When an Estate’s Debts Are Greater Than Its’ Assets—Administering the Insolvent Estate

Most wills contain a clause that directs the Executor to pay all taxes and debts of the decedent prior to making any distributions of the assets of the estate.  But what if the taxes and debts of the estate are more than the assets?  How does everyone get paid? What happens to the bequests to the beneficiaries?

The first step is to make an itemized list of all debts of the estate.  Include the balance of all credit cards, personal loans, student loans, car loans, mortgage and home equity loans, medical bills, income taxes, estate taxes, real estate taxes, estimated realtor commissions, administration expenses—everything you can think of.  Then make a list of all of the assets of the estate at their full market value—real property, cars, cash, investments, personal property.  Do no include the value of any asset that has a designated beneficiary, like a 401K, pension, life insurance or IRA.  These types of assets are not considered “probate assets” and do not count towards the net worth of the estate for purposes of determining insolvency. (However, they do count towards the net worth of the estate for purposes of determining if there is estate tax due).

Now compare the bottom line of the debts with the bottom line of the assets.  If the debts are more than the assets, you may have an insolvent estate.  If this is the case, you want to send letters to the creditors advising them of the date of death of the debtor.  They will have nine months to make a claim against the estate.  At the end of the nine months, any creditor that hasn’t made a claim is barred from asserting a claim.  At that point, the Executor will need to apply to the court to have the estate declared insolvent, and ask the court’s permission to pay debts in the following order (prescribed by N.J.S.A. 3B:22-2)

  1. Reasonable funeral expenses
  2. Costs and expenses of administration (such as executor commissions, legal fees and accountant fees)
  3. Debts for the reasonable value of services rendered to the decedent by the Office of the Public Guardian for Elderly Adults
  4. Debts and taxes with preference under federal law or the laws of this State
  5. Reasonable medical and hospital expenses of the last illness of the decedent, including compensation of persons attending him
  6. Judgments entered against the decedent according to the priorities of their entries respectively
  7. All other claims

What happens to the gifts to the beneficiaries?  Unfortunately, the beneficiaries are out of luck.  All available monies of the estate are put towards debts, and the beneficiaries receive nothing.