How Trusts are Affected by Bankruptcy

  • By:David Bate

Sometimes facing insurmountable debt leaves you no other choice than to file for bankruptcy. What happens during a bankruptcy if you are also the beneficiary named in a trust? The bankruptcy procedure gets a little more complicated but it is still possible to retain the trust benefits. A good bankruptcy attorney will need to look into the details of the trust, the bankruptcy and trust laws in your particular state as well as federal bankruptcy and trust laws before filing the case for bankruptcy.

Definition of a trust

In its most simplest terms, a trust allows another individual, known as the trustee, the right to keep assets in support of the inheritor or inheritors. The trustee many times if the individual who created the trust. Many different kinds of trusts, the two significant distinctions is whether or not the trust is revocable.

Irrevocable and Revocable Trust Differences

Revocable Trusts

  • Also referred to as a living trust
  • Can be accessed while the grantor is still alive
  • Can be changed if grantor’s wishes change or something unexpected happens
  • Can be removed at will
  • Becomes irrevocable when grantor passes away
  • Responsible to pay estate taxes and while grantor is live, treated as assets
  • Grantor can appoint themselves as trustee and appoint an additional trustee to assist in maintaining control of the trust

Irrevocable Trusts

  • Remove assets from the grantor’s ownership
  • Assets cannot be subject to probate or estate taxes
  • Cannot be changed once written – even by the creator of the trust
  • Grantor not liable for taxes on any income generated by the assets in the trust
  • Assets legally protected in the event anyone brings a successful lawsuit against the creator or grantor of the trust

Filing for Bankruptcy when a Trust is Involved

First it must be determined whether the trust is revocable or irrevocable. If the bankruptcy is being filed by a beneficiary of the trust, but the grantor is still alive and the trust is revocable, the beneficiary will be unable to go after the contents of that trust.

When filing for bankruptcy, you will be assigned a trustee to locate assets that you own, like your car, house, and any bank accounts. The trustee can then dispose of any of the assets that are deemed non-exempt and disperse proceeds to those you owe. Property that is considered exempt include:

  • Automobiles up to a specific value
  • A reasonable amount of necessary clothing
  • Household goods and furnishings that are reasonably necessary
  • Jewelry up to a specific value
  • Pensions
  • A part of your home’s equity
  • Tools used for your job or business
  • Part of your earned but unpaid wages
  • Public assistance

If there is an inheritance involved, the filer could disclaim the inheritance. It is critical to discuss this with your bankruptcy attorney if this is something you have done. If you disclaim the inheritance, you will no longer be able to receive any benefits from the trust. It also prevents the grantor’s assets from being used to pay off your debts. Disclaiming the inheritance has to be done well in advance of filing for bankruptcy, otherwise the courts will see this as a way to avoid using the trust to pay off our debts and can be construed by the courts as fraud.

It is critical to seek the assistance of an experienced estate planning lawyer Phoenix, AZ relies on to sort out the legal intricacies of filing for bankruptcy when a trust is involved.



Thank you to our friends and contributors at Kamper Estrada, LLP for their insight into trusts, estate planning, and bankruptcy.

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