Make an Intrafamily Loan “Bona Fide” to Avoid Gift Tax

T&E Chat

06.13.16 | T&E Chat

Your first reaction when a child or family member comes to you for financial assistance is to take out your checkbook and write a check. You make a gift, plain and simple. But if you’re concerned about gift taxes, an intrafamily loan — a loan between family members — may be preferable if structured and managed carefully. If done correctly, the IRS will treat the loan as a bona fide loan rather than as a disguised gift.

Factors to determine loan legitimacy
The IRS considers will look at a number of factors when determining if a loan between related parties is legitimate. These factors include the:

• Existence of a promissory note or other instrument,
• Payment of a reasonable rate of interest,
• A fixed repayment schedule,
• Adequate collateral or other security,
• Actual repayment of the loan,
• Whether, at the time the loan was made, the borrower had a reasonable prospect of repaying the loan and the lender had sufficient funds to make the advance, and
• The conduct of the parties.

The last factor is a catch-all that encompasses one of the distinguishing characteristics of a bona fide loan: the parties’ intention that the money advanced will be repaid. An examination of the first six factors may reveal conduct that’s inconsistent with a loan, such as failure to execute a promissory note or to repay the loan. Other conduct can indicate the lack of a debtor-creditor relationship, such as executing a promissory note after the fact or the lender’s failure to make reasonable collection efforts.

Proper documentation required
If you treat the transaction like a “real” loan, it’s more likely that the IRS will treat it as a loan as well. If you wish to make a loan to a loved one, we can help ensure it’s properly documented to pass IRS muster.

Should you have questions about how to structure an intrafamily loan, contact me at SDitman@berdonllp.com or your Berdon advisor.

Scott T. Ditman, a tax partner and Chair, Personal Wealth Services at Berdon LLP, New York Accountants, advises high net worth individuals and family/owner-managed business clients on building, preserving, and transferring wealth, estate and income tax issues, and succession and financial planning.