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Discharge of Partnership Debt

A creditor can discharge a partnership firm from its debt liability.  On such discharge, a partnership firm is said to receive an income.  This income of the partnership firm is called the Collection of Debt (COD) income.  The partnership firm will have to pay taxes for the COD income.

The COD income is distributed among the partners of a partnership firm.  The COD income is distributed according to the terms of the partnership agreement.  However if a partner’s interest is adversely affected by the distribution pattern adopted, the partners can deviate from the partnership agreement terms.  The income that each partner receives upon dissolution is considered a partner’s ordinary income.

By the discharge of a partnership debt, a partner is benefited in two ways:

  • the partner is discharged from his/her share of liability in the partnership debt; and
  • the partner is accredited with additional income.

Thus a partnership firm’s partner receives an economic benefit upon discharge of the partnership debt.  A partner who receives a COD income must maintain proper capital accounts.  The distribution of assets and liabilities must be made among the partners according to this capital account balance.  A partner who receives such COD income will have a Deficit Restoration Obligation (DRO).  DRO means the obligation of a partner to restore the deficit capital accounts upon partnership liquidation.

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