Tennessee has one of the highest rates of bankruptcy filings in the nation – in fact, in 2019, Tennessee had the highest bankruptcy rate in the United States. With the coronavirus pandemic, bankruptcy filings are increasing rather quickly, too. So, what does this mean to Tennesseans who have estate plans but are now in a bad financial situation and need help – the kind of help bankruptcy provides?
The purpose of estate plans is in part to protect your assets from creditors, lawsuits, and other similar issues. On the one hand, the purpose of bankruptcy is to give you a second chance or fresh start. On the other hand, bankruptcy also provides creditors assurance that they will get something in return. These two purposes are not aligned, and if you file for bankruptcy, your estate could be negatively affected. Here's an overview of what to know about estate plans and bankruptcy.
The Three Chapters of Bankruptcy: How Each Affects Tennessee Estate Plans in a Nutshell
Many people in Clarksville and elsewhere throughout Tennessee use asset protection mechanisms (e.g., asset protection trusts or limited liability companies) as part of a comprehensive estate plan. Though these mechanisms aim to protect your assets, a bankruptcy judge may try, nonetheless, to dismantle your estate plan and the protections it provides. Much of it depends on the type of bankruptcy you file and how exactly your estate plan is structured.
Bankruptcy comes in three specific forms: Chapter 7, Chapter 11, and Chapter 13. Only one is right for you, but each affects estates differently.
Chapter 7 bankruptcy is the most commonly used type of bankruptcy among individuals and families. In fact, it makes up well over 60% of all bankruptcy filings. It allows you to clean your slate without having the burden of a repayment plan. However, this benefit could come at a price: your protected assets.
In Chapter 7 bankruptcy, your assets are liquidated to pay back creditors. So, it becomes a question of what assets could become the subject of liquidation. Some assets can become exempt, like a trust you established for the sole purpose of protecting your heirs from probate and your assets from creditors.
When considering Chapter 7 bankruptcy as it pertains to trusts, is whether you have control over the trust and whether it is an irrevocable trust or a revocable trust. Here are the differences:
Revocable trusts are trusts that can be amended or revoked by the grantor. As such, the beneficiary does not have control over the trust and its funds, but the grantor does. So, when it is the grantor of the trust who is filing for bankruptcy, these assets could become the subject of a Chapter 7 bankruptcy proceeding because the grantor has control over the trust.
Irrevocable trusts are trusts that have funds permanently transferred into the trust with a designated beneficiary. Because the grantor no longer has control over the funds, the trust will not become part of the bankruptcy estate. That said, if the beneficiary of the irrevocable trust is the one who files for bankruptcy, then the trust funds could become the subject of liquidation. The determination would be made based upon the beneficiaries' control and access to the trust fund.
Preventing Trust & Other Asset Liquidation in Chapter 7 Bankruptcy
Even if you have control over the funds of a trust because you are the grantor or the beneficiary, the trust assets can still be protected. A good estate planning attorney will foresee situations like this and implement certain provisions into the trust. One common provision is a spendthrift provision, which bars creditors from accessing trust assets to pay off debts.
Further, when there are multiple beneficiaries to a trust, problems could arise, making it harder for creditors to obtain funds to repay debts.
Chapters 11 & 13
Chapter 11 is usually the preferred method for businesses (e.g., general partnerships, limited partnerships, limited liability partnership, limited liability companies, Chapter C corporations, Chapter S corporations). Chapter 13 is usually the preferred method for individuals who have a certain amount of unsecured and secured debts.
Chapter 11 is the least common of all bankruptcies while Chapter 13 is more common but not nearly used as much as Chapter 7. Both Chapters 11 and 13 bankruptcy require repayment plans. As such, trusts can usually go untouched in these bankruptcies because debts will be repaid through restructuring and repayment plans.
Is Bankruptcy Right for You & Your Tennessee Estate?
Right now, many families and small businesses in Clarksville are struggling. The coronavirus pandemic is taking its toll, and some of our community members are contemplating bankruptcy. If you have an estate plan and are concerned about your assets, contact an estate planning lawyer in Clarksville to find out if your assets could be at risk. Even if you aren't contemplating bankruptcy right now, let this be a reminder of why having a comprehensive estate plan is so important: protecting your assets for your heirs.
Don't make the mistake of waiting for another recession or pandemic to negatively impact your finances or your family business. Contact us at Crow Estate Planning and Probate, PLC today.