Family Loans and
the Gift Tax
Family Loans and the Gift Tax
Financial problems can hit anyone
even if they have good income. And if they are family members, either
an immediate one or a just a relative, it is important for you to
follow several rules in terms of giving a loan to them. The reason
for this is that the IRS are very much sensitive when it comes to
money if they are either going to be given as gifts or interest loans.
Process Involved in Giving Loan
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 $13,000 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 $12,000
aside for those larger loans. With this, you
can limit the total free gift tax that you consume to only $12,000
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.
Conclusion
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 an income.
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