It’s not a situation any executor likes to find themselves in, but if the estate is insolvent, or has more to pay out than it has on hand, then you are not responsible for the debt, assuming you didn’t have any special ownership circumstances.
That’s good, but it also means beneficiaries may not get all or some of their inheritance, which is never a fun conversation. Believe me.
When an estate can’t pay all the taxes, debts, and inheritances dictated in the will, you must follow a strict order to how and to whom you pay.
But first…
What is an insolvent estate?
An insolvent estate is an estate that doesn’t have enough cash or other assets to pay off its debts, taxes, administrative expenses, and inheritances*.
To figure out if your estate is insolvent, you should first figure out all of the debts that exist and compare those against your known probate assets. The most common debts people die with include:
- Mortgages
- Car payments
- Child support and alimony
- Business loans
- Overdue taxes
You should also check for any life insurance policies that may be attached to certain assets. E.g. a life insurance policy that pays off a home in the case of someone passing away earlier than expected.
Who gets paid first with an insolvent estate?
The majority of estates go through probate, although there are certainly ways to avoid the probate process. Each state has its own laws that dictate the details of probate*, but the priority of liens, creditors or other estate payments is typically fairly standard.
This is the typical order an estate pays in:
- Estate expenses (including court fees, executor fees, and other misc. expenses related to settling the estate)
- Funeral expenses
- Any national or local taxes due
- Creditors of the estate (people who are owed money by the estate)
- Inheritances and other payments to beneficiaries
Keep in mind that the priority payment from an insolvent estate works like in a trickle-down format. Meaning that if the estate runs out of money after covering the estate expenses, then the government may not get as much money*. And if you run out of cash after paying off estate creditors, then the heirs & beneficiaries may not get any assets — regardless of what the will says.
In other words, if an estate is insolvent, beneficiaries may lose some or all of their inheritance.
For state-specific payment order advice, type “[your state] probate payment order class .gov” into Google or whatever search engine you use. That should surface the applicable probate code or probate statute in your area.
It's also worth remembering that if some estate assets passed outside of probate, they will not be affected by this order. And again, this order can change by state, e.g. medical debt may have priority over state taxes.
Read more: The Complete Guide to Probate vs. Non-Probate Assets
What to know when an estate can’t pay its taxes and debts
Outside of two specific situations, an executor isn’t responsible for paying an estate’s extra debts. Those two situations are:
- You co-signed on the loan.
- You are the surviving spouse in a community property state. If you live in Alaska, Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin, you may have to foot the bill*. I’d consult with a probate lawyer if you’re in this situation.
Here are few other things worth knowing:
An insolvent estate may not have to pay all debts
Filing notice to creditors is a critical part of the probate process. This is when the executor proactively contacts all known creditors (people who are owed money by the estate), and say, “Hey! It looks like this late individual owes you some money. If you want it, please file a claim with the relevant probate court.”
Executors do this by posting a notice in a public newspaper and mailing/emailing relevant people and/or organizations. Once a claim is filed, the probate court will figure out who gets paid in what order*. If the estate doesn’t have immediate cash on hand to pay the creditors, then the estate may be forced to liquidate (sell) certain assets like retirement accounts (e.g. an IRA), stocks, or houses.
Here’s the kicker, though. Once a creditor is properly notified, it starts a clock known as the statute of limitations. If they don’t file a claim within the timeframe (a few months), then that debt doesn’t have to be paid.
So while not a guarantee, it is possible the estate could get out of paying some debts.
This means it is advantageous to file notice to creditors as soon as possible.
👉 For more info on how to do that now, check out our guide for How to File Notice Creditors in 6 Simple Steps
When to declare an estate insolvent
If the estate exhausts all cash assets they can liquidate before paying all taxes and paying off all the creditors, then the executor needs to tell (in the form of a petition) the probate court that it is insolvent. The probate court will officially declare the estate insolvent, and then the estate will have to pay out as much as possible according to the order set by the court.
In a situation like this, no inheritances will be distributed because all cash and assets will be used to pay off liabilities.
What to do when an insolvent estate can’t pay its beneficiaries
If you manage to pay off all the taxes and debts but realize the estate doesn’t have enough to give everyone what was appointed in the will, then things get trickier. Even if the person passed intestate, or without a will, beneficiaries can expect a certain windfall, and when those expectations aren’t met, emotions can run high.
Here’s the deal: executors aren’t responsible for peoples’ inheritances. Unless you took advantage of or grossly mismanaged the estate funds, in which case a beneficiary could complain to the court, you do not have to pay anyone’s inheritance out of your own pocket.
In cases where there is no money leftover after debts and taxes, then the process is simple: no one gets anything.
When there is enough to cover some but not all inheritances, you just need to follow the direction of the court. The probate court will help you figure out who to pay and in what amounts, and this is often done in percentages (Louis gets 25%, Jack gets 40%, etc.)
Final advice for executors of insolvent estates
If you’ve realized your estate is insolvent or fear it may be after looking through some numbers, start by:
- Recognizing you likely not responsible for any debt, tax, or inheritance burdens.
- Taking action on things like filing notice to creditors asap.
- Informing beneficiaries early in the spirit of transparency.
- Remembering that not all assets are probate assets, which means some inheritances may be distributed.
- Really trying to get a fair market value for each asset you sell, so you can increase the likelihood of distributing an inheritance.
That’s it for this breakdown of insolvent estates. Are you managing an insolvent estate? What experience or situations are you running into?
We'd love to hear more. Let us know if you have any questions or tips by dropping us a short comment below!
