Discussion:Cancelled debt attributed to one taxpayer, but filing joint

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Discussion Forum Index --> Advanced Tax Questions --> Cancelled debt attributed to one taxpayer, but filing joint


Discussion Forum Index --> Tax Questions --> Cancelled debt attributed to one taxpayer, but filing joint

Kbairtax (talk|edits) said:

14 January 2011
Used the search box...did not find an answer.

Client had debt cancelled in 2010. This was credit card debt solely in her name. She will be filing jointly with her husband for 2010...separate is not really an option due to education credits that would be lost. I am at this point trying to determine if we may be able to exclude all or some of the cancelled debt under the insolvency rules.

In reading Pub 4681(I know not law), they give an example of joint debt when separate returns are filed. In that instance, the couple splits the cancelled debt into their appropriate portions and then determines insolvency separately. There is no example of one taxpayer having debt when filng a joint return.

My question is, can the wife take 1/2 of the joint assets and joint liabilities when determining her solvency or insolvency??? SHe has very little in retirement savings which also have to be included, whereby hubby has a large 401k account and a piece of property solely in his name. If we have to take all the assets and liabilities from both parties even though the debt was not joint, then there is no way they are insolvent.

Thanks in advance

Kevinh5 (talk|edits) said:

14 January 2011
I'm pretty sure that when you file jointly, you would use the assets and liabilities of both taxpayers to determine insolvency.

Tax Writer (talk|edits) said:

14 January 2011
I agree with Kevin. Maybe Dave Fogel can weigh in on this one, but the most obvious answer is that if the taxpayers want the benefits that come along with MFJ (including the education credits) they are going to have to deal with the negative consequences of filing jointly, too. The husband's retirement accounts would have to be included in determining insolvency, so therefore-- they are not insolvent.

The taxpayer can't have their cake and eat it, too.

Gosix (talk|edits) said:

14 January 2011
I would weigh the loss of education credits against the negated insolvency.

And forgoing the education credits and any other credits might be wise. Both from a standpoint of most tax relief for the buck, and more importantly isolating any problems that may eventually be associated with the insolvency claim into one separate spouse.

DaveFogel (talk|edits) said:

14 January 2011
I agree with all of the above. You can't file a joint return and decide to treat some items as if you had filed separately. See later post, below.

Kbairtax (talk|edits) said:

14 January 2011
All....this is what I was expecting. Just making sure I am not missing something...this is my first actual COD siutuation but it seems straight forward. Makes sense that under joint debt but separate returns, that the debt cancellation would be split. Was hoping for the opposite, but in reality it does not make sense.

Thanks everyone havea great weekend...not long now til the floodgates open!

DaveFogel (talk|edits) said:

14 January 2011
Just to make sure you're not reading the example incorrectly, in Example 3 on page 5 of Pub. 4681, both husband and wife were jointly and severally liable for the debt. They agreed between themselves to split the debt 75% to the husband and 25% to the wife (this is based on Chief Counsel Advice 200023001). Each of them filed separate returns. The husband was able to exclude part of his share of the cancellation of debt (COD) income based on the extent of his insolvency, and the wife was able to exclude all of her share of the COD income based on the extent of her insolvency.

In your original post, you indicated that the credit card debt was entirely the wife's debt, so it wouldn't be split between her and her husband. If she files a separate return, and based on the extent of her separate insolvency, she can exclude the entire amount of the COD income, then that seems the way to go. But since they'll lose the education credits by filing separately, you'll have to compare the tax on separate returns to a joint return to see which way is best. See later post, below.

Death&Taxes (talk|edits) said:

15 January 2011
Dave: would you comment on PLR 8920019 regarding the possibility of filing jointly without harming the insolvency of one of the parties? This was mentioned in a workbook from a seminar I attended. I realize a PLR only deals with the situation of the person asking, but if viable, it would seem one way Kbairtax's client might be able to claim the credits.

DaveFogel (talk|edits) said:

15 January 2011
WOW!! I'm impressed, D&T! According to PLR 8920019 ---

"the determination of a taxpayer's entitlement to the insolvency exclusion under section 108(a)(1)(B) is based on all the assets reachable by the individual taxpayer's creditors. The filing of a joint return, pursuant to section 6013(b) of the Code, does not affect whether a spouse's separate assets will be used to determine the insolvency of the taxpayer."

According to the facts of this ruling, the wife had COD income and was insolvent, but the husband was solvent, so they filed separate returns for 1986. The wife excluded the COD income on her separate return up to the extent of her insolvency. They then elected to file a joint return, and the IRS ruled that the wife's insolvency is based upon her own separate assets, even on a joint return. So, I stand corrected.

Gosix (talk|edits) said:

15 January 2011
Wow here too. Mark me down as shocked.

Unfortunately I believe we will be seeing a lot of these insolvency issues in the near future. Time to do some reading of PLR 8920019 .

Wonder how it all sorts out on the State tax return. With community property issues etc.

Tax Writer (talk|edits) said:

15 January 2011
That's a great cite, D&T-- I'm also impressed.

This is why I love Tax Almanac so much.

Death&Taxes (talk|edits) said:

15 January 2011
Thank Wayne Hebert, Jerry Riles and the NCPE Cajun crew.

Kbairtax (talk|edits) said:

15 January 2011
D & T...thanks so much for finding that PLR. I have it in the client file.

Gosix..good question. Luckily I am in NY....I don't get to say that often!!

Many thanks to all on your comments. I guess we all learned something...the beauty of this forum. I think we will see this more and more and I am in fact amazed this was not brought up sooner. I was sure the yellow box would have yielded something from 2007/2008 when people were losing their jobs left and right.

Now to the calculating.

Solomon (talk|edits) said:

15 January 2011
Dave is cited on the blog regarding this topic.

taxblogger

DaveFogel (talk|edits) said:

15 January 2011
I don't understand why I'm being thanked on this blog when it's Death&Taxes that found the PLR and that should take the credit.

EZTAX (talk|edits) said:

15 January 2011
"the determination of a taxpayer's entitlement to the insolvency exclusion under section 108(a)(1)(B) is based on all the assets reachable by the individual taxpayer's creditors. The filing of a joint return, pursuant to section 6013(b) of the Code, does not affect whether a spouse's separate assets will be used to determine the insolvency of the taxpayer."

How does this square with the fact that we are supposed to count retirement assets not reachable by creditors or am I wrong in that?

Tax Writer (talk|edits) said:

15 January 2011
For Pete's sake, boys! I made that post last night. I thanked Dave because he made the analysis. As for D&T-- I would love to thank him for finding the PLR. But I don't know his name. I don't want to thank "Death and Taxes". I guess I could thank Farfel. She'd probably enjoy the joke in Doggie heaven.

Death&Taxes (talk|edits) said:

15 January 2011
And as I noted on the other discussion, this PLR was mentioned in the wonderful material given out at the NCPE 1040 Update seminar in Atlantic City January 6-7.

DaveFogel (talk|edits) said:

15 January 2011
"How does this square with the fact that we are supposed to count retirement assets not reachable by creditors or am I wrong in that?"

I don't think you're wrong. Note that the conclusion in the PLR that insolvency is determined on the basis of assets reachable by creditors was overruled in a court case issued in 2001. In Carlson v. Commissioner, 116 T.C. 87 (2001), the Tax Court ruled that assets that may be exempt from claims of creditors are included in determining the taxpayer’s insolvency.

Tkelly911 (talk|edits) said:

15 January 2011
Dave,

How did you weigh PLR's in appeals, given the statutory lack of controlling authority? I have had reactions across the board from AO's. An example of this are the series of PLRs concerning the interpretation of unforeseen circumstances in IRC § 121. Sometimes my assertation that PLRs are often looked at as persuasive won out in a hazards of litigation analysis, while at other times this characterization was rejected out of hand.

Gosix (talk|edits) said:

15 January 2011
Safe = Filing separately

Aggressive = Joint

I'm not sure if getting a couple thousand worth of tax credits can offset the safety of filing separately in this issue. But that is just me. Client would have to determine if they feel the risk suits them and their needs. It all sounds good until and if challenge time comes around.

DaveFogel (talk|edits) said:

15 January 2011
Tkelly911, in Appeals, I considered PLRs, but they were "low on the totem pole" of authorities. If there was no other controlling authority, then I treated a PLR as the IRS's announcement of its position on a particular issue. If there was better authority, such as a Revenue Ruling or a court case, then they took precedence over a PLR.

As far as the interpretation of unforeseen circumstances under IRC §121, as long as the PLR doesn't conflict with either the Code, Regs., Rev. Ruls. or court cases, then I would treat it as IRS position.

As you probably know, PLRs may not be used or relied upon as precedent. See IRC §6110(k)(3). Nevertheless, they may be cited to show the practice of the Commissioner. See Rauenhorst v. Commissioner, 119 T.C. 157, n.8 (2002), and cases cited therein.

Death&Taxes (talk|edits) said:

16 January 2011
EZ: "How does this square with the fact that we are supposed to count retirement assets not reachable by creditors or am I wrong in that?"

Dave, quoting Tax Court, " the Tax Court ruled that assets that may be exempt from claims of creditors are included in determining the taxpayer’s insolvency."

So if the spouse with COD (and where the other spouse has no liability) does not have the exempt asets, ie, no retirement plan in his or her name, would these assets be listed on the insolvency claim on a joint return?

JulieCbell (talk|edits) said:

2 May 2011
So if a husband and wife are filing jointly and only one is insolvent, how do we determine the value of the assets if the couple has jointly owned assets? For example, if a house is owned jointly, do you have to count 100% of the house as a part of your assets or can you limit it to 50% for the purpose of the insolvency calcuation? I'm finding conflicting information.

Kbairtax (talk|edits) said:

3 May 2011
Julie....read PLR 8920019. It is worth the read and will give you valuable insight and will put you in the right direction.

JulieCbell (talk|edits) said:

3 May 2011
Thank you, Kbairtax. I have read this PLR and it was useful in understanding that the couple may file jointly. I understand that the part where it talks about assets exempt from claims of creditors was later revoked (see TAM 199935002). That leads me to believe either 50% or 100% of the joint assets should be included in the insolvency calculation, but I'm still unsure about which percentage to use.

Ricky (talk|edits) said:

20 June 2013
I have a situation where a husband has filed bankrupty (Chapter 7), got out of approximately $46,000 in a community property state (La).

I have been advised by the client the debt is primarily from his construction business which closed in 2009. The business predates his marriage to his current (2nd) wife, and he was 100% stockholder. Therefore he held the stock as separate property (not part of the community).

Will the Section 108 exclusion apply to the husband's debt cancellation?

WEISSEA (talk|edits) said:

20 June 2013
See PLR 8920019 where the insolvent COD spouse did not have to include the assets of the solvent spouse.

Terry Oraha (talk|edits) said:

20 June 2013
http://www.aicpa.org/publications/taxadviser/2012/december/pages/clinic-story-01.aspx

about measuring insolvency

Ricky (talk|edits) said:

20 June 2013
Thank you very much Terry.

From the Tax Advisor article: "While determining if a taxpayer is bankrupt is straightforward (the debt is discharged in a Title 11 case), determining whether a taxpayer is insolvent can be tricky."

So since we have a Chapter 7 case (under Title 11), I wonder if it is a "done deal", or do I still have to be concerned with the wife's possible solvency, although the husband was clearly (very) insolvent.

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