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On Thursday, June 3, 2010, the IRS issued proposed regulations (the “Proposed Regulations”) that are intended to clarify the extent to which the deterioration of an issuer’s credit quality is taken into account in determining whether a modified or altered debt instrument is considered debt for federal income tax purposes. The Proposed Regulations clarify an ambiguity in the current regulations governing the modification of debt instruments (the “1001 Regulations”) regarding whether an issuer’s financial condition is disregarded for the purpose of determining whether a modified debt instrument is, in fact, debt.

The Proposed Regulations provide that a deterioration in the financial condition of an obligor (as it relates to the obligor’s ability to repay the debt instrument) will generally not be taken into account for the purpose of determining whether a modified or altered debt instrument is respected as debt for federal income tax purposes. However, this rule does not apply in cases where there is a substitution of a new obligor or the addition or deletion of a co-obligor. If finalized, the Proposed Regulations will be effective for modifications occurring on or after the date on which the Proposed Regulations are finalized and published as final regulations in the Federal Register, although taxpayers will be entitled to rely on the Proposed Regulations with respect to earlier modifications.