T.C. Memo. 2010-77 (Jensen) highlights the complexities of divorce and taxes. In this case, the taxpayer received Form 1099-C, Cancellation of Debt, for a pre-divorce loan. Because the divorce decree stated the debt was incurred by his wife and assigned him right of indemnification under state law, he believed the debt forgiveness was income to her, not him, and he did not report it on his personal income tax return.
At issue: Whether the right of indemnification relieves liability for debt. (Right of indemnification means if the other party fails to pay as agreed, you can sue to make yourself whole again.)
The court ruled the income belonged to the taxpayer because the decree did not relieve him of his responsibility for the debt. The original contract was not altered. In addition, the term “incurred” was not clearly defined in the divorce decree and the taxpayer failed to prove he was not the borrower.
Taxing Lesson: Assumption of debt does not necessarily transfer legal obligation.