One of the more difficult decisions you will make is to file for bankruptcy protection. Well, now that you have made that decision and you are making the tough choices to put your economic life back in order, you suddenly find out that your long-lost relative died and left you a sum of money. What do you do now? Do you get to keep the money? Must you turn it over to the bankruptcy trustee? The answer to these questions depends on several things.
First, the date you became entitled to the inheritance is important. For bankruptcy purposes, you become entitled to the inheritance on the date the decedent passes away. Second, you get different treatment depending on which chapter of the bankruptcy code you filed under.
Chapter 7 - If you filed under chapter 7, the basic rule is that any inheritance you become entitled to in the first 180 days after you file your bankruptcy petition with the court becomes part of the bankruptcy estate. This is true for most assets passing to you via a Will, intestate probate proceedings, or assets passing via a Payable on Death (POD) or Transfer on Death (TOD) designation. As a result, the inheritance, minus any exempt portions, would have to be turned over to the bankruptcy trustee to administer on behalf of the creditors you are seeking to discharge. If you become entitled to an inheritance after the 180 day mark, you will get to retain the proceeds.
Chapter 13 - Under chapter 13 cases, you do not necessarily have to
surrender your inheritance. But, it does count towards the non-exempt
property available to pay creditors. Accordingly, if it is received in
the first 180 days, it will generally be included in the bankruptcy
estate and you will pay as part of your plan an equivalent amount of the
inheritance. If received after the 180 day period, you are required to
inform the trustee who may still require the inheritance to be turned
over for the benefit of the creditors on the basis that failure to pay
more to your unsecured creditors by turning over the inheritance would
violate the Chapter 13 good-faith requirement.
A failure to report the inheritance will be viewed by the Court as fraud. If that occurs, your bankruptcy case could be dismissed without receiving a discharge, and all debts existing prior to this will be considered non-dischargeable for purposes of any future bankruptcy proceedings on your part.
Trusts - However, money passing to you via a Trust with
a spendthrift provision, is likely not subject to the bankruptcy
estate. The spendthrift provision keeps creditors, including bankruptcy
creditors, from reaching assets inside the Trust left to you by another
person. Keep in mind that you cannot set up a Trust for yourself to try to insulate
your assets from your own bankruptcy creditors. Such self-settled
trusts can be set aside.