It is possible that you find yourself in front of a mountain of debt and your only option is filing for bankruptcy, but you may also be the beneficiary of a trust.  Filing for bankruptcy will help you in clearing most, if not all, of that debt away. Bankruptcy cases tend to sometimes be complicated, especially if there is something like a trust involved.

What is a trust?

A trust is basically an agreement that gives another person, the trustee, the right to hold assets on behalf of the beneficiary or beneficiaries, often times the trustee is the person who opened the trust.  There are many types of trust but one of the major differences is whether the trust is revocable or irrevocable.

What is the difference between revocable and irrevocable?

A revocable trust is, which is sometimes called a living trust, can help assets pass outside of a will but it still allows access to it during the grantor’s lifetime.  If the grantor’s intentions change or there are unplanned for circumstances, the trust can be changed or even dissolved at will.  However, in most cases, a revocable trust becomes irrevocable at the time of the grantor’s passing. Even though a revocable trust may help avoid a will, it is still subject to estate taxes, and during the grantor’s lifetime it will be treated as an asset owned by the grantor.  It is also good to know that the grantor can name themselves as trustee and even get a co-trustee to maintain control over the trust.

An irrevocable trust normally moves assets out of the grantors ownership and even out of the reach of probate or estate taxes.  However, once made it cannot be altered in any way, not even by the grantor.  Meaning that once any assets are placed in an irrevocable trust, ownership of the assets change from the grantor to the trust.  The benefits to this are that since the assets are no longer under the ownership of the grantor, the grantor is relieved of any tax liabilities on any potential income produced by the assets in the trust.  The assets in the trust may also be protected in case anyone brings legal judgment against the grantor.

What happens to a trust in a bankruptcy?

When going through a bankruptcy, it is vital to determine who has control of the trust.  When filing for bankruptcy, a trustee will be appointed to your case by the court and the trustee will be able to find assets that you own, like your house, car, banking accounts.  The trustee can sell any of the assets that are considered to be non-exempt and pay the creditors with the money obtained from those sales.  Determining the whether the trust is revocable or irrevocable is also important. If the trust is revocable, the beneficiary will not be able to immediately control those assets.  For example, if the beneficiary is the one filing for bankruptcy, but the grantor has not passed, since in a revocable trust the grantor has the ability to alter the trust how they want, the trustee technically cannot pursue that trust.

Like with most legal matters, there are some exceptions that may allow a beneficiary to file for bankruptcy and still keep the trust intact.  There is something known as the spendthrift provision that can limit creditor claims to trust assets even when the trust is irrevocable or the grantor has passed which prevents the assets going to a third party.  The filer could also disclaim the inheritance.   While doing this will not allow the filer to benefit from the trust, it also prevents the grantor’s assets from going to a creditor.  However, it is important to speak with an experienced bankruptcy attorney if you have done this.  This is because the “disclaim” must have happened before the filing of the bankruptcy case, and must have happened long enough ago that the court will not be inclined to view the disclaim as fraud.

The situation could become a bit more complicated if it turns out that there is more than one beneficiary to the trust.  Also, it is important to consider that the assets in the trust are in slightly more at risk if filing for a chapter 7 bankruptcy rather than a chapter 13 or chapter 11.

If you have questions about a trust and/or a bankruptcy case, call us at 770-609-1247 to discuss how we can best help you.