Every year, hundreds of thousands of people across the US file for bankruptcy. In 2019, 772,646 Americans filed for bankruptcy. While most people who file for bankruptcy understand it can significantly impact their lives, many don't expect it to affect their estate plans.
If you're considering filing for bankruptcy, knowing how it will influence your estate plan can allow you to preserve your legacy more easily.
How Does Bankruptcy Affect Estate Plans?
The short answer to this question is: it depends. How significantly your estate plan changes as a result of your bankruptcy filing largely depends on whether your file for a Chapter 7 or a Chapter 13 bankruptcy.
In a Chapter 7 bankruptcy, you agree to liquidate your assets (minus vital assets such as your home or car) to repay creditors. The United States Trustee Program (part of the Department of Justice) appoints a bankruptcy trustee to your case, who works with you and your creditors to determine an acceptable arrangement for all parties. To file for Chapter 7 bankruptcy, you have to meet specific requirements, such as making less than the median income for your state.
In a Chapter 13 bankruptcy, instead of selling assets to repay creditors, the trustee works with you to set up a repayment plan so you can repay your creditors within a specified time frame (often 3-5 years). To file for Chapter 13 bankruptcy, you cannot exceed a certain amount of debt, and you must make enough money for your creditors to consider a repayment plan a feasible option.
Filing for a Chapter 7 bankruptcy is more likely to affect your estate plan and documents such as your will then filing for a Chapter 13 bankruptcy. Because Chapter 7 bankruptcies liquidate assets to repay debts, it's possible some assets you own that you intended to be passed down in your will instead get seized by creditors to repay your debts.
How Can I Protect Assets?
One way to protect assets is by creating an irrevocable trust. If you draft and sign an irrevocable trust, you immediately relinquish your right to any assets included in the trust, abdicating them to the individual(s) named in the trust.
However, irrevocable trusts created immediately before bankruptcy are typically considered invalid by the bankruptcy court. The court wants to prevent individuals on the brink of bankruptcy from using irrevocable trusts to protect assets, so you need to create the irrevocable trust far in advance of your bankruptcy for it to stand up in court.
What Happens if I Inherit an Estate in Bankruptcy?
If a bankrupt debtor dies, their beneficiaries inherit the bankruptcy estate. In most cases, if you inherit a Chapter 7 bankruptcy, you'll need to liquidate your inherited assets to pay off the decedent's creditors. Once any creditors are fully paid off, you'll get the remainder of the inheritance.
If you inherit a Chapter 13 bankruptcy estate, however, things might be different. You may be able to ask the estate administrator to file for case dismissal or discharge the debt since the debtor passed away. You may also be able to ask the bankruptcy court to convert the estate into a Chapter 7 bankruptcy, allowing you to quickly liquidate assets to pay debts and then collect the remainder of the inheritance. The judge presiding over the case will make the final decision.
The steps you take during your bankruptcy case can significantly change how it impacts your estate plan. At the Law Office of Russell S. Hershkowitz, LLC, our attorney has decades of experience helping clients navigate bankruptcy cases.
To receive a free consultation with our team, contact us online or give us a call at (407) 753-4111.