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. Over the past few weeks, many have lost jobs and are feeling financially insecure, and clients have asked us how they can help. 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. Making gifts or loans to family during times of financial turmoil is something that you may wish to do regardless of tax consequences or interest rates, but in a low interest rate environment such as the one we find ourselves in today, loans are particularly attractive from a tax perspective. Taking the time to properly document a transfer of assets as either a gift or a loan may save the entire family tax and stress down the road.
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.