Adding yourself as a cosigner to a family member’s bank account can be a simple way to help manage finances. However, if you need to file for bankruptcy, being a cosigner on an account you don’t own can create a problem. Even though you can take steps to help protect a parent’s or child’s account from bankruptcy creditors, there are no sure bets. You’ll have to prove you don’t own it to keep the balance safe.
What Happens to Property in Bankruptcy
Filing for Chapter 7 or Chapter 13 bankruptcy can be a great way to solve financial problems and erase burdensome debt, especially since you can keep property you’ll need to work and live if it’s covered by a bankruptcy exemption. Any property you can’t exempt will be sold by the bankruptcy trustee appointed to your Chapter 7 case, or you’ll pay the nonexempt property value to Chapter 13 creditors.
Disclosing Property You Own and Property You Manage
You must disclose everything you own and things you don’t own if they’re in your possession, including a parent’s or child’s account you manage as a cosigner. Some types of property are more difficult to protect than others, and cash and money in banking and investment accounts fall into this category. Not only must you disclose it, but as a cosigner, you have the appearance of owning it, and the trustee will likely want to take it, if at all possible
Listing the Account in the Bankruptcy Papers
The bankruptcy paperwork has a specific place for listing property you possess but don’t own. It’s on the Your Statement of Financial Affairs for Individuals Filing for Bankruptcy form, although your attorney might want you to include it elsewhere, too.
Listing the managed account this way tells the trustee:
- you have control of the account
- you don’t own it, and
- you don’t believe it qualifies as an asset.
You’ll do the same for any other similarly situated property. For instance, if you’re borrowing your aunt’s car while your car is out for repairs, you’ll list your aunt’s car as property being held for someone else.
The Trustee Will Evaluate the Account for Creditors
Just because you identify the account as property you’re holding for another doesn’t mean the trustee will agree. Part of the bankruptcy trustee’s job is to ensure that creditors receive the maximum payment possible.
Financial accounts are one of the first places a trustee will look for money because bank account funds are notoriously hard to protect with bankruptcy exemptions. So, you can expect the trustee to examine a bank account thoroughly when determining whether you’re an owner.
Signs of Bankruptcy Fraud
The trustee will look for something else, too: fraud. And with good reason. Some of the oldest fraud cases involve family members transferring property to each other to avoid paying creditors. But since the practice isn’t legal—it’s a fraudulent act—a concerned trustee will likely evaluate:
- how long the account has been opened
- what the funds have been used for, and
- who deposited the funds into the account.
The court will examine whether the transfer rendered the transferor insolvent and how close it occurred to the bankruptcy filing. If the court agrees that typical signs of fraud exist, the court will likely issue an order stating that the account funds belong to the bankruptcy estate and that the money should be distributed to creditors.
Example 1. Suppose a filer had the money to repay creditors but deposited the funds into an account for a family member shortly before filing for bankruptcy instead. The trustee will likely suspect that the deposit was a fraudulent transfer intended to hide funds from creditors and move to reclaim the money.
Example 2. Suppose there’s evidence that Grandma deposited funds into an account for Grandchild several years back. Since then, the funds haven’t been touched. The trustee would likely acknowledge that the funds weren’t the bankruptcy filer’s property.
Steps to Help Protect a Parent’s or Child’s Account in Bankruptcy
Trustees aren’t unreasonable. If you can show that your only role is managing the funds, the trustee won’t press the issue. There would be no reason to engage in a meaningless fight.
Here are some steps you can take that might help avoid unnecessary litigation:
Disclose the account. It’s important to state your account involvement in the bankruptcy paperwork. If you exclude it and the trustee finds the bank account later, it will appear that you’re hiding something, and you’ll have a more difficult time straightening the issue out.
Be prepared to show proof that the funds aren’t yours. Some accounts are easier to explain than others. For instance, if the account funds consist entirely of Social Security funds (which are protected from creditors) that are used only for the recipient's benefit, there’s no reason to wait for the 341 meeting of creditors, the one hearing all filers must attend. You can explain it when the court assigns the trustee to your case. Dealing with a potential issue preemptively and transparently can solve the problem more efficiently.
Exempt the balance. You can "exempt" or protect a certain amount of assets in bankruptcy. If you have an exemption you can use to protect the account, use it. But you’ll still want to explain that you don’t actually own the account and are using the exemptions in an abundance of caution. You don’t want to trustee to later claim that your use of the exemption is an ownership admission.
Keep in mind, however, that if you can’t protect the balance, the bankruptcy court is unlikely to let you out of the case—especially in a Chapter 7 matter. You should speak with a competent Chapter 7 bankruptcy lawyer if losing the balance will cause a serious financial issue.
Tools That Might Help Protect a Parent’s or Child’s Account
Many people want to know how to set up a bulletproof account guaranteed to protect funds in bankruptcy. The problem is such an account doesn’t exist. The court can look beyond any account set up to defraud creditors.
Certain accounts can, however, provide an extra layer of protection from creditors when you need to manage the financial account of someone else. Your options will depend on whether the individual is a minor or an older adult.
- Minors. Accounts created under the Uniform Gifts to Minors Act (UGMA) and Uniform Transfers to Minors Act (UTMA) allow an adult to transfer assets to a minor and act as a custodian to manage the account until the minor reaches the age of maturity. Transferring money to an UGMA/UTMA account is irrevocable, and the funds belong to the minor. This change of ownership prevents the adult’s creditors from going after the account. Even so, it won’t have the desired effect if the timing suggests that the transfer was intended to defraud creditors. The account is fair game for the minor’s creditors, too.
- Adults. Instead of using a joint account, an adult can typically give another adult account control using a power of attorney. A power of attorney doesn’t convey an ownership interest so the funds won’t be subject to the creditors of the account manager.
Even though these tools exist, it’s important to remember that they can’t ensure the safety of the funds, shouldn’t be used to avoid paying creditors, and might not be the best solution for everyone.
When dealing with significant amounts of money, it’s prudent to speak with a lawyer to find out if other estate planning techniques, such as using trusts, would be more appropriate to accomplish your goals.