Section 108 uses the shareholder’s basis for this route
When a shareholder contributes a corporation's indebtedness to capital, section 108(e)(6) generally treats the corporation as satisfying the debt for an amount equal to the shareholder's adjusted basis in that debt. An owner should therefore not assume that forgiving a $100,000 loan automatically eliminates $100,000 of corporate liability without income. If the shareholder's basis is less than the relevant debt amount, a cancellation-income difference can arise. The general capital-contribution exclusion does not override this special rule. This guide focuses on a C corporation; S corporations have additional statutory basis coordination that must be analyzed separately. A formal stock-for-debt exchange can invoke different rules, including fair-value treatment, and related-party debt acquisitions can have consequences before the contribution. Classify the actual transaction and debt history before selecting the tax treatment.
Compare face amount with supported creditor basis
Assume a shareholder has a $100,000 corporate principal claim and a supported $40,000 adjusted tax basis in it, with no accrued-interest complication. If the shareholder contributes that claim to the C corporation's capital under the applicable rule, the corporation generally is treated as satisfying $100,000 of debt for $40,000, producing a potential $60,000 cancellation-income amount before exclusions and other adjustments. At an assumed 21% corporate rate, that amount corresponds to $12,600 of federal tax if fully taxable. The example assumes the basis difference has been established through a transaction history whose separate related-party acquisition consequences were already addressed. It does not imply that buying one's own company's debt at a discount avoids earlier recognition. If basis instead equals the $100,000 principal, this isolated calculation can produce no difference, but the other transaction rules still must be reviewed.
Reconstruct the debt before releasing it
Collect original advances, purchase documents, principal and interest schedules, prior deductions, basis adjustments, repayment history, ownership dates, and any assignment of the claim. Determine whether the amount is bona fide debt rather than equity mislabeled as a loan. Separate accrued interest and other items whose payment would create a deduction or income under different rules. A liability balance in the corporation's ledger does not establish the shareholder's tax basis. If the debt was acquired while the holder was related to the debtor, review section 108(e)(4) and other acquisition rules separately. Preserve the legal release or contribution agreement and identify when the debt was actually discharged. A year-end journal entry chosen merely to clean up the balance sheet should not precede an analysis of who owned the claim and what tax investment remained in it.
Model the corporation and shareholder independently
Determine corporate cancellation income, any applicable exclusion and attribute reduction, shareholder stock basis consequences, and the treatment of the contributed debt. A shareholder cannot assume an immediate bad-debt deduction simply because the company removed the liability. Voluntary capital contribution and worthlessness are different events. Corporate insolvency or bankruptcy exclusions require their own evidence and can reduce tax attributes, so absence of current tax does not necessarily mean no economic tax cost. Keep C and S corporation rules distinct, especially where prior S losses reduced debt basis. If additional shares are issued, determine whether the transaction is actually a stock-for-debt exchange rather than the contribution route modeled here. The document and economic rights should match the tax analysis, with no unsupported choice between face value and fair value simply to obtain a lower income amount.
Compare cleanup alternatives before signing
Evaluate repayment, new cash capital, debt extension, contribution, or exchange using liquidity, lender covenants, ownership dilution, current income, and future basis. A debt cleanup can be worthwhile even with cancellation income, but the company needs a funded tax reserve. Prepare a closing schedule showing legal debt removed, creditor basis, deemed satisfaction amount, recognized or excluded income, attribute adjustments, and ending stock basis. Provide the same file to the corporation and shareholder preparers. The practical outcome is a supported recapitalization rather than a bookkeeping shortcut. Knowing the creditor's actual basis before releasing the claim prevents a founder from converting a financing problem into an unexpected corporate tax bill or assuming the shareholder receives a deduction for a claim deliberately contributed to equity.
Sources & further reading
Consult the original guidance and its effective dates. These references support the educational discussion; their application depends on the specific facts.