If you receive an inheritance during Chapter 13 bankruptcy, most courts will require that it go to creditors as part of your Chapter 13 plan. Find out why your inheritance will be used to pay your debts in Chapter 13 bankruptcy and why consulting a bankruptcy lawyer is crucial if you might receive an inheritance while paying into a Chapter 13 case (it's possible to pay more than you owe).
In a Chapter 13 bankruptcy case, filers repay some or all they owe to creditors over three to five years. They make monthly payments to the Chapter 13 bankruptcy trustee, who distributes the funds to creditors.
At the end of the repayment period, qualifying debts are eliminated or "discharged." Most people emerge from Chapter 13 owing only a house payment and student loans, when applicable.
In almost every case, yes. If your inheritance is part of your "bankruptcy estate," and you can't protect it with a bankruptcy exemption, you will probably have to use it to pay at least a portion of your debt. Here's how this works.
A bankruptcy estate is formed when you file a bankruptcy case. The estate consists of everything you own at filing, including assets like a house, household goods, bank accounts, vehicles, your right to a future tax refund, and your right to file a lawsuit against someone who caused you damages.
The bankruptcy estate property can be used for creditor payment in bankruptcy unless you can remove the asset by protecting it with a bankruptcy exemption. Bankruptcy exemptions are laws that allow bankruptcy filers to keep property necessary to work and live.
If you can't protect bankruptcy estate property—including an inheritance—you'll have to pay its equivalent to creditors in Chapter 13.
If you received the inheritance before filing, you must protect the funds with a bankruptcy exemption to keep it. Otherwise, you must pay any unprotected funds to creditors through the plan. Because bankruptcy exemptions for inheritances are rare, you'll likely need to use a cash or wildcard exemption.
If you receive an inheritance after filing a Chapter 13 case, you can expect the bankruptcy trustee to argue that the inheritance should be paid to creditors because they're entitled to all discretionary income during the plan period. Although not all courts agree, most require a debtor who receives an inheritance during a Chapter 13 case to include those funds in the repayment plan.
The logic is that it would be unfair to allow the debtor to benefit from the windfall at the expense of the creditors. Talk to a local bankruptcy attorney to find out how the courts in your jurisdiction treat inheritances received after filing for Chapter 13.
Most Chapter 13 bankruptcy filers don't fully pay the lowest debt category, or "nonpriority unsecured creditors," which includes credit card balances, medical bills, personal loans, utility bills, and other unsecured debts. Common unsecured debts you can't pay less toward are student loans, support obligations, and recently incurred tax debt.
The Chapter 13 plan calculation system is complicated, and most bankruptcy lawyers use a sophisticated software program to determine the required payment. However, the amount debtors repay unsecured creditors is determined by several factors, including:
Your income and expenses. You must pay all of your "disposable income" into your plan. The Chapter 13 plan calculations subtract certain allowable expenses from your income. Disposable income is the amount remaining after the deductions.
The value of the property in your bankruptcy estate. In Chapter 13 bankruptcy, you must repay unsecured creditors at least the amount that those creditors would have gotten if you had filed for Chapter 7 bankruptcy. The amount that creditors get in Chapter 7 equals the value of your nonexempt property. This is often called the "best interest of creditors" test.
In most states, an inheritance isn't afforded specific bankruptcy protection. Instead, you might be able to protect some of it with a cash or wildcard exemption. In Chapter 13, you would pay unsecured creditors at least as much as the value of the inheritance minus any exemption amount covering it.
Example. Suppose you inherit $10,000 just before you file for Chapter 13 bankruptcy and deposit it into your savings account. However, your state doesn't allow you to exempt the inheritance and doesn't have a cash or wildcard exemption. You must pay your unsecured creditors at least $10,000 unless an exemption protecting funds in a bank account is available. If not, the trustee and creditors might allow you to make the required payment over your three to five-year plan. However, some might object and want the plan to require the funds to be immediately dispersed.
Learn more about how to calculate a Chapter 13 plan payment.
If you anticipate receiving an inheritance soon, filing for bankruptcy might not be the best approach for handling your financial issues. You might find that you must pay most or all of your bills and pay the trustee up to 10% to send creditors monthly checks. A bankruptcy lawyer can review your case and help you determine your best course of action.