Loaning Money to Family Members

Many of you will find yourselves in a position where you want or need to loan money to a son, daughter, or other family member. Before you do, you will want to carefully consider whether you can afford to lend the money and how the IRS will view the transaction. In addition, consider the effect on the relationship and the financial effect on yourself if the loan is not repaid or is not repaid in a timely manner.

In other words, treat the decision to lend seriously.

Put it in writing : Make the deal as businesslike as possible. Be clear up front that for IRS purposes, a valid loan agreement is imperative otherwise, the IRS could argue that there was no loan at all — that the money you gave was really a gift.

Set an interest rate : If you set a rate that is lower than the applicable federal rate, you may have to report income you never received and there could be gift tax consequences. If you charge a low interest rate, rather than no interest, the imputed interest is based on the difference between what you actually charge and the amount due, using the applicable federal rate.

There are, however, two important exceptions to the “imputed-interest” rules. The first exception is known as the $10,000 gift-loan exception, and the second exception is for loans of up to $100,000 to individuals who have little net investment income. These exceptions are a bit confusing and I would be happy to explain how they might work in your situation.

Be careful: Loaning money to a family member is something that should be done seriously. It can damage relationships between parents and children and between siblings. There are also income tax and estate planning problems. Given the complexity of the imputed interest rules and the related exceptions, it’s wise to work with a tax expert in structuring loans to family members.