Should My Child’s Bankruptcy Affect My Own Estate Planning?

how-to-secure-a-mortgage-after-bankruptcy-slideshow-300x120One of the biggest estate planning concerns that we hear about from parents is that they are reluctant to leave a potentially sizable inheritance to their financially irresponsible adult children. This raises an interesting question that you probably have not considered in connection with your own estate plan: What happens if my child files for bankruptcy just before I die? Will my estate be forced to pay off my son or daughter’s creditors?

The 180-Day Rule for Bankruptcy and Inherited Property

Bankruptcy is actually a lot like probate. In probate, an executor gathers a deceased person’s assets, pays off any creditors, and distributes whatever is left over to the decedent’s heirs or beneficiaries. With bankruptcy–specifically a Chapter 7 “liquidation” bankruptcy–a court-appointed trustee gathers a debtor’s assets, pays off any creditors, and distributes whatever is left over back to the original debtor.

With the exception of certain legally exempt items, all of a debtor’s property becomes part of his or her “bankruptcy estate” once the debtor files for Chapter 7 protection. That means the property now belongs to the trustee and not the debtor. Depending on the circumstances, the bankruptcy estate can include property that the debtor inherits from a parent or another family member. More precisely, federal bankruptcy law says the bankruptcy estate includes “any interest in property” that a debtor acquires “by bequest, devise, or inheritance” within 180 days of the original filing.

Let’s translate this into plain English. Mary has an adult son, John. John filed for Chapter 7 bankruptcy on January 1, 2017. Mary died on March 1, 2017, leaving her entire estate to John. Since Mary’s death occurred within 180 days of John’s bankruptcy filing, his inheritance from Mary’s estate is now considered part of his Chapter 7 bankruptcy estate. The trustee is then free to use John’s inheritance to repay his creditors.

Now, you might be asking yourself, “Couldn’t John just disclaim the inheritance?” The answer is no, at least not after Mary has died. If John wanted to keep Mary’s estate out of his bankruptcy case, he should have disclaimed his inheritance before her death–or asked his mother to amend her estate plan while she was still alive.

Get Advice on Revising Your Wisconsin Estate Plan

If you have a child who is in financial trouble and may be contemplating bankruptcy, that should prompt you to reconsider your own estate planning arrangements. Instead of distributing your estate through a simple will, for instance, you may wish to consider creating a trust, which, depending on how it is structured, can afford your assets greater protection from your children’s creditors.

The estate lawyers of Krause Donovan Estate Law Partners, LLC practice law in the areas of Probate, Wills, Estate Planning, and Trusts. We assist clients in and around Madison, Wisconsin with all matters related to estate planning, trusts, and probate matters. Our dedicated attorneys will even make house calls if you are unable to come to our office.

To attend a free estate planning workshop or to receive our client planner to assess your estate planning mindset, contact our office by calling (608) 268-5751 or use our online contact form.