue that a prepayment allocable to OID or principal is not an organizational action. It would be helpful for the IRS to issue guidance that exempts payments allocated to OID and principal from the filing requirement. The OID regulations contain special rules for pro rata prepayments of a debt instrument. A pro rata prepayment occurs when the issuer makes a prepayment (that is, a payment before maturity that is not made under the debt instrument s payment schedule) that results in a substantially pro rata reduction of each remaining payment on the debt instrument. 106 In that case, the debt instrument is bifurcated into two debt instruments (one that is retired because of the prepayment and one that remains outstanding). In that case, the holder s adjusted basis in the original debt instrument is allocated between the two bifurcated instruments. 107 It appears that such a transaction might be considered an organizational action that should be reported on Form COMMENTARY / SPECIAL REPORT Many debt instruments provide for interest that is not paid in cash. In that case, the interest is considered to be PIK, which is generally treated as OID for tax purposes. There are two principal approaches for debt instruments to provide for PIK interest. One approach is to increase the principal amount of the debt instrument by the amount of interest that would otherwise be paid in cash. The other approach is to pay the interest in PIK bonds. For example, if a holder is issued a $1,000 bond that provides for PIK interest at 10 percent (payable annually), the issuer could issue a $100 bond to the holder in payment of the first year s interest. The tax treatment is the same for both kinds of PIK bonds. The debt instrument is treated as having been issued with OID, and the holder accrues OID at a constant yield. When the instrument provides for PIK bonds, the original instrument and the PIK bonds are treated as a single debt instrument for tax purposes. 108 There is uncertainty whether providing PIK interest to a holder is an organizational action that requires Form It appears that the provision of PIK interest to a holder by means of an increase in the principal amount would not require the filing of Form In that case, the increase in the principal amount would not affect the holder s adjusted basis in the debt instrument. Instead, the adjusted basis increases as a result of the daily accrual by the holder of OID. A different result potentially occurs when the PIK interest is provided by means of PIK bonds. After the payment, the holder has two instruments (the original debt instrument and the PIK bond). This is somewhat analogous to a stock distribution or split, which are treated as organizational actions that affect adjusted basis. 109 It may be possible to avoid filing Form 8937 for the issuance of a PIK bond if the original debt instrument and the PIK bond cannot be separated (or cannot be sold separately). The effective date for filing Form 8937 for debt instruments that provide for the payment of PIK bonds is for organizational actions that occur on or after January 1, Another debt transaction that appears to have some uncertainty regarding Form 8937 is a payment of cash or property (other than debt) by the issuer in retirement of a debt obligation. Generally, a holder recognizes gain or loss as a result of a payment in retirement of a debt obligation. 111 One would not 102 Reg. sections (e)(1), (a)(1). 103 Reg. section (g). 104 Section 301(c)(2). 105 Reg. section B-1(g), Example Reg. section (f)(2). 107 Reg. section (f)(1). 108 Section 1273(a)(2); reg. sections (j), examples 7-8, (c)(3). 109 Reg. section B-1(g), examples 1, Reg. sections (n)(2)(ii)(F), (3), B-1(j)(4). 111 Section 1271(a)(1); reg. section TAX NOTES, June 8,