Bankruptcy Effects on Estate Planning

Emily received a notice from her late husband’s bank—his accounts were frozen due to a creditor’s claim filed just three days after the funeral. This meant she couldn’t access funds to cover estate expenses, including final medical bills, and her own living costs, and she now faces a probate court hearing over the creditor’s rights—a cost exceeding $5,000 in legal fees alone.

As an Estate Planning Attorney and CPA with over 35 years of experience, I often see the devastating ripple effects of bankruptcy, even when it appears unrelated to a client’s estate plan. Clients assume that debts discharged in bankruptcy disappear entirely, but this isn’t always the case, especially when considering the complexities of probate and asset distribution. My CPA background gives me a unique advantage in understanding the tax implications of debt discharge, including the critical step-up in basis, capital gains considerations, and accurate asset valuation—often overlooked by estate planning attorneys without a financial background.

What Happens to Assets Already in a Trust?

A properly funded revocable living trust generally shields assets from creditors in a bankruptcy proceeding. However, this isn’t a foolproof guarantee. A bankruptcy trustee can look back and scrutinize transfers made to the trust within a certain timeframe—typically 90 days, but potentially longer (up to a year or more in cases of fraudulent conveyance) before the bankruptcy filing. Transfers made in contemplation of bankruptcy, even if legitimate on their face, may be deemed fraudulent and subject to clawback by the trustee. This means assets could be pulled from the trust to satisfy pre-bankruptcy debts. Careful timing and documentation of trust funding are paramount, especially if a client anticipates financial difficulties.

How Does a Bankrupt Decedent’s Estate Handle Creditor Claims?

When someone dies with outstanding debts and their estate is subject to bankruptcy, the process becomes significantly more complicated. Probate creditor claims follow the formal claims system outlined in Probate Code §§ 9000–9399. Creditors must file a formal claim with the probate court within a specific timeframe—typically four months from the date of the decedent’s death. The personal representative of the estate is legally obligated to investigate and either pay or dispute these claims. Failure to do so can result in personal liability for the representative. It’s vital to remember that the probate process doesn’t erase a creditor’s right to pursue valid debts.

Can Bankruptcy Wipe Out Inheritance?

Generally, an inheritance received after a bankruptcy discharge is considered new property and is not subject to the bankruptcy estate. However, this isn’t always clear-cut. If the bankruptcy trustee can prove the debtor concealed assets or engaged in fraudulent conduct to receive the inheritance, they may be able to recover it. Moreover, if the inheritance is deposited into an account that was subject to a bankruptcy lien, it could be seized to satisfy pre-bankruptcy debts.

What are the Spousal Liability Implications?

California law distinguishes between community property exposure and statutory spousal liability. Community property is generally liable for the debts of either spouse incurred during the marriage. Family Code § 910 governs the treatment of community property obligations. However, even for separate property debts, a spouse may have limited liability. Probate Code §§ 13550–13554 outline the rules regarding spousal claims against the deceased spouse’s separate property. These rules are complex and depend on the nature of the debt, the surviving spouse’s contribution to the debt, and the value of the estate.

What if the Estate is Small?

For smaller estates, simplified procedures may be available, but even these are impacted by bankruptcy. In California, as of April 1, 2025, the small estate threshold is Probate Code § 13100 = $208,850 for deaths on/after that date. While these procedures avoid formal probate, creditors can still pursue claims against the deceased’s assets. The personal representative still has a duty to investigate and resolve debts, and bankruptcy can complicate the process. Moreover, the hard one-year creditor action limit under CCP § 366.2 applies regardless of whether formal probate proceedings are initiated, and this deadline is NOT tolled by probate.

The Importance of Proactive Estate Planning

The key takeaway is that bankruptcy and estate planning are inextricably linked. If you or a loved one is facing financial difficulties, it’s crucial to consult with both an estate planning attorney and a CPA to develop a comprehensive strategy that minimizes risk and protects your assets. California’s mandatory payment order, as detailed in Probate Code § 11420, dictates the sequence in which estate debts must be paid, and understanding this order is critical for effective estate administration. Don’t wait until a crisis—like Emily’s situation—forces your hand. Proactive planning can save you substantial time, money, and emotional distress.

What does a California probate court look for when interpreting testamentary intent?

In California, a last will and testament operates within a probate system that emphasizes intent, clarity, and procedural compliance. When properly drafted, a will does more than distribute property—it creates legally enforceable instructions that guide courts, fiduciaries, and beneficiaries through administration with fewer disputes and less uncertainty.

To ensure the will functions as intended, the executor must understand their executor duties, while the family should be prepared for the court supervision required to enforce the document.

When a will is drafted with California probate review in mind, it becomes a stabilizing roadmap rather than a source of conflict. Clear intent, proper authority, and compliant execution protect both families and estates.

Controlling California Statutes on Estate Debts and Creditor Claims

• Debt Priority:
  
  California Probate Code § 11420
  
  Establishes the mandatory statutory order in which estate debts must be paid before any distributions to beneficiaries.
• Probate Creditor Claims:
  
  California Probate Code §§ 9000–9399
  
  Governs how creditor claims must be formally filed in probate and why informal demands, letters, or invoices are legally ineffective.
• Creditor Lawsuit Deadline:
  
  California Code of Civil Procedure § 366.2
  
  Imposes a strict one-year deadline from the date of death for most creditor lawsuits, which is not tolled by probate proceedings.
• Surviving Spouse Liability:
  
  California Probate Code §§ 13550–13554
  
  Limits a surviving spouse’s personal liability for a decedent’s debts to the value of property received under these statutes.
• Small Estate Threshold:
  
  California Probate Code § 13100
  
  Sets the $208,850 small estate affidavit threshold for deaths occurring on or after April 1, 2025.