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Family members need money? Consider establishing a family bank

Kevin Wong, CPA

11.01.21 | T&E Chat

Your son comes to you requesting financial support. He is in the process of purchasing a home and is still short a few dollars after securing a mortgage with the bank. You and your spouse have already given him a gift earlier in the year based on the annual exclusion and have both fully utilized the lifetime gift exemption. What are you to do at this point?

If you’re interested in lending money to your children or other family members, consider establishing a “family bank.” A family bank is a family-owned, family-funded entity, such as a family limited partnership or dynasty trust. It is designed with one purpose in mind, making intrafamily loans. You and your spouse can create and fund these entities with the help of an attorney. These entities can enhance the benefits of intrafamily loans while minimizing unintended negative consequences.

Basics of Intrafamily Loans

When a family member requires financial assistance, loans can be an effective tool to use without triggering unwanted gift tax consequences. The loan would not be treated as a taxable gift if the loan is structured in a manner similar to an arm’s length transaction between unrelated parties. This means, but is not limited to, the following:

  • Documenting the loan with a promissory note;
  • Charging interest at or above the applicable federal rate;
  • Establishing a fixed repayment schedule; and
  • Ensuring there is a reasonable prospect, the loan will be repaid by the borrower.

Intrafamily loans can offer benefits other than gift tax savings. When done right, the loans can promote accountability and encourage responsible financial behavior from the borrower. They can also be used as a tool to help cultivate the younger generation’s entrepreneurial spirit by providing needed capital to start a business. By utilizing intrafamily loans, you can help your family members without depleting your wealth, utilizing your lifetime exemption, or creating a sense of entitlement.

Considerations for a Family Bank

People tend to lend money to their loved ones with little planning or regard for potential unintended consequences. This has led to many conflicts, hurt feelings, misunderstandings, and false expectations among family members. A family bank can help alleviate these problems by “professionalizing” a family’s lending activities. Not only will it preserve the tax saving nature of intrafamily loans, it would do so while minimizing the negative consequences.
Financing may be available to family members through the family bank even if they are having difficulty securing a loan with a bank or other lending services. Lending can also be done at more favorable terms than with banks and other lending services.

Building a strong family governance structure for the family bank that promotes communication, group decision-making, and transparency would be one way to avoid family conflict and resentment. It is important for the family bank to establish clear guidelines regarding the types of loans it is authorized to make. All family members should be allowed to participate in the decision-making process. This ensures equality and avoids false expectations.

A family member may require financial assistance currently or in the future. Contact me to learn more about intrafamily lending and family banks. I can be reached at 212.331.7441 | kewong@berdonllp.com or contact your Berdon advisor.

Kevin Wong is a Senior Tax Manager in the Personal Wealth Services Group of Berdon LLP with nearly 10 years of professional experience. He works closely with high net worth individuals on matters involving their personal income tax, family businesses, and fiduciary, gift and estate taxes.

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