The recession made many parents and grandparents into personal bankers, making loans to strapped children or grandchildren to help them cope with unemployment or other financial misfortune.
However, family loans need to be prepared properly to avoid tax repercussions. Here are some tips on how to do that:
Put loan terms in writing – the IRS says a loan is a loan, and requires that family loans be put in writing with clear terms and a repayment schedule.
Use fair market interest rate— for loans of more than $10,000, you must set a fair market value interest rate or the IRS may consider it a gift instead of a loan. That interest rate must be at least as high as the minimum monthly interest rates set by the IRS. However, because you are allowed to give gifts of up to $14,000 per year tax-free, you can forgive up to $14,000 annually in payments.
Obey tax laws – the loan must be properly structured if the borrower plans to deduct the interest. Depending on how much the loan is, a lender may need to pay income taxes on the interest earned. However, if the family member does not pay you back, you may be able to take a deduction for a nonbusiness bad debt.
Plan for contingencies – you should plan for certain contingencies; i.e., if the loan will be forgiven in the event the borrower or lender passes away before it is paid off. Be sure to talk about estate planning issues with a qualified estate planning attorney.
One of the main goals of our law practice is to help families like yours plan for the safe, successful transfer of wealth to the next generation.
As a Personal Family Lawyer®, I can further advise you on all your options and make things as easy as possible for your family during a Family Wealth Planning Session. If you would like to have a talk about estate planning for your family, call our office today to schedule a time for us to sit down and talk.
To your family’s health, wealth and happiness!
David Feakes
P.S. Want to get started on the most important planning you’ll ever do for your family? Give our office a call at (978) 263-6900 to get started. You’ll be so glad you did.
David Feakes is the owner of The Parents Estate Planning Law Firm, PC – a law firm for families in the Acton, Massachusetts area. David helps parents protect the people they love the most. If you would like to receive David’s exclusive, free report, “Six Major Mistakes To Avoid When Choosing An Estate Planning Attorney,” you can get it right here.
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