Giving a Family Member a Loan? The IRS Wants to Know.
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What is the main topic discussed in this episode?
Here's your money briefing from Monday, May 11th. I'm J.R. Whalen for The Wall Street Journal. Many people are struggling through the pandemic and some are turning to family members for a loan to get by. But the IRS keeps an eye on family loans to make sure both parties are following the rules.
They're saying if you're going to make a loan, they want to see that it's a real loan and you need to charge a prescribed interest rate and you need to have paperwork and you need to, it needs to say things like what the terms of repayment are and things like that.
Why does the IRS care about loans between family members?
The important news here is that the interest rates required by the government are just as low as they've ever been almost.
That's Wall Street Journal tax reporter Laura Saunders. Coming up, she'll talk about how low family loan interest rates are and when it makes more sense to give a monetary gift instead of a loan.
Helping out a family member financially is a nice gesture, but the IRS says anybody who plans to lend money to a relative should be aware of certain tax rules. And Wall Street Journal tax reporter Laura Saunders is with us to explain. So Laura, why does the IRS have any say in family loans?
Well, that's what a lot of people ask. The IRS has a big say in family loans. Once upon a time, when interest rates were higher and the gift exemption was lower, people were trying to make gifts to relatives disguised as loans that didn't charge any interest. And so Congress didn't like that. And they tell the IRS that it should publish a list of interest rates every month that set a kind of a boundary between what is a loan and what is a gift. and it's been around ever since.
But the IRS would only know about these family loans if family members file official paperwork.
Well, they don't come up, I think, too much on your tax returns, but certainly if you take a bad debt deduction because your relative didn't pay you, it would come up that way, and it might come up in an audit.
What documentation and rules make a family transfer count as a real loan?
And people should follow the rules even if they think the IRS isn't going to catch them.
Okay, so is the government saying, essentially, if you're going to charge interest for a loan, here are some guidelines?
Well, they're saying if you're gonna make a loan, especially a loan that's large, over $15,000 for one person or $30,000 for a couple, they wanna see that it's a real loan and you need to charge a prescribed interest rate and you need to have paperwork, and it needs to say things like what the terms of repayment are and things like that. Now, it's not too hard to get this from a professional, and you won't have to pay a lot of money for it, but it needs to look like a real loan. The important news here is that the interest rates required by the government are just as low as they've ever been almost.
Okay, let's go through the numbers. Let's start with long-term loans.
So long-term loans, that's nine years or more, the interest rate required is 1.15%. That's basically 1% on a nine-year loan. And that rate doesn't adjust upward. If you make the loan this month, you don't have to raise it when the IRS raises their rate. It's a fixed loan like you get with a mortgage. It's a fixed-rate mortgage. So that's only 1%. Now, a family member could charge more if they wanted to, but they can charge as little as about 1% on these loans. On short-term loans, the rate is just about one quarter of a percent, 25 basis points, we would call it. And that's for loans that are three years or less. So this is just an amazing opportunity. If family members want to lend to other family members and have the money to do it, they can do it at a rock bottom cost.
And that can be a real win for the borrower. If it's a mortgage, they might be able to get a much bigger house. They won't have to pay their family as much money as they would pay a commercial lender.
Which IRS interest rates apply to long-term versus short-term family loans?
The other thing is that it could help, say, if the family is able, with a student who's paying off, say, professional loan debt, student loan debt, often that's 6%, 7%, 8%. To get that down to 1% is an amazing thing.
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Chapters
5 chapters
1
What is the main topic discussed in this episode?
0:05–0:37
2
Why does the IRS care about loans between family members?
0:37–2:07
3
What documentation and rules make a family transfer count as a real loan?
2:07–4:08
4
Which IRS interest rates apply to long-term versus short-term family loans?
4:08–5:32
5
How low are current IRS-prescribed interest rates for family loans and what does that mean for borrowers?
5:32–6:59
Speakers
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