Debt Dies With You? No. Here’s How to Plan Wisely.
By Joe Busnengo, Attorney At Law
There’s an assumption I often hear that when people with any outstanding debt pass away, that debt will die with them. It’s a nice enough idea, but it’s simply not true. Debts most definitely do not die once the owner of that debt dies.
This doesn’t mean that all of the deceased’s heirs will need to pay his or her debt. However, it does mean that, in that event, all of their assets would go to their creditors and little, if anything, would go to their heirs.
Let’s think about this scenario during the probate process in which you’ve been appointed executor of your recently passed mother’s estate. Now you're actually managing all of your mom’s assets. There is a will that says that not only are you the executor but you also get her house. So is your mom’s house yours now? It would be, but as it turns out, your mom had debts that need to be paid off first and there can’t be any distribution of assets before that happens.
What Happens Next?
First, a little bit of “advertising” of the debt needs to occur as the process of paying off the debt begins. Start by publishing a notice in the newspaper that the decedent (in this scenario, your deceased mother) has died and therefore, anyone who thinks that the decedent owed them money has six months to come forward. It’s important that you use a particular type of newspaper for this notice and word the notice in a certain way, which we can guide you on at Miles & Gurney, LLC.
Is publishing a notice enough to cover you? Not necessarily.
What many people don’t realize is that the U.S. Supreme Court has stated that if you have a way to determine on your own that the decedent might have owed somebody money, publishing in the newspaper is merely a first step. Upon discovering that a debt might be owed, you must contact the creditor, send them a notice and state that it appears a debt may be owed to them from the decedent. You’ve now started the clock for them to come forward and claim the debt as their own.
Here’s why this second step is so important: If it’s clear within some documentation that a debt might have been owed and you don’t contact the creditor, just publishing a notice with a six-month period for creditors to come forward is not going to be enough to protect you. You can’t merely bury your head in the sand because a failure to look for potential creditors is not an excuse.
If you don’t notify a creditor that clearly is owed money and you proceed with distributing all of the assets, that move could come back to haunt you a year or two down the road. If the creditor comes forward and there's no longer anything in the estate to pay them with, you may have to look at owing them money out of your own pocket because you distributed assets that you shouldn't have.
Above all, as an executor, your responsibility is less to determine whether money is owed or not than it is to perform your due diligence to determine if money might have been owed. Even if you see a utility bill that appears to have been paid, you should still be sending the utility company a notice just in case.
If You’ve Handled Debts Right, What Else Could Go Wrong?
You've paid everything off that's supposed to be paid off. You've given notice to everyone who was supposed to receive notice. You have all of the assets distributed to the people who were supposed to receive them.
Unfortunately, you missed one detail in the paperwork. Staying with the example of your mother as the recently deceased, it appears that hidden in the paperwork are details in which she loaned $20,000 to your cousin Ed. Now, Ed is not an heir so he isn’t going to receive any distributions from the estate. In fact, he may not even know what’s going on. Seeing as he's a distant cousin of yours, the two of you don't talk very often.
Yet, one of the heirs talks to Ed and learns how good your mom was to him in loaning him $20,000 for the down payment on a house. Suddenly, the heir begins to think, “Wait a minute. She loaned him all of this money? As heirs, why didn’t any of us get that money distributed back to us? We should have gotten a piece of that.”
The heir and others like him can now sue you, the executor, for not collecting on the debt.
So as an executor, you can be held liable for what you didn't do. In this case, the money that cousin Ed should have paid back to your mother may now need to come out of your own pocket. You may be able to sue long-lost cousin Ed for this amount (unless the statute of limitations has passed), but there’s still no guarantee that you’ll be paid back for the debt in full.
7 Classes Of Debt - Which To Pay First?
You do, in fact, need to take care of some debts upon the decedent passing. So how do you handle that if there isn't enough money in the estate to pay all the debts?
For example, imagine there's a funeral bill, a tax bill and a $20,000 credit card bill. Combined, all of these bills total $22,000. Unfortunately, there’s only $2,000 in the estate. In this event, many people would think all they need to do is take the $2,000 in the estate, divide it by three and pay each of the three parties, right?
Wrong. You would likely be sued by the Federal Government and by the funeral parlor, because in Illinois, there are seven different classes of debts for a decedent. You must pay all of the first-class debts before you pay any of the second-class debts before you pay any of the third-class debts and so on. If there are multiple debts of a given class but not enough to pay them all off, the payments are prorated.
What comprises these debt classes? The bill for the funeral will be first class debt, which means it will be paid first before any of the other classes of debt. After this, we can’t forget about the outstanding debt to the IRS, which is a third-class debt. So we’ve covered both of these bills with our $2,000 in the estate.
Where does that leave the credit card bill? That doesn’t fit nicely into any of the first six categories, so it counts as a seventh-class debt. Seventh class debts are any debts that don’t fit into the other classes and only get paid after all the other debts get paid. If there’s no assets left, they simply don’t get paid.
As you can see, there are plenty of opportunities for executors to inherit some real challenges as it pertains to debt from the decedent. If you’re going to successfully navigate this process through probate, make sure you turn to someone who has helped executors take the right steps countless times before to address any outstanding debts in the proper manner – our estate planning attorneys at Miles & Gurney, LLC.
Let’s have a frank conversation today about a decedent’s debt to help prepare you for the road ahead and help minimize your exposure to additional liability too. Call us for an initial consultation at 312.929.0974 today.
Joe Busnengo practices in the areas of probate, family law, and estate planning. While a student at Northwestern University School of Law, he gained experience with family law as an extern at Chicago Volunteer Legal Services and with probate and estate planning as a clerk at Prather Ebner LLP. Since graduating and being admitted to the bar in 2013, he has represented clients in adoption, divorce, and estate planning matters through Chicago Volunteer Legal Services and Wills for Heroes. He is currently a member of the Chicago and Illinois State Bar Associations and serves as co-chair of the CBA YLS Public Outreach—Wills for Heroes subcommittee.