You’re already dealing with the loss of a loved one, and now you’ve discovered that they died with more debt than you (or perhaps they) realized. It’s certainly not what you’d hope for, but it also might not be as bad as you fear.
The good news? You are most likely not responsible for paying the estate’s debts.
The bad news? Your workload as the executor just increased, and you (and any other heirs) may not receive any of the gifts you anticipated from the estate.
Understanding the probate process will help you move more easily through the difficult work of determining how to address estate debt.
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What is an insolvent estate?
An insolvent estate is when the total value of an estate’s assets are less than the total debts and liabilities owed on the estate. If the estate is unable to pay what is owed at the time of estate settlement, the estate is considered “estate insolvent.”
How probate assets and debts are handled
In most instances, when a person dies, their estate must go through probate. State law controls the probate process, so rules can differ from state to state. However, most follow the same order of priority for payments made from estate assets. Regardless of any bequests made in a will, the estate must make payments in the following order:
Estate expenses, including legal fees, executor fees, and court fees
Family allowances (state-dependent)
Payments to beneficiaries
As you can see, beneficiaries are the last to receive their funds. An estate must first pay for the funeral expenses, admin expenses, taxes (including the deceased’s state and federal taxes for the prior year as well as any estate taxes), and creditors before any heirs/beneficiaries.
When an estate doesn’t have enough to pay taxes and Debts
First thing’s first: as a beneficiary or as an executor, you are not personally responsible for paying any of the deceased’s taxes or debts — with two exceptions. First, if you were a co-signer on a loan, you are responsible for repayment of that debt. Second, if you are a surviving spouse in a community property state (Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, Wisconsin), you may be liable for at least part of your spouse’s debt.
Most states provide creditors a set period of time (such as 90 or 120 days) to come forward and make a claim against the estate. To do so, they must follow a specific process with the probate court. Be wary of any creditors that contact you directly to demand payment. Claims made after the time period will not be repaid. If the estate runs out of money (or available assets to liquidate) before it pays all of its taxes and debts, then the executor may need to petition the court to declare the estate insolvent. At that point, the estate must pay off as much debt as possible in the order determined by state law.
Beneficiaries will receive no assets, and any creditors that didn’t get paid will remain unpaid.
When an estate doesn’t have enough to pay beneficiaries
After handling all the taxes and debts, discovering that the estate will not have enough funds to provide heirs with the assets they’re expecting can be a tricky situation. Some heirs may feel entitled to funds or to a specific piece of property or item that had to be liquidated to pay debts.
If you're an executor handling an estate in this situation, rest assured that, as with the deceased’s taxes or debts, you are not personally responsible for paying beneficiaries. In some instances, beneficiaries may petition the court if they believe that mismanagement of estate funds has resulted in the loss of their benefits.
The probate court will oversee the process if the estate doesn’t have enough money to pay its beneficiaries, deciding which beneficiaries receive what amounts. A reduction in the intended benefit is called an abatement. If the deceased didn’t leave enough to cover all bequests made in the will after all funeral expenses, taxes, and debts have been paid, then the court will have to order abatements.
Managing an estate with significant debts can be challenging, and adding legal fees can feel like rubbing salt in the wound. Many people complete the probate process without an attorney — even when the estate has unpaid debts.
At Trust & Will, we’re here to help you keep things simple. You can create a fully customizable, state-specific Estate Plan from the comfort of your own home in just 20 minutes. Take our free quiz to see where you should get started, or compare our different estate planning options today!
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