WE MAKE YOUR IRS TAX MYSTERY, HISTORY!

STRATEGIC TAX LAWYERS:  TAX BLOG

Best Ways to Loan Money to Family without Triggering the IRS

Tuesday, June 23, 2015
Are you in a position where you need to loan money to a family member? We are the Strategic Tax Lawyers, a firm of Tax Lawyers, IRS Bank Levy Attorneys, and IRS Leniency Program Lawyers, who are experts in tax code.  Collectively, we have years of experience dealing with the IRS.  We want to advise you about loan money the tax-smart way.

We recommend charging the individual an IRS-approved interest rate.  This is because if you loan money to a family member and don’t charge any interest, then you could face future tax rules that are complicated and will not work in your favor.  If you charge an interest rate that is equivalent to the IRS-approved applicable federal rate (AFR), which are for term loans, then you won’t have complications down the road.  In fact, the AFR is currently at a low rate, which will not make a significant dent in the amount you are letting the family member borrow.

The rates are based on short-term loans for three years and less (0.43%), loans for three to nine years (1.53%), and longer term loans for over nine years (2.3%).  These rates are low and affordable and will save yourself a headache with the IRS.  The AFRs are usually updated each month and are based on bond market conditions.
You should also plan on family loan strategies that are tax smart. For example, if parents want to loan a child $50,000 to buy a first home, then you can create a nine-year term loan and charge 1.53% with the agreement of a balloon repayment when the term ends. Or you can opt to loan the money over 20 years instead by charging 2.3% for long-term AFR.
However, on your tax return you will need to include the interest as income and your child can deduct the interest as home mortgage interest. Just remember to make a term loan versus a demand loan in which repayment is demanded at any time.  With a demand loan, the AFR is not fixed so you would need to charge a floating AFR.  This will not be as advantageous if the interest rate will increase in the upcoming months.  
We believe that interest-free loans to family members are not the best idea because below-market interest rules could apply causing complicated rules to calculate what the interest payment should have been. You may have to pay income taxes on what the so-called interest would be, even if you didn’t collect any interest.  This could also take away any estate tax exemptions you could qualify for.
We advise to just avoid all the IRS tax issues by simply charging an AFR on family loans.  This also keeps the agreement business-like which can save unnecessary grief.
Contact the Strategic Tax Lawyers, a firm of Tax Lawyers, LLP, a firm of IRS Bank Levy Attorneys, and IRS Leniency Program Lawyers, who are experts in tax code.  Collectively, we have years of experience dealing with the IRS.  Call the Strategic Tax Lawyers at (800) 669-4775 for a free consultation to assist you with your tax-related matters.