Q: Several of my children owe me money and if they have not paid me back at my death, I want each debt deducted from their share of the estate. I do not want to cause waves or hard feelings now so I am reluctant to even bring up the subject. Any suggestions?
A: You have a very touchy issue that happens in many families and would best be resolved now by you. Otherwise very emotional disputes often arise among children.
The following are only a few of the issues that arise at death: was the amount in question really a loan or just a life-time gift; has the amount been repaid; how much is still owing; was interest intended; and at death was the intent to just forget the debt or deduct it from the debtor-beneficiary's share?
A provision in your Will can deal with the issue but such a clause can not state the exact amount owing at death, so normally this part of the Will must be amended often to update the amount. The advantage of a Will provision is that you do not have to communicate with any children.
As an aside, nothing should be said in the Will as background or as explanation. To do so opens the legal doors to invalidate that provision arguing that you wrote it under a mistaken assumption or that the matter was true at the time of writing the Will but things had changed.
A second way to handle the matter is to have each debtor-child sign a demand promissory note (you can call the note due anytime), showing the amount and any intended interest rate. I would suggest a format where payments can actually be noted on the document. That way everything is present on one piece of paper.
The note will be part of the estate and can be distributed to the debtor- child, thus reflecting a decrease in his or her net share of the estate.
In the past if a debt was distributed to a child, the IRS would consider it "income" and the amount owed had to be declared as "income" by the debtor- child. That is no longer the case. Thus, the note would be treated like any other inherited asset and would not be taxable to the receiver.
BE AWARE that a valid debt can be barred by the statute of limitations five years after it became due (five years either after the date of the demand note or after the last payment, whichever is the last to occur). It is not unusual in settling an estate to find that these "beneficiary debts" are not enforceable because of the five year rule (much to the unhappiness of the other children) even if mentioned in the Will, represented by a promissory note, or just owed, which means that no reduction occurs unless voluntarily agreed to by the debtor-child. Thus the beneficiary debtor needs to resign the note or acknowledge the debt (preferable in writing) before each five year period ends. Otherwise, legally that child is entitled to a full share.
And despite what the trust sellers and trust pushers may say at their seminars, having a living trust in Colorado will not change things, although apparently the results may be different in some of our community property sister states.