The continuing era of low interest rates has benefited many borrowers, but it has wreaked havoc for many families concerned about wealth management. In years past, aging parents might have turned to fixed income investments to provide relatively safe and solid retirement income. Currently, however, bond ownership comes with at least two problems:
More and more these days, estate-planning experts are pointing out that there are ways to take advantage of the low interest rate climate. One is by making intra-family loans. Under this arrangement, the client – often one or both parents – loans money to a younger family member – child or grandchild – at a rate less than that which would be charged by a commercial lender. Structured correctly, the IRS does not consider the transaction to be a gift. The child or grandchild gets a boost, either with the infusion of cash that can in turn be reinvested in an asset likely to appreciate, such as personal residence or business. Moreover, the family member enjoys the favorable interest rate.
The IRS usually treats interest-free loans as gifts, but properly structured, the transaction will be treated as a true loan. In order to pass IRS scrutiny, the loan should have the following characteristics:
If the loan has to be repaid, one might wonder how is the intra-family loan an estate-planning tool? Consider the following hypothetical:
Assume the parent makes a nine-year loan to a child of $1 million. Provided the borrowing relative can earn more than the 1.33 percent AFR, the loan will transfer wealth to the borrower without tax liability. For example, if the family borrower invests the $1 million for the nine years at a 6 percent annual rate of return, he or she will have approximately $1,690,000 at the end of the loan, and will only have to repay his or her parents $1,119,700 throughout the course of the loan. Therefore, the child is entitled to keep the difference of $570,300, without any gift tax consequences.
If the parent was going to make the investment anyway, the risk to the family has not changed and the loan was a successful way to transfer wealth in the next generation.
The attorneys at Romano & Sumner, LLC have more than 20 years of combined experience providing expert legal assistance to clients in all types of wealth management and estate planning. At Romano & Sumner, we never use a cookie cutter approach. We listen to you and offer multiple alternatives that will help you maneuver through the complicated tax and legal arena. We pride ourselves upon our professionalism and client service. We keep our clients informed, returning your calls within 24 hours. We’re ready to assist you as you make the important decisions that affect your family. Call us at 281-242-0995 or complete our online contact form.
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