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FS-Cancellation of Debt Income
Jan L. Warner & Jan Collins

Question: My wife and I divorced after 15 years of marriage. Since we have no children, we had the opportunity to accumulate a good bit of wealth -- that is, until the stock market and real estate market nosedived on us. Still, in all, we were able to split nearly $2 million dollars in assets. We both still work. All papers have been completed and we have gone our separate ways, but both of my parents have died since we divorced, and in both of their wills, they direct that their estate deal with notes totalling $120,000 plus interest that my wife and I signed back in the early 1990s.

I have three siblings and my parents directed that everyone be treated equally. My wife and I used the money from these notes to purchase some of the property we have now, and we didn't think of notes when we settled our divorce. My brother, who is the personal representative of both estates, told me we could either pay the money back with interest or, alternatively, the estates would forgive the amounts and charge them to me. That would mean my wife would receive the benefit of my inheritance if the debts were to be forgiven.

My ex-wife says she won't pay anything because she and I completed our divorce and it's finalized. I feel sandbagged. Any suggestions?

Answer: First of all, with this kind of money and notes signed by both of you, it is inconceivable that the loans could have "slipped through the cracks" when you and your ex negotiated your divorce case.

That aside, there are other problems. If the debts are forgiven and cancelled, since you and your wife are both on the notes (jointly and severally, we assume), you will both most likely be saddled with additional income in the amount of your share of the forgiven debt. Called Cancellation of Debt Income, these amounts would be included in your respective gross incomes depending on the terms of the notes. The cancellation is considered income because you and your wife clearly had control over these sums.

In your case, we don't suggest that the loans be cancelled. Instead, we suggest that you pay back your share, plus interest. Your wife's statement that she is clear of these debts is misguided, in our view. She owes your parents -- and now their estates -- unless you previously agreed to assume these responsibilities solo.

That means that your parents' estates have viable legal claims against your wife for the principal and the interest; again dependent on the terms of the notes and your divorce settlement.

To be fair, unless you are willing to assume your wife's debts, you should go so far as to offer to pay the cost of collection from your ex-wife when the estates sue her.

Finally, it is difficult to understand how $120,000 used to increase your and your ex-wife's assets could be forgotten, especially when notes were signed. However, mistakes like these do tend to pop up in matrimonial cases. That's why is it a good idea for litigants to make sure their lawyers have all of the information required to avoid messes like this one. It is also a good idea for parents who lend money to take a security interest in assets so that their children won't end up forgetting them later on down the line.

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Suggested Reading:
Separation and Divorce Guidebook
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FS-Be Wary of Credit Issues with Ex
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FS-Becareful of Bargaining Away Alimony As Child Support
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FS-Lawyer Tells Me to Lie & Pension Double Dipped
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FS-On and Off Again Reconciles Can Create Agreement Disasters
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FS-The Dangers of Family Loans
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FS-Transference of Affection & 10 Tips of Divorce
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