Deceased Husband's Debt Haunts Wife

Dear To Her Credit,

My husband passed away in 2010. He had credit cards in his name only when he died.

Now I get 1099-C forms in the mail for cancellation of debt, dated April and May of 2012. How do I know what to do with these? How do I file, and am I liable for tax on this cancelled debt? I want to make sure I do everything right.

My husband didn't leave any will, insurance or anything.

-Monica

Dear Monica,

Losing a spouse is hard enough. When financial issues are left unresolved, it's even harder.

If the 1099-C forms are in your name, you are generally responsible for paying tax on the canceled debt, but only if you were liable for the debt in the first place.

However, figuring out if you are responsible for your spouse's debt is not always easy. You can start by determining if you are subject to community property laws.

If you live in a community property state, and you were married when your husband incurred the debt, you are generally liable for his debt. Community property states are Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. Alaska is an "opt-in" community property state.

If you do not live in a community property state, and you were not a joint cardholder with your husband, you are generally not liable for the debt.

However, community debt rules are not identical even in community property states. You may still be held responsible in a non-community property state in some cases; for example, if you benefitted from the purchases on a credit card.

From the perspective of the Internal Revenue Service, you should consider the following issues if you're not sure whether you were liable for canceled debts. IRS Publication 4681, Canceled Debts, Foreclosures, Repossessions, and Abandonments, says, "The amount, if any, you must report depends on all the facts and circumstances, including:

State law, (including community property laws)
The amount of debt proceeds each person received
How much of the basis of any co-owned property bought with the debt proceeds was allocated to each co-owner, and
Whether the canceled debt qualified for any of the exceptions or exclusions described in the publication."

Based on these circumstances, if you determine that you were liable for the debt, you must report the canceled debt as income for 2012.

On the other hand, Karla Dennis, licensed Enrolled Agent and CEO of Cohesive Tax in Cypress, Calif., says, "If the spouse was not jointly liable for the debt and they do not have an estate, then she does not need to report it."

If you're in doubt whether you should report the canceled debt, Dennis says, "The safe bet is to report it and then use IRS Form 982, Reduction of Tax Attributes Due to Discharge of Indebtedness, to show insolvency at the time." This strategy works if your debts exceeded your assets at the time the debt was canceled.

For more information, or if the amounts are significant and you are still worried, seek help from a tax professional in your area.