SkylarSkylar Corporation has suffered losses for several years, and its debts to
ID: 2335065 • Letter: S
Question
SkylarSkylar Corporation has suffered losses for several years, and its debts total $485,000; SkylarSkylar's assets are valued at only $360,000. SkylarSkylar's creditors agree to reduce SkylarSkylar's debts by one-half in order to permit the corporation to continue to operate. SkylarSkylar's NOL carryover is $140,000.
Requirements
a.
What impact does the reduction in debt have on SkylarSkylar's NOL?
b.
Is SkylarSkylar required to report any income?
a.
What impact does the reduction in debt have on SkylarSkylar's NOL?
b.
Is SkylarSkylar required to report any income?
Explanation / Answer
SOLUTION
A. The debt is reduced by 50% rate on a base of $485,000, so the debt reduction is $242,500 ($485,000*50%). Since the debt reduction does not occur during bankruptcy, the deductibility is subject to limitations.
Insolvency = Debts - Assets
= $485,000 - $360,000 = $125,000
Operating loss = NOL carryover - Insolvency
= $140,000 - $125,000 = $15,000
Therefore, the debt reduction is $242,500 and operating loss is $15,000
B. Income recognized = Debt reduction - Insolvency
= $242,500 - $125,000 = $117,500
Therefore, the company should include $117,500 in the gross income.
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