ó Parents often want to help their adult children who
need a financial boost, and it frequently comes down to
a choice of whether the help should be in the form of a
gift or a loan.
could be tax implications with either choice, depending
on the dollar amounts involved.
Internal Revenue Service is not concerned with most
personal loans or gifts that a parent makes to a child,
but when the dollar amount exceeds $14,000, the parent
must file a gift tax return. And parents who loan a
child as much money as it would take to purchase a home
are required to charge interest on the loan or face
penalties imposed by the IRS.
certified public accountant, Howard Davis, president of
Davis, Davis & Associates, said he has clients who
make loans to their children. The loan documents may
either have the child paying interest only, or principal
and interest. Or, the child doesnít pay anything at
September 2016, the minimum interest rate that the
federal government will allow is 0.61 percent for loans
up to three years; 1.22 percent for loans three to nine
years; and 1.88 percent for loans lasting nine years or
the IRS determines that $1,000 interest is owed on the
loan amount based on the Applicable Federal Rates that
the IRS sets each month for private loans, the $1,000 is
considered a gift from the parent to the child. The IRS
will tax that $1,000 as interest income to the parent,
which the parent must report as taxable income,"
see a fair number of these loans. Iím sure there are a
lot more of these types of transactions I donít
see," he said.
parents forgive the loan or donít pursue collection
actions, the IRS may conclude the loan is a gift and
count the loan amount toward the parentsí lifetime
gift exclusion, which this year is $5.45 million. The
exclusion is the amount a parent can give away over the
course of a lifetime or as part of their estate.
child is then required to report the loan amount as
income and pay tax on it. The IRS does not always find
out about private loans from parent to child because a
lot of people may not bother to report them.
Baum, managing director of wealth management at UBS
Financial Services in Pittsburgh, said there is no right
or wrong in what path a parent takes in terms of going
with a loan or choosing to offer a gift. There are just
you lend money among family members, you run the risk of
having uncomfortable social relations as a result of
this lending transaction," Baum said. "But
gifting with certain requirements could also be
beneficial. For instance, you could tell a child you
will pay for their college education, as long as he or
she maintains a 3.0 grade point average."
financial adviser who often works with affluent clients
who have considered these issues has concluded that when
dealing with adult children it often makes more sense to
go with the loan.
you provide too much financial support, you could dampen
their drive to become financially independent,"
said Rebecca Pavese, a financial planner at Palisades
Hudson Financial Group in Atlanta.
at Carnegie Mellon University in 2012 found the biggest
risk of loaning money to a friend or family member is
not the loss of the money, but the potential loss of a
a detailed survey provided to 971 individuals, the
researchers came away with two main findings.
found borrowers had self-serving biases about personal
loans. They are more likely to believe the loan was
initiated by the lender and the loan had been paid off
as agreed. If the loan was delinquent, they were
inclined to feel it was a gift.
second finding was that overdue personal loans had
wide-ranging negative consequences, such as loss of
closeness, loss of trust and lenders feel that the
delinquent borrowers were going out of their way to
Pavese, a 16-year veteran financial adviser who also
handles the administration of loans between parents and
children, said a loan can be a great solution for a
child trying to escape the burden of credit card debt or
the fallout of other poor financial choices.
"intrafamily loans," children pay less than
they likely would if they borrowed from a bank and
parents earn a decent return while helping children help
first rule is: Donít let your adult childís needs
unbalance your own finances. "Never let helping
your child jeopardize your retirement," Pavese
acknowledges such loans can also cause tension in
relationships if a child cannot or will not repay the
borrowed amount. "To avoid later headaches, make
all terms of the loan clear and set them down in
writing," she said.
setting an interest rate that is at least as high as the
AFR, Pavese said the next step is to set up a repayment
schedule and decide in advance the penalty for failing
to make payments on time.
your child defaults on a loan, there should be stated,
concrete consequences, such as withholding of future
gifts," she said. "At the very least, you
should be very reluctant to lend again unless he or she
demonstrates substantial improvement in
the loan is intended to be a mortgage on your childís
primary home, you should hire an attorney to draft the
note. The loan must be secured by the home and recorded
under state and local law for your child to deduct the
mortgage interest on his or her tax return.