Debt after Death: Who Takes on the Debt after a Debtor Dies?

Picture this scenario: You are approaching the end of your life, yet your balance sheet is in the red. You still have a significant sum you owe to an assortment of creditors. “Ah-ha!” you triumphantly think. “They can only take it while I’m alive. I only need to keep them away a little longer.” Not quite.

debt after death

As nice as it would be if all debt immediately vanished after death, that unfortunately isn’t the case. If it were so, there would be no incentive to pay back your liabilities, as they would vanish after you pass away, a victory for the grantor and a huge loss for the creditor, making them unlikely to grant loans in the first place. Fortunately, however, if you do have outstanding debt at the time you pass away, your children can not legally be forced to pay it off out-of-pocket. Nevertheless, it is critical to learn the laws surrounding unpaid debt, as creditors often try to solicit money from those related to the grantor. For example, in regards to credit card debt, debt collectors try to convince adult children who recently lost their parents that it is their responsibility to pay off the remaining balances. Note, however, that these said children have no legal obligation to these creditors. The deceased’s family does not owe anything. Before you exclaim that this means your debt does in fact disappear, note that your children could, however, receive a diminished inheritance if creditors take money from your Individual Retirement Account (IRA). Luckily, simply adding your kids to your pension as heirs can help you get around this.

If you do wish to ensure that your liabilities do not come to haunt you, and your family, it is crucial that you engage in careful asset protection planning, such as by adding your children to your pension as heirs, as stated above.

What role does life insurance play in regards to debt?

Life insurance is a wise investment because it guarantees money to your designated beneficiaries at the time of your death. While life insurance may help take some financial burden off of your family and cover the costs of your funeral, it is not always enough to erase the debt you have accumulated throughout your lifetime. One way to ensure that your life insurance policy will take care of all outstanding debt is to name the beneficiary as your estate, which will cover the debt from your assets and avoid your children from inheriting your debt. Note that this will mean creditors will still be able to collect, but it will ensure your children do not have to answer for your unpaid liabilities.

Naming the estate as your beneficiary can bring up a few issues, especially because your estate is not considered a living entity. This means thats stretch IRA, which allows beneficiaries to not have to pay taxes on both already existing contents as well as new account activity, will not be an option. If you die before you’re 70.5 years of age, then in the next five years, the IRS will then be obligated to pay out all funds to your estate. However, if you surpass the date of your 70.5th birthday, the IRS will have the rest of your life expectancy to make distributions to the estate. Since they were named indirectly, your beneficiaries will eventually receive your IRA through the estate and will have to not only take the funds earlier but possibly have to pay more taxes on them. The IRS Single Life Expectancy Table will be helpful to your living beneficiaries, because, since they are promised the IRA stretch, they can utilize it to determine their life expectancy to stretch the distributions over the remainder of their life. Life insurance can thus be helpful when handling debt, but it is best to be aware of the limitations that may come with it.


Why You Should Avoid Probate

Naming your estate as the beneficiary will require you to go to probate court. Probate is a process where a deceased person’s will is validated and both the distribution of their assets to their heirs and payments of their debt are handled accordingly. It might be a good idea to avoid probate for a number of reasons. Not only can it be a prolonged process that could take years, but it can be an expensive one too. Probate courts tend to have multiple fees, one to just file probate and additional ones that arise throughout the process. Since the deceased person’s estate must be fully approved by the Surrogate’s Court, the probate judge can delay the process and even have to consider assets with minimal to no value. Furthermore, the probate process is not private and any information can easily be accessed by the public as it goes on record.

Credit Card Debt

As aforementioned, while your children will not be held accountable for your credit card debt, they can still be negatively affected. It is possible for your debt to be collected from your estate and this would minimize your children’s inheritance. The only exception where your debt would be inherited to your children and they would be required to make payments after your death, is if they signed as the executor of the estate. Holding the title of executor means one would have the responsibility of seeing to it that the deceased’s wishes regarding asset allocation are met.

Tax Debt and How to (Legally) Avoid it

Tax debt cannot be inherited and your children will not be responsible for any withstanding tax at the time of your passing. It is the responsibility of the estate to take care of property and income taxes, provided that there are sufficient funds. The executor of your estate will receive a collection letter from the IRS requesting payment and it is then up to the executor to pay the tax debt before they can distribute assets accordingly.

There are a few ways to avoid paying tax on debt. When you are not able to pay off the debt you have accumulated throughout your lifetime and your debt total exceeds the total amount of your assets, you are considered insolvent and the debt may be void. Student loans that have been forgiven are not subject to tax. Additionally, debt can be erased if there is a Public Service Loan Forgiveness clause that will allow your work service to be sufficient enough to not have to pay tax on any student loans that have been canceled. It is important to note that private education student loans are not applicable, as this exception is only for federal loans, certain public companies, or schools with programs that help underserved profession areas. One should expect to be subject to income tax if the student loans were forgiven in other manners, such as being insolvent.

According to the Mortgage Forgiveness Debt Relief Act, when one forecloses on their home, mortgage debt can be forgiven and it is not taxable. Additionally, if you have filed for bankruptcy, simply do not list the debt as income and you will not be subject to tax on it.

Forgiven interest that would have been deductible had you paid it, such as interest on business debt, is not subject to taxation. You do not have to pay tax on debt that has been accumulated from applied interest. However, forgiven debt is taxable under certain circumstances. If the debt was considered nondeductible, such as with credit cards, taxes on the forgiven debt as well as on the interest must be paid.

When the cancellation of debt is a gift, it is not considered income and does not need to be reported as such. The IRS will typically not give you a problem for gifts received by family members. However, when large amounts of money are received from others, such as those with whom you have a working relationship, the IRS does not consider it a gift. A gift tax return or form 709 must be filed by the gifter if the amount given in one year exceeds $13,000. This will not affect the giftee and there will be no taxation required.

Federal gift tax does apply when a gift is made or when a transfer is received and full compensation is not rewarded. The gift giver is responsible for the gift tax and the tax is based on the gift’s value. This was implemented to prevent people from giving away all their savings before death and avoiding the estate tax. The only gift that is exempt from gift tax is one made to your spouse. If you pay on someone’s behalf for medical or educational purposes or you receive a promotional gift, it is not excluded from taxation.

A Capital Gains Tax is when you make a profit off of an item you have sold, typically occurring with investments and personal property. If you own something, more than likely it is considered as a capital asset and with all capital assets, capital gains taxes can apply. The net gain you make from a sale must be reported on your taxes. The reported amount includes the item’s price, plus any other costs, including shipping and handling, installation, money spent to improve and increase the asset, and all taxes and fees. More often than not, your house is considered exempt, as it is usually the largest asset people have. When a big capital gain occurs from the sale, you can be exempt from some, if not all capital gains tax. In order for this to occur, you must have owned the house and used it as your primary residence for two or more years prior to 5 years of the sale. Additionally, you must not have excluded the profits from the sale of another home in the 2 years prior to the most recent sale. If these requirements are satisfied and you are filing as a single person, you can exclude as much as $250,000, and married couples can exclude as much s $500,000 of the gain.

The amount of time one has owned the house is significant because it determines whether or not someone will have to pay taxes. Long term capital gain occurs when you sell an asset after owning it for more than one year and short term capital gain occurs when a sale is made after having ownership for only less than one year. Generally, significantly more taxes will apply with short term gain than with long term and those in the lowest tax brackets will be exempt from any taxes made from long term capital gain. It is important to note that no matter what, one will have to pay capital gains tax should they decide to later sell property that they have inherited. The capital gains tax due will be according to the property’s value at the time of death. For tax purposes, the “step-up” basis rule is used to determine the cost on inherited property. An heir receives a basis in inheritance, meaning the true value is the one at the time of death and not the price

the deceased originally paid for it, whether that be higher or lower. The step up basis rule states that any net gain is not considered income tax.

Estate Tax

Upon your death, while you do have the right to transfer property, you will inevitably be faced with taxes, specifically estate tax. Your Gross Estate consists of everything you own and the total value is computed after excluding certain exemptions such as debts and mortgages. The value of taxable gifts is then added to the total value of your Gross Estate so that taxes can be determined. To limit or avoid estate tax entirely, before you die you should remove assets from your estate, buy life insurance for added protection, and leave your spouse with a large amount because there will be no estate tax on it.

The Role of Trusts

When stated in a will, assets will go directly to the named beneficiaries. However, assets stated in a trust will first be received by a trustee who will then distribute them accordingly. This method of having trusts set up can be a useful way to avoid taxes.

Qualified Personal Residence Trust (QPRT)

Qualified Personal Residence Trusts only concern one asset: houses. QPRT’s must be irrevocable in order to successfully dodge the estate tax. For this to happen, your assets must be removed from your estate. When the trust expires, the trust will own both the house and any increase in value before your heirs receive them later on.

Irrevocable Life Insurance Trust (ILIT)

Taxes can additionally be avoided by having an Irrevocable Life Insurance Trust. However, with ILIT’s, any income that has come from your life insurance is considered a part of your estate. Therefore, it would be wise to put your life insurance policy in a trust so that your beneficiaries can eventually benefit from it.

Bypass Trust

Bypass Trusts allow you to place an amount into a trust, which must not exceed the estate tax exemption, so that your spouse and children reap its benefits later. Income can be received from the trust, and although the trust is separate from the estate, one will not lose income from the assets. After death, the trust with its appreciation can be inherited and is exempt from estate taxes.

Intentionally Defective Grantor Trust (IDGT)

If you own a share of a privately-owned company but it is not valued for much, one option would be to place it in an Intentionally Defective Grantor Trust. IDGT’s allow you to keep the share and over time, should it increase in value, the generated appreciation which is nontaxable, will be given to your heirs. Another option would be to “freeze” your assets which would allow the appreciation to avoid taxes.

Student Loans

Unpaid student loans can be inherited. However, they can also be covered by life insurance policies. A death discharge states that federal student loans can be exempt after the death of the borrower. In the case that the parent takes out the loan in their name, the loan will be void if either the parent or the child passes away; for a loan to fully be discharged, a valid death certificate will be necessary. On the other hand, private student loans can be passed down and the parents who co-signed will likely be liable to not only pay the debt but to pay it upfront in its entirety because of “acceleration clauses.” Additionally, spouses are at risk for inheriting unpaid student loans, depending on where they live and the time at which the loans were taken out. In community property states, all debts accumulated during marriage are the responsibility of both spouses, meaning the surviving spouse will be liable to continue making payments after the death of the borrower. While this applies to just loans taken out during the marriage, spouses may be responsible for loans from prior to the marriage as well, if the lender taps into joint accounts to cover remaining debt. Furthermore, consolidating debt can help prevent your debt from piling up. For instance, one can choose to consolidate their student loans, meaning their existing balances can be paid off by combining multiple loans from a single lender to pay off any other loans.


Mortgages do not get erased after you pass away if you have left your house to your family. Your children will not be responsible for paying off the mortgage in full, but by law, they will be required to keep up with the monthly payments. In the event that the beneficiary decides to sell the house and the mortgage is worth more than the existing home value, they can foreclose or go through with the sale and will not be held responsible for the uncovered differences. Should your children decide to disclaim their inheritance, the person named in case the child passed away before the parent will receive the property, and if no other beneficiaries were named, the house will likely go to the general estate.

Medical Debt

Laws regarding medical debt vary depending on location. While your children may not be directly held accountable for paying, in many states, medical debt is to be paid off through one’s assets. More than half of states in the U.S. have laws called “filial responsibilities” that state that unpaid medical bills must be partially paid by the children of the deceased if the estate is not enough to cover it all. If the deceased parent was covered by Medicaid, the state where they die will be responsible for any debt accumulated after 55 years of age. If at the time of a parent’s death, adult siblings lived in the deceased’s home 2 or more years prior to the passing and helped them to an extent that replaced being placed in a nursing home, the state cannot collect. It is highly important that the debtor engages in asset protection to legally keep their debts away from creditors because personal assets are not protected by insurance against collection rights of medical institutions. When unexpected medical treatments are deemed necessary but the insurance will not cover them, a lien is filed. So say you cannot afford your lengthy hospital stay, the hospital then has the right to possess your assets and even levy your financial accounts until the debt is discharged. Your assets will be used to compensate the creditors and these consequences can often cause one to file for bankruptcy. Therefore, securing an asset protection plan early on is crucial.

While unfortunately, debt does not disappear after death, there are many preventative measures one can take to ensure that their financial burdens do not get passed on. It is important to be aware of the laws regarding the various debts you may have and the status of heritability each one has. As previously stated, it is also highly recommended to engage in asset protection measures to secure your assets do not get depleted by creditors attempting to satisfy your debt. Consult with a professional estate planning and asset protection attorney in order to make sure that all your assets are protected and to learn how to deal with debts properly to ensure that your children’s inheritance will not be compromised. For immediate assistance, contact the Law Office of Inna Fershteyn at 718-333-2394.