None of us like to think about our own or our loved ones’ mortality, but ignoring that eventuality will not make a stressful situation any easier. When a family member dies, it’s important for you to know what responsibilities you might be facing. Here is a breakdown of what you can expect if a family member dies and leaves debts behind:
Paying From the Estate
After a death, the executor of the deceased’s will is responsible for notifying creditors of the death. At that point, the creditors submit proof of the debts, and ask for repayment from the estate. The executor will then pay off the debts, first by using whatever cash the deceased left, and then by liquidating whatever assets are left. If there is still not enough to pay off the debts, then the estate is declared insolvent. The creditors cannot then go after the heirs — unless they were cosigners on any of the debts.
When the estate pays the creditors, secured debts (meaning debts with an asset attached, like a home or a car) are paid first, while unsecured debts (generally, credit cards) are paid afterwards. This means that the unsecured debts might not receive a payment in the case of an insolvent estate.
Credit Card Debt
Creditors will do what they can to see that a debt is paid. In most cases, that simply means that debts must be paid off before any assets can be passed on to the beneficiaries of a will. When there is no money in the estate to pay off a credit card debt, creditors will generally close the account and forgive the debt. However, as we all know, creditors can be quite tenacious. Often, creditors will attempt to collect payment from the heirs, even though there is usually no personal liability if the estate is insolvent. If you are hounded by a creditor for a deceased family member’s account, discuss the situation with a lawyer before you make any payments.
The one caveat about personal liability has to do with community property states. In those states, any account opened by one spouse could automatically be considered a joint account, in which case the surviving spouse could be considered liable for the debt. Again, an estate lawyer can help a spouse in that case to determine the best course of action.
It’s important to note that the 2009 Credit Card Act has now made it illegal for credit card companies to add additional fees or penalties to an account while the estate is being probated.
Dealing with the IRS
If a spouse passes away while still owing back taxes, the surviving spouse must pay the IRS both those back taxes and any current taxes owed. In the year of the death, the spouse must file taxes for the deceased’s final year of income, and s/he may file a final joint income tax return, although there must be a note of the death when filing.
The IRS will hold spouses liable for tax debt, but it will not hold any other family members responsible. However, as with any other debt, the estate must pay any taxes owed before heirs can claim their inheritance.
In general, life insurance will not be considered part of the estate, and is safe from creditors. Since the insurance company pays the benefits directly to the survivor, the money is never placed in the deceased’s name, and is therefore not in the estate. There are a couple of exceptions to this, however. First, if the deceased names the estate as the beneficiary, rather than an individual, then that money is fair game for creditors trying to collect from the estate. In general, it’s a good idea to name a specific beneficiary for this reason.
A second way that a life insurance payout might be taken by creditors is if the beneficiary is a cosigner on any of the debts. In that case, the creditor has the right to sue the surviving cosigner for the balance if s/he does not continue making payments on the debt.
It is important to note that there is a difference between being a cosigner and an authorized user on a credit card. An authorized user did not sign the application and is simply allowed by the signer to use the card, which means s/he is not liable for the debt incurred.
The Bottom Line
Know your rights and responsibilities before you have to deal with the fallout of a death in the family. Familiarizing yourself with what you might have to deal with will make a stressful and sad time easier to manage.