Will my family inherit my debts?
Minnesota law provides some protection to spouses and descendants, so that they can inherit some property, free of claims of many creditors. Many estates have adequate resources to pay all valid claims. An estate is called “insolvent” if it lacks the resources to pay all claims. In these estates, it is especially important to have guidance on which claims have priority and can be paid.
Let’s review the different situations where someone dies with financial obligations. Will the heirs have to pay all of the decedent’s bills? What if the estate lacks the funds to satisfy every debt?
A creditor is someone to whom money is owed. A secured creditor is one who holds collateral for a debt, such as a home mortgage, a car lien, or a home owners association.
A general rule is that secured debts survive one’s death. In order for the family to sell a property and recover the net proceeds, the mortgage must be satisfied and the home owners’ association (if any) must be paid all assessments which it is owed. In the usual situation, these debts are paid from the sale proceeds by the closer.
But what if the value of the property is less than the mortgage against it? The family will likely not recover any value from the property. The family can elect to “let the property go back to the bank”. The family can stop making payments and let the bank foreclose. The debt will expire and the bank will own the property. Instead, the family could choose to make monthly mortgage payments for a period of time, perhaps several years. The bank probably has the right to foreclose, but a bank will normally accept payments, if the loan is kept current. The family might hope for an improved value in a few years, so as to sell the home and receive some net proceeds. In the mean time, the family has a place to stay, and can consider the situation as paying rent. The personal representative could try to arrange a short sale, if conditions are right, but he or she should get good tax advice at the time, to be sure that a tax is not created. A short sale is a sale to a third party at a price less than the mortgage balance. The lender agrees to take a payment less than the mortgage balance, and writes off part of mortgage balance.
One must be aware of a financial hazard involving home owner association (“HOA”) assessments and liens. The unpaid assessments of a HOA are a lien on the property. Also, the owner of the property is personally liable to the HOA for the assessments. In one case, we prepared a transfer-on-death-deed, “TODD”, for a client so that her property could go her heirs without probate proceedings. The home was subject to a mortgage and HOA assessments, which were all current. The property value declined after the TODD was recorded. When she died, the heirs, compared the value of the home, to the mortgage and decided not to file an Affidavit to take over ownership of the home. They would have been personally liable to the association for assessments from the moment that they took ownership. The heirs could “walk away” from the mortgage, but if they accepted ownership, they would not escape the HOA assessments.
If a car is worth less than the balance of the car loan, the family can let the car be repossessed and not be liable to the loan company. If the car is worth more than the loan, the family should make arrangements to pay off the loan fairly soon. Because of car insurance complications, it is best to transfer the car title to a new person as soon as possible.
Many debts are “unsecured”, which means that there is no collateral to guarantee the loan. Credit card debt, medical bills, and some bank loans are not secured. Unsecured creditors have a right to file a claim against estate assets. Normally the heirs are not liable to the creditors. However, if an heir co-signed for a debt, like a credit card, then the heir might be liable for the debt.
Also, a spouse can be personally liable for necessary medical services furnished to his or her spouse, even if the spouse did not sign any papers for the medical care. A spouse is normally liable for the taxes due on a jointly filed tax return. Children would not be liable for these debts.
What if the estate assets are insufficient to pay all debts?
The creditors have a right for 24 months after date of death, under the Multi-Party Account Act, Minn.Stat. 524.6-207 and 524.6-307, to collect from any heirs who collected funds from any bank or financial office, because of a non-probate account designation, such as joint ownership, “pay-on-death” or “transfer-on-death”.
Similarly, the use of a revocable trust will probably not protect the assets, from post death claims of creditors. On the other hand, life insurance which is payable to individuals (not “the estate”) is normally protected from claims of creditors.
A personal representative should seek legal advice and must act carefully in situations where a home is one of the assets, and also in situations where the claims of creditors approach or exceed the value of assets other than the home. The personal representative must be especially careful in these situations.
1. If a high priority claim is not paid.
2. If tax returns are not filed.
3. If exempt assets are used to pay a claim.
High priority claim not paid. When assets are insufficient to pay all claims, the law requires that certain categories of claims are paid prior to others. For example, if a personal representative paid the decedent’s Minnesota tax obligations, but not federal tax obligations, the IRS can collect the amount from the personal representative, personally, because the federal tax obligations are higher priority than the state tax obligations. The liability is probably limited to the amounts that was wrongly paid to a lower category creditor or distributed to heirs.
Tax returns not filed.
The personal representative is responsible to file income tax returns for the decedent. The IRS or the Minnesota Department of Revenue might prepare tax returns for the decedent, based on assumptions, calculate a tax and then collect from the personal representative, personally, if funds were available, but the funds were either distributed to heirs, or paid to a lower level creditor.
Exempt asset used to pay claim. Minnesota law states that a homestead is exempt from many claims, if it is inherited by a spouse or descendants. The heirs can possibly object to any expense being taken from the gross proceeds on the sale of the home, except liens existing at the time of death. An example can illustrate how this can be a very serious problem.
John died, survived by children Barbara and Craig. John owned a home subject to a mortgage, $2000 in bank accounts, and some house furnishings. Barbara was appointed the personal representative, and took steps to prepare the home for sale. Barbara personally made house payments for 6 months, hired a painter and an electrician to fulfill lending requirements, and hired a realtor. Barbara personally paid the utility expenses, property taxes and house insurance, because the estate lacked funds to do so. Then a purchase agreement was signed and the property was scheduled for a closing. The balance of the mortgage was to be paid from sale. Craig showed up at the closing and demanded a share of gross proceeds undiminished by any expense except for the mortgage. Now, Barbara has a serious problem. Technically Craig is correct. The improvements to the home, and the other expenses are not to be paid from an exempt asset, unless all persons holding the exemption, approve of payment. Barbara should have gotten Craig’s approval before advancing any money to the estate. If Barbara does not sign the closing papers, the estate might be sued by the realtor, who is owed a fee. The realtor did her job, by getting a qualified buyer to sign a suitable purchase agreement and who is ready, willing and capable of closing. Earlier that day, the buyers sold their existing home, expecting to purchase this home. The buyers might sue the estate. Barbara might have to personally absorb the various costs, unless she and Craig can reach an agreement.
In summary, the heirs and the personal representative must retain qualified legal and tax advice before getting too involved in the process of the estate.
This area of law is complex. This article is not a substitute for personal legal advice for a specific situation.