Entitled to an Inheritance While in a Chapter 7 or a Chapter 13 Bankruptcy?
Individuals who are bankrupt have a duty to inform the trustee in bankruptcy of any property they become entitled to after the date of the bankruptcy. You would hope, therefore, that if a beneficiary became aware of their entitlement under an estate, they would inform the trustee in bankruptcy, and the executor of the estate (and solicitors acting on the executor’s behalf) would be made aware of the situation. Unfortunately, this does not always happen.
If the executor (or their solicitor) failed to check if a beneficiary was bankrupt and paid the inheritance directly to the beneficiary, the trustee in bankruptcy would be entitled to sue the executor or solicitor for the amount paid to the bankrupt beneficiary. A bankruptcy search should, therefore, always be undertaken before distributions are made. When the result of a bankruptcy search shows a beneficiary has been declared bankrupt, it is advisable to contact the trustee in bankruptcy to check how the inheritance is to be paid.
If you receive an inheritance after filing for bankruptcy, it might become part of your bankruptcy estate. In a Chapter 7 case, this means the trustee can take the inheritance unless it’s protected by an exemption. In a Chapter 13 case, receiving an inheritance could increase the amount you have to repay to your creditors. Consulting with an experienced bankruptcy attorney is your best option.
Inheritance Received Within 180 Days of Filing
If you inherit within 180 days of filing for bankruptcy, you must disclose the asset(s) to the court and trustee by amending your bankruptcy forms. To add personal property or real property, such as land or a house, you’ll amend Schedule A/B. If you are claiming the property as exempt, you’ll also amend Schedule C.
It doesn’t matter when you are actually due to collect the inheritance, even if it won’t be for months or years. The date that matters is the date the decedent passed away. On that day, you became entitled to receive the inheritance even if you didn’t know about the death or the property until later.
In a Chapter 7 case, an inheritance received within 180 days after you file for bankruptcy becomes part of your bankruptcy estate with the rest of your property. If it fits within one of the exemptions available to you (categories of property you are entitled to keep in bankruptcy, as set out in state or federal law), you will be able to keep it.
If you file for Chapter 13 bankruptcy, the consequences of receiving an inheritance also depend on whether the property is exempt. You don’t have to give up your property in Chapter 13; instead, you make monthly payments that will be divided among your creditors, as part of your Chapter 13 repayment plan. How much you have to pay into your plan depends, in part, on your nonexempt property. Your unsecured creditors (those holding debts that aren’t backed by collateral) are entitled to be paid at least as much in Chapter 13 as they would have received if you had used Chapter 7: the value of your nonexempt property. So, if you receive an inheritance that isn’t exempt, you will have to add its value to what you repay to your unsecured creditors, which will increase your plan payments. (If the property is exempt, it has no effect on your repayment plan.)
Inheritance Received After 180 Days of Filing
If you inherit or become entitled to inherit more than 180 days after you file, the consequences may differ. A Chapter 7 trustee cannot claim the inheritance in this case; it’s yours to keep, whether the property is exempt. In a Chapter 13 filing, however, the judge may take an inheritance into account when deciding on a motion by the trustee or a creditor to amend your plan regardless of when the inheritance arose. (This can happen when your income and assets increase for any reason during the repayment plan period, from three to five years.)
The Inheritance is More than Enough to Pay the Debts
If you’re one of the lucky ones who receives a large inheritance, you could see some of it despite the bankruptcy. Regardless of the size of the inheritance, you’ll probably be able to exempt some portion of it. The exemption is either defined by state law or is drawn from the list of exemptions in the Bankruptcy Code, depending on which of those your state allows. The Bankruptcy Code has no specific exemption for inheritances. Instead, it has a “wildcard” exemption that can be used for anything not covered by the other categories. The amount of the wild card exemption amount is adjusted every three years. If the inheritance is large enough, you might also see some of that money once the trustee is finished administering your bankruptcy estate. After your exemption amount is taken out, all the creditor claims are paid, and the administrative costs are covered, anything left over will be returned to you.
What If a Non-Filing Spouse Inherits During Bankruptcy?
If the inheritance belongs to your spouse, who didn’t file for bankruptcy with you, that money or property is not part of your marital property or part of your bankruptcy estate. However, even if the inheritance is considered your spouse’s separate property, commingling it with your assets might cause the inheritance to lose its separate status. For example, if your spouse spends part of the inheritance buying you an expensive sports car, the car could become part of your bankruptcy estate.
Avoiding the Problem
To ensure that your inheritance won’t end up in your bankruptcy estate, you might suggest that you be left the property in a revocable living trust that contains a valid spendthrift provision, which limits a creditor’s access to funds in the trust, rather than in a will. Some courts have held that property left via this type of trust is not part of the bankruptcy estate. This property can include cash, family heirlooms, real property, and personal property. Contrary to popular belief, trusts are not vehicles solely for the wealthy and privileged. Anyone can set up a trust and doing so can save an heir the avoidable complications of dealing with an inheritance during a bankruptcy. There may be other ways to protect the inheritance, but those will be specific to the laws of your state that govern wills and inheritances. Consult with a bankruptcy attorney or a probate attorney to find out the best course of action for your circumstances.
How Can a Trustee Find Out About the Inheritance?
When the bankruptcy filer’s right to the inheritance comes after filing bankruptcy, you might think that it would be easy to put one over on the trustee and the court by never reporting it. That would be a mistake. Probate and bankruptcy files are public records and easy to access. Anyone involved in either case could find the probate record and contact your trustee. A common source is an unhappy relative who contacts the trustee out of vengeance. Also, an attorney involved in either case might have an ethical duty to report the inheritance to the trustee after becoming aware of it. You might not be able to protect much of the inheritance from the bankruptcy trustee, but the alternative could be worse. If you’re caught withholding that information, the court will demand that you turn over the inheritance. It won’t matter if you’re already spent it. The court will expect you to replace the value. You will also likely lose the discharge you worked so hard to get. You’ll end up with a worst-case scenario. Not only will you lose your property, but you’ll also owe all the debts you brought into the bankruptcy.
For more information pertaining to chapter 7 bankruptcy and chapter 13 inheritance claims pleas contact an attorney at the Scura law firm.