Tax Planning for Family Loans
Lending money to a relative might happen once, twice, or several times throughout one’s lifetime. How often has an individual loaned money to family with tax laws in mind? Commonly, the borrower’s financial needs are of greatest concern at the time the loan is made. However, if the lender does not plan well for the loan, taxes could be imposed.
Interest. The Internal Revenue Service might not recognize an interest-free loan between family members as a loan; rather, tax officials might deem this exchange of money as a gift. To avoid gift tax consequences and ensure the loan is treated as a loan for tax purposes, impose an interest rate on the borrower. Another problem that can occur if lenders do not charge interest involves lenders paying interest themselves. According to the
News & Observer, “If you don’t charge interest, you will have imputed interest and be taxed on the difference between the IRS Applicable Federal Rate (AFR) and the interest rate actually charged.” Click here for an
archive of past and current AFR information. Federal interest and tax laws should be reviewed in addition to state requirements. Excessive interest is not permitted by law.
North Carolina G.S. § 24-14 provides that:
No person…making loans…may charge, take or receive, directly or indirectly, simple interest in excess of one and one-half percent (1 ½%) per month or an annual rate equivalent to the Federal Discount Rate plus five percent (5%), whichever is the greater, computed on the actual or average daily unpaid balance of the principal amount of the loan for the time actually outstanding.
Documentation. Memorialize the terms of the loan in writing. Documenting the loan provides clear responsibilities for the lender and borrower and serves as evidence that the money transfer was intended to be repaid.
Forgiving. Forgiving a loan made to a family member could trigger the tax consequences for the lender as noted above under interest. At the same time, the unpaid balance could be recognized as income for the borrower, and they might be taxed accordingly. Family loan forgiveness is a sensitive area. An individual should consult with a tax attorney before forgiving a family loan. Generally, gift tax requirements apply to forgiven loans more than $14,000. Loans structured properly from inception could avoid this issue even if the forgiven amount is in excess of the gift tax annual exclusion.
Learn more about loaning money to family by consulting with a North Carolina tax attorney. Whether your loan is for three months or thirty years, preparing appropriate records can help avoid or minimize tax consequences.
