Family members regularly transfer assets between one another. Transfers between spouses are so common that the IRS completely disregards them for transfer tax purposes. Most frequent are transfers between parent and child and grandparent and grandchild. If a parent transfers assets to a child and expects nothing in return, it is a gift, subject to gift tax or use of exemption. If a parent does not want to make a gift to her child, she can loan assets to the same child, and the transfer will not be subject to gift tax or use of exemption.
For a transfer to be respected as a loan rather than a gift, there must be an interest rate and an expectation of repayment. The IRS recognizes, however, that family members are willing to make loans to each other at lower interest rates than are standard for commercial transactions. These rates for “intra-family” loans are set by the IRS each month and change with other, more commercial interest rates. If a parent loans money to a child and charges no interest or interest at less than the IRS rate for that month, the “loan” can be recharacterized as a gift (subject to gift tax or use of exemption). If, instead, the parent engages her estate planning attorney to draft a simple loan document charging the applicable federal rate for the month the loan is made, there will be no gift, gift tax or use of exemption.
Interest rates for this type of loan are low but have been rising rapidly. To put today’s rates in context, below is a chart showing some historical rates for loans between family members and how they stack up against current rates.