This article contains general legal information, not legal advice. Rocket Lawyer is not a law firm or a substitute for a lawyer or law firm. The law is complex and changes often. For legal advice, please contact a lawyer. If you`re lending your children a significant amount of money — say, enough to buy a home — it`s important to charge interest. If you give a loan to a family member and you don`t charge interest, you may face unfavorable and complicated tax rules, as I will explain later. However, you can avoid any tax complications if you instead charge an interest rate at least equal to the applicable federal rate (AFR) approved by the IRS. Since THE RFAs are almost incredibly low right now, you can be nice to yourself by charging the AFR and at the same time be very nice to the borrowing family member. Here`s the most important thing to avoid: If you`re granting a demand loan (a loan where you can ask for repayment at any time) as opposed to a term loan, the AFR is not set in the month you take out the loan. Instead, you need to calculate a floating AFR based on ever-changing short-term AGRs.
So, if you believe, like me, that interest rates will eventually rise (perhaps much higher), you should take out a term loan if the goal is to provide a high interest rate to the borrowing family member. An illegal loan is a loan that violates or violates any provision of applicable loan laws. Examples of illegal loans are loans or credit accounts with excessive interest rates or that exceed legal size limits that a lender can extend. For loans under $100,000, there are certain exceptions to the credit rules in the market. However, the preferred approach is to avoid all tax problems by simply charging an interest rate at least equal to the AFR. Either way, I think it`s always a good idea to charge at least a little interest on family loans just to keep the deal on a commercial basis. Believe me when I say that keeping things in business can save anyone a lot of unnecessary grief. Yes. It is legal to borrow money, and when you do, the debt becomes the borrower`s legal obligation to repay. In the event of late payment, you can take legal action against your borrower in small claims court. It may sound harsh, but it`s important to understand it in advance. A loan between lovers has the same legal weight as a bank loan.
Nothing in the tax code prevents you from making loans to family members (or non-relatives). However, if you don`t calculate what the IRS thinks is a “reasonable” interest rate, the so-called sub-market lending rules come into play. One last thing: under a favorable tax loophole, you are completely exempt from the below-market credit rules if the sum of all loans between you and the borrower is $10,000 or less. (This includes all outstanding loans to that person, whether or not you charge reasonable interest.) Thanks to this loophole, interest-free loans of $10,000 or less usually don`t cause tax problems for you or the borrower. Write a note indicating the amount of the loan, the time of repayment, the interest rate and any guarantees or guarantees. The law requires lenders to disclose the cost of the loan so that consumers can make comparative purchases. The law also provides for a period of three days during which the consumer can terminate the credit agreement without financial loss. This provision is intended to protect consumers from unscrupulous lending tactics. If you don`t, the IRS may say that the interest you should have charged was a gift. In this case, the interest money will be paid within your annual donation limit of $14,000 per person. If you give someone more than $14,000, you will need to file a donation tax form. All the legal documents you need – customize, share, print and more If you insist on giving a family member a completely interest-free loan, the dreaded interest rate rules may apply in the market.
If this is the case, you need to follow complicated rules to calculate the borrower`s imaginary interest payments to you. Then you can pay taxes on real income and living on imaginary interest. Imaginary interest payments can also trigger imaginary gifts from you to the borrower, which can affect your valuable federal gift and inheritance tax exemption. Mad? Yes. But I did not establish those rules. His beloved Congress did so. Everyone should be happy with this plan. They charge an interest rate that the IRS deems appropriate.
The borrower must be satisfied with the low interest rate. And you are happy to provide financial support to the borrower without causing tax complications. What happens if you borrow money and the debtor does not repay you? Unlike an institutional lender, individuals have limited resources and experience when it comes to collecting debt. If the loan amount is relatively small, you can take the debtor to small claims court. Every state has small claims courts before which you can represent yourself, and the parties cannot be represented by a lawyer. If the loss of this amount of money would cause you serious financial damage, you can choose to say so and avoid the loan. If you continue, you may want to set terms in a written promissory note that both parties can agree and abide by. For your part, you will have to include interest income on your tax return (no surprises). On your daughter`s side, she can deduct interest as mortgage interest as long as you secure the loan with her house (a relatively simple legal process). Otherwise, your daughter will usually not be able to deduct interest. Many people turn to their friends and family for loans when they buy a significant asset or start a business.
Lending to family and friends is a high-risk business where the lender has little to gain, other than the satisfaction of helping someone you know. When it comes to borrowing money, even from family and friends, a common refrain you`ll hear over and over again is “put it in writing.” Wow, that`s pretty low prices! However, RTAs are updated monthly based on bond market conditions. Today`s very low ABFs reflect the current environment of very low interest rates, which may not last much longer. THE RFAs for each month are published in the Internal Revenue Bulletins and can be found on the IRS website www.irs.gov. In the case of a term loan, the AFR applies to the month in which you take out the loan for the entire term of the loan. In May 2016, a North Carolina Supreme Court banned an online car title lender from operating in the state. The North Carolina attorney general had filed a lawsuit against the lender, who was doing business under several names, for illegal loans. Its loans were deemed illegal in several ways: interest rates ranging from 161% to 575% (against North Carolina`s 30% cap on such debt); final balloon payments in excess of the loan principal; seizure of secure cars after late or missed payment; and the fact that these conditions or details were often retained or not clearly communicated to borrowers. In addition, borrowers have never received written loan agreements. A typical example: payday loans, a type of short-term personal loan that calculates an amount that can correspond to 300% to 500% of the amount borrowed. Often used by people with bad credit and little savings, payday loans could certainly be seen as predatory, taking advantage of those who can`t pay urgent bills in any other way.
But unless the lender`s state or municipality explicitly sets a lower cap on these amounts for loan interest or loan fees, payday lending isn`t really illegal. An illegal loan is not the same as a predatory loan which, although exploitative, may not be illegal. For small loans, the answer is simple: no. The IRS doesn`t deal with most personal loans to your son or daughter. .