Wednesday, December 14, 2011

Lending and Gifting Between Family Members

Do I have to pay tax for receiving or giving gifts?
The donor of the gift is liable for gift tax if the value of the gift is greater than the annual exclusion of $13,000.00.  The donor may gift $13,000.00 each to his or her son, daughter, nephew, grandchild, and next door neighbor tax free.  Husband and wife, as donors, may collectively gift double the amount, $26,000.00, to each respective donee tax free.

Gifts above the annual exclusion is subject to tax, unless the donor utilizes his or her lifetime exemption which is at $5.120 million for the year 2012.  The lifetime exemption reverts to $1 million in the year 2013 if the laws are not extended or changed.  Therefore, you will lose the $5 million lifetime exemption if the laws are not extended to preserve this exemption.  If the donor gifts $1,013,000.00 to his sister, then the donor may utilize his lifetime exemption for the amount above the annual exclusion.  The donor's lifetime exemption is then decreased by the applied amount, with the remaining balance, if any, available for the donor's future use.

Gifts above the annual exclusion must be reported to the IRS, even if it may not be subject to tax, on April 15th the following year after the occurrence of the donation.  The form on which the gift must be reported is the IRS Form 709 which can be found on the IRS website here.

How do I make a loan to a family member?
To avoid getting in trouble with the IRS, loans to family members should be made in writing.  It should also be free of ambiguity so that there can be no mistake as to whether it is a gift or a loan.  The IRS sets forth a minimum interest rate at which loans between family members must charge in order to avoid the argument that the transfer should be considered a gift. The interest rate depends on whether the loan is short term of three years or less, long term exceeding nine years, or somewhere in between.  The minimum interest rate is determined by the Applicable Federal Rate which can be found in this link here.

Interest on the loan is taxable income to the lender.  This interest may be forgiven by the lender.  The forgiven amount becomes taxable income to the borrower unless the lender treats the forgiven amount as a gift.  Of course, the $13,000.00 annual exclusion applies to this type of gift also.

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