Inheritance and Bankruptcy

If you inherit money from someone who dies within 180 days of the filing date of your Chapter 7 bankruptcy, that money becomes part of your bankruptcy estate. The inherited money is used to pay your creditors. This is true even if you have received a discharge and your Chapter 7 bankruptcy case has closed.

For instance, if you file a Chapter 7 bankruptcy on April 1, and your great aunt dies on September 28 (within 180 days of the bankruptcy filing date), any money you receive from your great aunt’s estate must be turned over to the bankruptcy trustee. It does not matter when you receive the money or when your case was discharged. You might receive the inheritance years later, but if you were it must be turned over to the bankruptcy trustee for payment to creditors. An inheritance is considered received when you become entitled to it (usually when the decedent passes away), not when you actually collect it. You may be charged with bankruptcy fraud if you fail to inform the trustee of your inheritance or turn over the money.

If the trustee receives inherited money, your case will be reopened and a bankruptcy estate is formed. Notices to creditors are sent and the trustee will distribute the funds to creditors. In some cases you will be able to keep some of the money, and in other cases some of the funds may be returned. Inherited property is treated the same as cash. If you receive a car or a family heirloom, the property must be turned over to the trustee. In some cases you may be able to exempt inherited property or the trustee may consider the value of the inheritance too small or burdensome to liquidate and distribute.

The 180 day rule does not apply in a Chapter 13 case. If you become entitled to an inheritance after your Chapter 13 case closes, the money is yours to keep. However, any inheritance that you are entitled to during your Chapter 13 case will increase the amount unsecured creditors are entitled to receive. Your inheritance is considered additional disposable income which must go to pay your creditors. In addition, the trustee can argue that keeping all of your inheritance without paying more to your unsecured creditors may violate the good faith requirement of a Chapter 13 plan.

What can you do? First, if you are considering bankruptcy and are aware of a significant chance of someone leaving you inheritance money, speak with an experienced attorney. There are options to avoid turnover including rewriting the will to cut you out, or setting up a spendthrift trust. A spendthrift trust cannot be reached by creditors or the trustee. Consult with an attorney to properly create a spendthrift trust or rewrite a will. There is nothing illegal or immoral about estate planning and your loved one may prefer leaving money to you rather than your creditors.

Second, if you inherit during a Chapter 13 case, you should look at your dismissal options. You are not entitled to a dismissal as a matter of right in a Chapter 7 case, but you are generally able to dismiss your Chapter 13 case at any time.

What should you not do? You should not follow the game plan of the Persfull boys of Rockford, Illinois. James and Joseph Persfull (hardly boys at 52 and 48 years) were each convicted of bankruptcy fraud and concealing property from the estate. You see, James was in the middle of a Chapter 7 bankruptcy when his mother died. She left her estate to her two boys, James and Joseph. James knew the trustee would take his inheritance, so he filed a “Disclaimer of Inheritance” and a “Declination of Office,” in which he pretended to forego his interest in his mother’s estate, when in fact, he received his entire inheritance with the help of Joseph (somewhere shy of $100,000). When the bankruptcy trustee uncovered the scheme, both James and Joseph were tried and convicted of federal bankruptcy crimes. James received 39 months in federal prison and three years supervised release, and Joseph received 30 months in federal prison and two years supervised release.