How Do Debts Affect Probate?
Debts Must be Settled in Probate
With certain rare exceptions, probate and trusts have no impact on debts. This was most dramatically demonstrated during the real estate crash from 2007 through 2009. Many parcels of real property were foreclosed during that period of time, despite the fact that a probate was pending or a trust was being administered for the property in question; neither probate nor a trust has any impact whatsoever on the rights of a secured creditor to foreclose upon real property. Likewise, and as part of the same concept, neither an estate that is being probated nor a trust that is being administered can file for bankruptcy, in contrast to a corporate entity which can. In addition, the general rule is that before assets can be distributed in a probate proceeding or a trust administered, all debts of the decedent must be paid. If the debts are not paid, then the creditor can seek payment from the beneficiary to the extent the beneficiary received assets.
There is one mechanism that a probate or a trust can use to deal with creditor’s claims; the known creditors can be forced to file a written claim and if they fail to do so, the claim will be barred. On occasion, despite being given written notice of the proceedings, a creditor will fail to file a timely claim and as result the creditor will be barred as a matter of law. Likewise, on occasion, the attorney representing the probate estate or trust administrator can negotiate a discount on the amount owed.
Debts and Estate Planning (Trusts)
This problem with debts has an impact upon estate planning. A potential beneficiary may have serious problems with debts, such as back child support or back taxes. In addition, the beneficiary may be receiving governmental assistance; receipt of an inheritance may disqualify an individual from governmental assistance, including health care for the poor, known as medi-cal in the State of California. There are a few mechanisms to deal with the problem of a debtor/beneficiary. The debtor/beneficiary may be disinherited; in some circumstances, a special trust, known as a special needs trust can be established for the beneficiary/debtor. Finally, if the debtor/beneficiary is about to receipt an inheritance or gift, he or she can disavow the inheritance, typically by assigning his or her rights to another.