Family Loans and the Gift Tax


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Process Involved in Giving Loan in 2017


Above all it is very much important for you to document or take note of the loan.  The most common problem that individuals encounter is that they do not take note of the loan especially if they are not going to ask interest for it.  The truth is that even if you are not going to ask for an interest, you still have to note it down.  And if you are going to ask for an interest, you have to take note of everything such as terms of payment and the collaterals involved in the loan just to have everything in black and white.  If you will not do this properly, you may find yourself paying for gift taxes.  The good thing about documenting these loans is that you need not have the formalities of getting a lawyer for it.  You just need to write it on your own using any document processing program.


Once you have the note, it is important for you to keep it with you especially if the money loaned from you is going to be for mortgage or purchasing a property.  Most of the time, these loans that are used for mortgages will usually undergo legalization through a lawyer.  The reason why it is important for this loan to be noted is to get the tax benefit to be given for mortgage interests.  Aside from this tax benefits, declaring the loan will save the borrower from criminal charges just because of the hidden loan.


This note will also make it very clear to you that the money obtained from you is a loan and not as a gift.  This is just a way of establishing solvency or financial obligation to the borrower.


Most of the time, people who are loaning money to their relatives would usually not ask for an interest.  However, the IRS may put on an interest on that loan and since there is going to be an interest, the IRS will do its best to charge you tax for it.  This is what you call imputed interest.  For the IRS, the definition of a loan is that it should have interest and that interest is taxable.  So if you think that not setting aninterest rate is better or will give fewer problems, then think again.


Aside from this, the IRS will still find a way to charge you with tax on the money that someone loaned to you.  Since the borrower got money from you, they assume that they do not have finances to settle the interest.  With this, they will be giving you gift taxes.  You have a limit of $14,000 free gift taxes, meaning the amount that you used will not be taxable without exceeding this limit.  With this, the IRS will deduct the "interest" of the loan on your gift taxes.  Once you have exceeded that limit, you will lose your lifetime tax exemption on gifts and tax exemption on estates.


Avoiding Imputed Taxes Interest in Two Ways


Rule 1: $10,000

If you want to avoid all the imputed interests, you have to understand when imputed interest applies.  This imputed interest or other tax problems are not applicable if the amount owed to you by the borrower is less than or equal to $10,000.  But, this $10,000 limit includes the outstanding amount owed plus the interest.


Rule 2: $100,000

Just in case the first rule is not going to work for you, you can use $100,000 rule.  This is when the whole total amount of outstanding loans, may it be with interest or not, is not more than $100,000.  There will be no imputed interest if the net income for investment within the year is not going to be greater than $1,000.  This net investment income is defined or will include the interests and some royalties that are used in knowing the amount of margin-account interest.  The imputed interest can be avoided especially by families who are borrowing money from each other since they are not included in the groups of people with large investments.  However, if the investment income is greater than $1,000 then the borrower should pay the same amount.


Here is an instance to give you a clearer picture.  A parent lends his son money to buy a house amounting to $100,000 without interest.  However, the IRS would demand an interest of 3%.  With this, the child should pay an amount of $3,000 of interest.  However, the child will not pay anything if the investment income is lower than $1,000 but if he is earning $1,200 then he would need to pay the amount limit of $1,000 instead of the actual interest price.


However, you have to secure a document that will show the borrower's investment income before you will be eligible for this rule.


Using Demand Loan to Your Benefit


No matter how beneficial it is, you will find that it may impact your gift tax.  If you want to prevent yourself from having this problem, you can try to have a demand loan.  This is the instance where you can demand for the amount to be paid in full whenever you want.  But you can just use this for formality with the IRS in terms of computing the imputed gift.  Both you and your borrower can still arrange the payment schedule and options informally.


Imputed gift will be determined on an annual basis on the demand loan.  Within a year, the interest needed to be paid in a year will be given a total amount of $14,000 aside for those larger loans.  With this, you can limit the total free gift tax that you consume to only $14,000 yearly.  Just imagine all the things that you can to consume if you will not have a demand loan like tax exemption on estates and lifetime gift tax benefits.




If you see that these rules may be confusing.  With this, it is important for you to research a lot of information about it like asking the IRS or other financial advisors.  However, it all boils down to the point that you have to apply interest rates on the money borrowed for you.  You would just need to be compliant with the federal rates set that can be found on the IRS' web page.  If you charge lesser than the appropriate amount of interest rate, then you will be taxed on the interest defrayal since it will be considered as income.


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Akron Income Tax Co.

2215 E. Waterloo Rd. Suite 113

Akron, Ohio 44312

(330) 733-1040

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