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Lending money to a family member
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The tax man
The IRS assumes that a loan earns interest, and expects you to declare that income on your taxes.

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The IRS even calculates a minimum interest rate it requires you to receive. Known as the applicable federal rate, the figures are published monthly in the agency's Internal Revenue Bulletin.

If the IRS believes the loan is really a gift in disguise, it will require the donor to file a special tax form at the end of the year. While the IRS permits a certain amount of tax-free gifts over a lifetime, once the giver has exceeded the limit, he or she will be liable for taxes on the gift.

But there are some general exceptions to the federal gift tax, according to the IRS, including: an annually exempted gift amount; tuition or medical expenses paid for someone else and (for the most part) gifts to a spouse.

In addition to federal regulation, "different states have different rules," says Rudy D'Agostino, partner in the Longmeadow, Mass.-based CPA firm of Meyers Brothers PC. "You want to check the rules locally."

Best bet: if the transaction is a real loan, charge an interest rate and make sure there is an ongoing paper trail, including a loan agreement, proof of repayment and plenty of receipts.

In spite of the extra paperwork and mandatory interest, borrowers -- especially those with less than perfect credit -- stand to get a better deal with a friend or family member than on the open market, says Bendix.

"It can be a tremendous benefit," he says. "The reasonable rate is going to be so much better than for any other non-secured loan."

Saying no
Just because someone asks for money doesn't mean you have to give it. But it's more difficult saying no to family because, chances are, you want to preserve the relationship. If you don't have the cash, or if the loan would strain you financially, tell the potential borrower that you just don't have the money.

If you have it, but don't want to make the loan -- or suspect the person really wants a gift -- you can invoke a variety of reasons: the stock market's hit you pretty hard, kids or grandkids in college, family medical bills etc. If you run your own business, it's probably not much of a stretch to say that most of your cash is tied up there. Having money is one thing, says Bryck, being liquid is another.

When you say no, steel yourself. Sometimes a family member will take your "explanation" as an opening to negotiations. "I'm sorry, I just can't right now," is all you really need to say.

Family businesses also present their own lending problems, says Bryck. Sometimes, relatives see the company as a personal cash cow.

"But one of the cardinal rules of a family business is to treat it like a business, and not a family bank," he said.

Keeping the peace
Often, maintaining family harmony relies more on what you don't say. Remember to keep any loan request strictly between you and the potential borrower. The family doesn't need to know that Uncle Ned's business is going south unless he wants to announce it himself.

And if you haven't got cash for a loan to your oldest daughter because your youngest already borrowed $10,000, omit that detail when you refuse the request.

If you do make a loan to a relative, resist the urge to meddle. A parent with a ready checkbook might think "that they have some say in the person's lifestyle decisions," says Bryck. But that attitude is counterproductive.

"It sort of drags the borrower back into a childlike state."

Dana Dratch is a freelance writer based in Atlanta.

Bankrate.com's corrections policy -- Posted: July 24, 2002
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