Palm Springs Law Blog

Monday, September 5, 2022

How Bankruptcy Can Impact Your Estate Plan

Bankruptcies are triggered for many reasons. Many fall outside your control. According to one report, unpaid medical bills are the top reason for U.S. bankruptcies.

Many Americans face immense financial pressures in their senior years due to living on a fixed income and having major medical issues. If you face bankruptcy, you should understand how it will affect your estate plan.

Here are some ways bankruptcy could affect your estate plan.

Chapter 7 and Chapter 13 Bankruptcies

Bankruptcies happen when your debts exceed your income. Declaring bankruptcy protects you from your creditors while you repay at least some of your debts and start over financially. The two most common ways to financially start over are liquidation under Chapter 7 and reorganization under Chapter 13 of the Bankruptcy Act.

In a liquidation, your assets get sold to pay your creditors. In a reorganization, you work out a repayment plan for your debts.

What happens to your debts upon your death?

Only people and businesses can file bankruptcies. An estate cannot file for bankruptcy. After you die, your creditors can file a claim with the probate court. The estate will pay your debts. If your estate needs to liquidate assets to pay your debts, your executor will have the power to do that.

Anything left over will get distributed according to your estate plan. If your entire estate goes to paying off your debts, your heirs will not receive anything.

How Bankruptcy Affects an Estate Plan

The effect of bankruptcy on your estate plan will depend on which type of bankruptcy you file.

Chapter 7 Bankruptcy

If you die after filing Chapter 7 bankruptcy, the case will continue. Even though an estate cannot file a bankruptcy petition, the estate can remain in the case after you die.

The bankruptcy will proceed with liquidation by selling your assets. Your secured creditors will be paid from the bankruptcy estate. After all qualifying creditors are paid, most of the remaining debts will be discharged. This means those debts get wiped out, and the creditors cannot file a claim against your estate in probate court.

The bankruptcy court cannot discharge some debts. For example, courts cannot discharge tax debts. If there was anything left in your estate after the bankruptcy ended, the creditors on these non-dischargeable debts could file a claim in probate court.

Chapter 13 Bankruptcy

If you die after filing a Chapter 13 bankruptcy, your executor has options. After you die, you cannot make payments to your creditors under the payment plan you negotiated. The bankruptcy court will decide how to handle your case after your death. Some options include:

End the Case

A judge could dismiss the case. If this happens, the creditors will probably file claims in probate court, and your estate could get depleted by paying off the creditors.

The judge could also end your case with a discharge. The difference between a discharge and a dismissal is that your debts get wiped out with a discharge. If the court discharges your debts, the creditors with discharged debts cannot file a claim in probate court.

Continue the Case

A judge could allow the case to go ahead, with your estate taking your place. This can cause difficulties because repayment plans usually take three to five years. As a result, the probate court would not be able to close your estate until after the debt repayment plan ends.

Convert to Chapter 7

A bankruptcy judge could convert your bankruptcy case to a liquidation. All of your assets would be sold, and the proceeds would be used to pay off your debts.

Planning Around a Bankruptcy

Bankruptcy usually happens due to unforeseen situations. But you can plan around bankruptcy. You can structure your estate plan to protect your assets from possible bankruptcy. As long as you lack fraudulent intent, this strategy might preserve more of your estate for your heirs.

To discuss your options for protecting your assets for your heirs, schedule a free consultation with Heritage Legal, PC, a Palm Springs, California, estate planning law firm. Get in touch with us today.

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