• Bernhardt Wealth Management

Is It a Gift, or Is It a Loan? The IRS Wants to Know

Updated: Mar 14

We are still in the season of giving, and many of us have given the gift of money to children, grandchildren, and other family members. On the other hand, many people make loans to family members to help them out, and often these loans are on terms not generally available, including no-interest loans or very relaxed payback plans.

Logic might tell you that any loans you make to family members would be a personal matter that wouldn’t necessitate the government getting involved. But whenever has the tax code followed logic?

Especially for those with significant estates, the key issue to remember is that the IRS wants to be able to calculate gift taxes against the amount you would ultimately owe in estate taxes when you pass on assets to your heirs. If you were to make a no-interest loan to a son or daughter, the IRS would count the amount of interest you would be foregoing as a gift. If you do charge interest, the amount of interest would need to be reasonable in the eyes of the government.

What’s reasonable? The government monitors interest rate movements in the marketplace and calculates minimum applicable federal rates (AFR) for loans covering different time periods, posting them on its website. If you charge family members or heirs less than this rate, then the government would calculate the difference, and that would be counted as a gift to the family member to whom you made the loan.

These rates are pretty low: a short-term AFR (up to three years) in September 2021 is 0.17%; the AFR on loans of three to nine years is 0.86%, and anything over nine years would have a rate of 1.71% to 1.73%, depending on whether the interest is being paid back yearly, quarterly, or monthly.

Note that these rules don’t apply to loans of less than $10,000 that are not used to purchase income-producing property. And if you don’t want to go through the hassle of charging interest, you could always calculate (or have a professional calculate) the implied interest payments, and then offset that amount with your $15,000 annual gift exemption to the borrower. But even then, it’s a good idea to document the terms and stated interest rate in case the IRS ever decides to come back and do an audit.

Bernhardt Wealth Management helps clients obtain accurate, actionable information in order to develop smart strategies around gifting, charitable giving, philanthropic efforts, and additional important matters related to estate planning and other aspects of your financial legacy. As you look ahead toward your plans for the new year, we would be eager to place our expertise at your disposal. To learn more, click here to read our article, “Doing Good and Doing Well: QCDs and Charitable Giving.”

Buen Camino and Best Wishes for the New Year!

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