It is not uncommon for families to make loans to children or other family members in need of funds. “Wealthy families often run a ‘family bank’ with advances to various family members as they have liquidity needs,” explains americanbar.org. While it may be tempting to not charge interest when loaning funds to a family member, the IRS will impute interest if it is not charged. The rate of interest on intra-family loans is generally lower than the prevailing market interest rate in commercial transactions, attorneys Steve R. Akers and Philip J. Hayes explain. The interest rate is based on AFR, the applicable federal rate, in turn based on market yield on Treasury bonds.
The estate planning attorneys at Geyer Law might help clients use these “just between us” loans in any of the following situations:
- Non-recourse loans to children
- Sales to children of property or business interests in exchange for a note
- Loans to an estate
- Loans to life insurance trusts
- Home mortgages for family members
- Loans as vehicles for gifts (payments on loan are forgiven)
Besides the fact that “just between us” loans typically carry an interest rate that is lower than that charged by commercial lenders at the time, what are the main reasons for using intra-family lending?
- To keep interest payments in the family rather than having them be paid to outside lenders.
- A family member may have such a poor credit history that he/she can’t qualify for a loan from a commercial lender
- Borrowing from outside lenders may entail substantial closing costs and other expenses
- The child borrowing the money might be able to invest it and earn much more of an after-tax return than the AFR rate on the note itself.
If the parent doesn’t need the money back, wouldn’t it be better to simply make a gift to the child rather than setting up an intra-family loan? Yes, in many cases:
- There would be less of an accounting burden (no need to keep track of the interest as it accrues to make sure it is paid regularly or reported as income)
- Gifts remove assets from the parent’s estate for estate tax purposes
Each family’s situation is unique, and regardless of your financial status, our goal at Rebecca W. Geyer & Associates is to accomplish your objectives and to provide for your family in the best way possible.
Intra-family loans are just one tool among many to be considered in the estate planning process.
– by Corrina A. Smith