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Psst ... Can you spare some dough?
Christy
Heady • Bankrate.com
At first blush, lending money to a family member seems
to be a relatively easy decision. After all, families should
stick together.
But there are many considerations, including details
of the loan itself, that can make it challenging. If, for
example, the loan is created in a less-than-business-like fashion,
it could draw unwanted attention from the Internal Revenue Service.
And a problem with a repayment? That can send ripples throughout
the family.
Finally, of course, are the issues of whether the
relative has the available cash to lend and whether he is comfortable
lending to a family member. These are just a few of the considerations
that go into the decision of one relative lending money to another.
Many of the same issues are involved with co-signing for a loan
with a relative. In both cases, one relative puts his own money
-- and credit report -- at risk for another one.
Some family members may decide it's easier or better
for the loan seeker to go to a lending institution such as a bank,
thrift or credit union. Others may choose to make a gift to help
the relative, but let a lending institution make the loan for the
balance of the required amount.
If, however, the parents, grandparents or other relatives
decide to pull out their checkbook, use a written contract or promissory
note including such relevant details as:
- amount borrowed
- interest rate
- life of loan
- repayment schedule, and the date each payment
is due
Monetary gifts should be recorded as well.
Take a common example of parents wishing to help their
son and daughter-in-law put together the down payment for a home.
If parents are giving the money, they should create a gift letter,
which is a notarized document stating that the recipient does not
have to repay the money and that the gift is not considered a debt
of the recipient.
Each parent can give up to $10,000 a year per individual
recipient without incurring a federal gift tax or using up his or
her $600,000 lifetime exemption for federal gift and estate tax
purposes. If Mom and Dad each give $10,000 to their son and
the same amount to his wife, they can give $40,000 tax-free to the
couple for the year.
Those families that are able to make even larger gifts,
say $60,000, should consider giving the maximum yearly amount at
the end of one year and the remaining amount at the beginning of
the next year. For example, $40,000 could be given in December,
and $20,000 given in January.
Then, there's the issue of loans.
If a parent loans more than $10,000 a year to a family
member, the parent could be required by the IRS to show proof that
the money was a loan. Otherwise, the loan could be considered
a gift.
Low interest loans are another option for a parent.
But the interest rate on the loan must be at least
as high as the "applicable federal rate" that is set and published
monthly by the Internal Revenue Service in the Internal Revenue
Bulletin -- contact the IRS at (800) 829-1040 for further information.
If the interest rate on the loan is less than the applicable federal
rate, the parent will be subject to the "imputed interest" rule
for income tax purposes.
Under this rule, the parent will annually be deemed
to have received taxable interest on the loan computed using the
applicable federal rate, whether or not any interest is paid by
the borrower. Due to the complicated tax rules in this area,
have your tax adviser or attorney prepare the loan documents when
making loans to family members.
Posted: May 19, 1998
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