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With Forgiven Debt Both Spouses Can Get the Full Tax Bill

By on February 16, 2016

Question:

Dear Steve,

I came across your site doing research for a client on 1099-c from an ex spouse. Very helpful and it led me to this information on my Intelliconnect research site. You may already know this but I thought I would send it on. Thank you for your help and I just wanted to try and pay it back.

In a legal memorandum, the IRS addressed the issue of allocating discharge-of-indebtedness income resulting from a joint debt of a husband and wife when the spouses file separately for the year in which the debt is discharged. The Office of Chief Counsel advised that the discharge of all of the co-obligors of the full amount of a joint and several obligation by a creditor should not be treated as income to each co-obligor in the full amount of the discharged obligation. Rather, an appropriate allocation of the discharged indebtedness should be made between the co-obligors, based on all the facts and circumstances. CCA 200023001.

COMMENT

If the allocation can be made with certainty, IRS agents are instructed to issue a notice or notices of deficiency in accordance with the allocation. In a case in which it is not possible to make an appropriate allocation, the Chief Counsel advised that notices of deficiency should be issued to both spouses for the full amount of the discharged liability.

To the extent the debt being discharged is allocated to passive activity expenditures, discharge-of-indebtedness income is treated as passive activity gross income. Conversely, to the extent the debt is allocated to non-passive activity expenditures, the discharge-of-indebtedness income is treated as non-passive. See §3.440.

Shaun

Answer:

Dear Shaun,

This all looks like great advice and excellent research. I’ll be the first to admit I’m no tax expert and I nearly always turn to real tax experts when it comes to specific tax matters.

I attempted to verify your findings but I could not locate the specific section you referenced. Maybe you can come back and post a link to the specific section so readers can see exactly what you were referring to.

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However, I did find this IRS document from 1999 that did say, “Accordingly, if the allocation can be made with certainty, we recommend issuing a notice or notices of deficiency in accordance with the allocation. In a case in which it is not possible to make an appropriate allocation, we recommend issuing notices of deficiency to both spouses for the full amount of the discharged liability.”

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