Credit Jack Clinton, Attorney
& Samantha Graf, Attorney
This time, we’re covering how to handle an insolvent estate. (That means there’s not enough money left in the estate to cover all outstanding debts.)
Here’s the good news: It might not be as scary as you think.
You might have seen it coming: You figured that not only would you not inherit a significant amount of cash when your parents or elder relatives passed away, but you also might have some debt to contend with. Then the inevitable happened, and you found yourself facing a seriously unpleasant blend of grief and logistics. Maybe creditors started calling. Maybe you uncovered debt that you didn’t even know mom had. Maybe mom does have some assets but you’re getting pulled in a million directions and you don’t know whom to pay.
This is the reality of being an heir to an insolvent estate.
Many people assume that, as heirs to an insolvent estate, they are liable for their parents’ debts. The truth? That’s only the case if you (accidentally or intentionally) mishandle the distribution of assets in the estate. Even if you’re the formally-appointed personal representative (commonly known as the estate’s executor), you’re only acting on behalf of the deceased person. You don’t automatically sign on for the debt. You do, however, need to know how to deal with it correctly in order to resolve the estate—and absolve yourself of any liability.
If you’ve inherited an insolvent estate, it’s critical to have a knowledgeable attorney on your side. The rules surrounding insolvent estates and appropriate allocation of assets are nebulous, to put it kindly. (Translation: enough to give you a major migraine.) If you stop reading now, you’re still walking away with the most important information: Seek an attorney’s advice. Think you can’t afford the attorney, especially since the estate in question is in debt? Think again. Attorney’s fees for estate resolution fall under the deceased person’s estate, which means you might not have to shell out a single dime of your own money.
Want to learn more? Here’s a crash course:
Insolvent estates typically land in one of two categories: The first is when there are essentially no assets available. In this scenario, there’s no benefit to going through a probate. Your attorney will notify the creditors that the debts will not be paid, and to contact the attorney’s office with any questions or complaints (rather than bothering you!).
The second scenario is when a probate process is applicable. This usually happens when there are some assets available, but not enough to cover all outstanding debts. In this scenario, it’s all about prioritization. In a probate process, there are seven categories of prioritization when it comes to allocating assets from an insolvent estate. A qualified attorney will start by establishing all outstanding debts and liabilities, and then classify each according to the seven categories. Then they’ll be able to determine which debts and liabilities will be paid out of the available funds, and which ones simply won’t get paid.
Here are the categories, in order of priority:
- Cost and expenses of administration—this includes attorney’s fees and expenses such as hiring a dumpster to clean out mom’s house
- Reasonable funeral expenses
- Debts with preference under federal law (e.g. federal taxes)
- Reasonable medical/hospital/nursing expenses pertaining to final illness
- Reasonable medical/hospital expenses for the year preceding death
- Debts with preference under state law (e.g. state taxes)
- Any other claims of unsecured debt (e.g. credit cards)
(Note: a homestead can pass to next of kin without being counted as an asset. That means you can inherit mom’s house even if her liabilities exceed her assets. You will, of course, be responsible for any outstanding mortgage.)
Remember how we said you might be liable if you mishandle the distribution of assets? Here’s a common trap: Creditors have a full four-month window to submit their claims. If you start writing checks to the people who yell the loudest, such as a persistent credit card company, but three months later you uncover a higher priority item (like federal tax debt), you would be liable to cover the higher priority debt after all the estate’s assets have been exhausted. Consider this one more reason to have a good attorney on your side who can help you gather all the information and ensure accurate distribution.
Again, once all remaining assets have been distributed, your attorney can notify creditors what (if anything) they can expect to receive, and insist that any further communication is routed through the attorney’s office. That means no hassling phone calls, collection letters, or (gulp!) knocks at the door.
We hope this information provides some measure of relief during a difficult time. It’s nothing compared to the relief that comes when an estate is formally closed, with all assets distributed and all creditors paid up (or otherwise placated). We’re experienced in resolving insolvent estates, and we can help.