What Are Tax Attributes on Form 982?

When debt is canceled or discharged, it is often considered income. However, under circumstances like bankruptcy or insolvency, the Internal Revenue Service (IRS) allows this canceled debt to be excluded from gross income. This tax relief is reported on Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness. The exclusion requires a corresponding reduction of certain tax benefits, known as tax attributes, ensuring that while immediate tax liability is avoided, future tax advantages are diminished.

Defining the Tax Attributes

Tax attributes are specific items that can reduce a taxpayer’s liability in future years. When a taxpayer excludes canceled debt from income, the value of these attributes must be reduced. The attributes subject to reduction include:

• Net Operating Loss (NOL): An NOL occurs when a business’s allowable deductions exceed its income for the year. This creates a loss that can be carried forward to offset profits in subsequent years.
• General business credit carryover: This is a collection of various business-related credits that a taxpayer could not use in a particular year and is allowed to carry forward to reduce tax liability directly.
• Minimum tax credit: This credit is available to taxpayers who previously paid the alternative minimum tax (AMT), allowing them to recoup some of that payment against their regular tax in later years.
• Capital loss carryovers: When a taxpayer’s capital losses exceed their capital gains, the excess loss can be carried forward to offset capital gains in future years. For individuals, up to $3,000 of these losses can also reduce other types of income annually.
• Basis of property: This represents the taxpayer’s investment in an asset for tax purposes. A higher basis reduces the taxable gain when the property is sold, so reducing the basis means a larger gain will be recognized upon its future sale.
• Passive activity loss and credit carryovers: These are losses or credits from activities in which the taxpayer does not materially participate, such as certain rental real estate ventures. These carryovers can typically only be used to offset income from other passive activities.

The Standard Order of Attribute Reduction

The IRS mandates a specific sequence for reducing tax attributes when a taxpayer excludes canceled debt from income. This order must be followed unless a specific election is made to change it. The reduction is applied against the excluded income amount after the tax liability for the year of the debt discharge has been determined.

The first attribute to be reduced is the Net Operating Loss (NOL). Any NOL for the tax year of the discharge is reduced first, followed by any NOL carryovers. This reduction is applied on a dollar-for-dollar basis until the NOL is fully used or the excluded debt amount is exhausted.

If any excluded debt amount remains, the process moves to the general business credit carryover. For every dollar of excluded debt, the general business credit is reduced by 33 1/3 cents. The next attribute in line is the minimum tax credit, which is also reduced by 33 1/3 cents for each dollar of remaining excluded debt.

Following the credits, the sequence returns to dollar-for-dollar reductions. The capital loss and capital loss carryovers are reduced next. After that, the basis of property is reduced, but not below the amount of the taxpayer’s total liabilities immediately after the debt discharge. The final attributes in the standard order are passive activity loss and credit carryovers and foreign tax credit carryovers, with the credits also being reduced at the 33 1/3 cents on the dollar rate.

The Election to Reduce Basis First

Taxpayers have the option to deviate from the standard attribute reduction order through a specific election. This choice allows a taxpayer to first reduce the basis of depreciable property before reducing any other attributes. This can be a strategic decision for individuals and businesses who anticipate significant income in the near future and wish to preserve attributes that could offset that income.

By choosing to reduce the basis of depreciable property first, a taxpayer can protect Net Operating Losses (NOLs). An NOL can directly offset future ordinary income, which is often taxed at higher rates than capital gains. The trade-off is that reducing the property’s basis will lead to lower annual depreciation deductions and potentially a larger taxable gain when the asset is eventually sold.

This election is formally made on Form 982 by checking the box on line 5. By doing so, they agree to apply the excluded debt amount first against the basis of depreciable property. Any amount of excluded debt that remains after reducing the basis of all depreciable property to zero is then applied to the other tax attributes in their standard order, starting with the NOL.

How to Report Reductions on Form 982

Once the attribute reductions have been calculated, they must be reported in Part II of Form 982, titled “Reduction of Tax Attributes.” The form lists the attributes in the standard reduction order, providing a clear roadmap for reporting.

It is important to enter the actual amount of the credit reduction, which is the figure calculated at the 33 1/3 cents on the dollar rate, not the amount of excluded debt applied to it. The total reduction amount, which should equal the excluded debt, is entered on line 14.

The specific lines for each attribute are as follows:

• Line 6: Reduction of any Net Operating Loss.
• Line 7: The calculated reduction for the general business credit carryover.
• Line 8: The minimum tax credit reduction.
• Line 9: The reduction of capital loss carryovers.
• Line 10: The basis of property, which is split for non-depreciable and depreciable assets.
• Line 12: The reduction for passive activity loss and credit carryovers.
• Line 13: The foreign tax credit carryover reduction.