Multigenerational family out for a walk, talking about family gifts and loansHave you ever contemplated helping out a family member or someone you love financially with a gift or loan? While it’s wonderful to be able to help a loved one, especially if they’re in need, it’s important to ensure that you’re financially able to do so. Furthermore, the gift or loan must be appropriately structured for tax and family reasons. Here’s what you need to know about family gifts and loans. 

Can You Afford To Make A Gift Or Loan?

The first question to ask yourself is if you can afford to extend a gift or loan to a loved one. You might have the financial resources, but that doesn’t necessarily mean you can afford to do so.

If you’re contemplating a family gift, we strongly advise updating your retirement planning projections to gauge the long-term financial impact of parting with those assets. Your SageVest advisor can help evaluate your broader wealth plans, relative to your personal retirement objectives.

We advise a similar approach if you’re contemplating a loan, as the reality is that loans are often not repaid, so you need to ensure it’s an amount you can afford to forfeit. You also need to consider the potential impact on your relationship if the loan’s not repaid.

Will The Gift Or Loan Solve The Problem At Hand?

Consider whether the financial assistance will be a one-off event or ongoing e.g., helping your child with a down payment on a home versus supplementing an income gap. If the financial need might be ongoing, we strongly suggest that you only enter into gifting or loan scenarios with clearly articulated boundaries, parameters, and limits.

How To Complete A Gift

If you don’t need or want to be repaid, an outright gift is the easiest way to assist a family member or friend. Here’s what you need to know:

Annual Gift Limits

The IRS restricts how much you can gift to one person in any given calendar year. This amount is known as the Annual Exclusion. For 2019 and for 2020, it is $15,000. The gift is not taxable for the recipient.

If you gift in excess of this amount, you’ll need to file a gift tax return. Two common ways to avoid this include:

  • Spousal Gifts: If the gift recipient is married, you can make another gift up to the annual exclusion limit to the spouse, if you’re comfortable doing so.
  • Bridge Years: Depending upon how quickly funds are needed, you can bridge years by making a gift now and another gift in January of the following year.

Gift Tax Filings

If you end up gifting more than the annual exclusion amount, you’ll have to file a Form 709 with the IRS. Your accountant should be notified and can easily help you prepare your 709 filing.

The good news is that unless you’ve already exceeded your lifetime gift exemption amount (now over $11 million), there’s no tax due upon the completion of the gift or gift tax filing notice. It serves only as a notification to the IRS that you’ve consumed some of your lifetime gifting potential.

Family Equalization

If you’re thinking of making a gift to one child, but have multiple children, does that gift need to be equalized among the other family members? This is frequently the most complicated aspect of family gifting and there’s no right or wrong answer. Some families believe in giving resources based upon need, while others want to keep gifts equal.

If you want to make a gift and are concerned about equalization, two common solutions include:

  • Estate Planning Updates: You can account for any gifts advanced during your lifetime by updating your estate planning documents.
  • Equalization Gifts: You can consider completing equal gifts to each child at the same time, assuming you’re in a financial position to do so.

How To Complete A Loan

If you want or need to be repaid, or estate equalization is a concern, extending a loan might be the best solution. The loan is an asset that you own, and can be equalized among other family members as part of your estate. It’s also an affordable way of extending resources to a loved one, as term and payment options can be more flexible than traditional loans. Key aspects that you should be aware of when making a loan include:

Loan Documentation

Loans should never be simple IOUs or personally drafted. Work with an attorney to draft a document that formalizes the loan.

Securing The Loan

If you want to safeguard your investment, the loan should be secured against an asset. If the loan’s home-related and the borrower wants to deduct interest payments, the loan must be secured and recorded.

Family Loan Interest Rates

Interest must be charged on family loans. The IRS specifies an Applicable Federal Rate (AFR) that represents the minimum interest rate you must charge. AFR rates are updated monthly and range from short to long-term. They’re almost always lower than commercial rates, helping to make personal and family loans more affordable.

Interest-Only Loans

If your family member might have trouble repaying the loan principal, you can ease repayment obligations by structuring an interest-only loan.

Loan Interest Is Taxable To You

Any loan interest paid to you must be reported on your tax return and is taxable as ordinary income.

Record Keeping Obligations

The primary pitfall to extending a loan to someone else is the need to keep meticulous records. This helps ensure payments are being satisfied and that any principal payments are properly recorded and applied to the outstanding loan balance.

SageVest Wealth Management understands the complexities of balancing personal and family wealth objectives. We can help guide you towards informed financial decisions that meet the financial needs and objectives for you and your loved ones. Please contact us for more information on how we can help secure the future for you and your family.

Prepared by SageVest Wealth Management. Copyright 2019.

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