Question: My daughter is buying her first home, but struggling to qualify for a bank loan. I want to help by loaning her the money, interest free. I hear the IRS won’t allow it. Is this true?
Answer: First, are you interested in adopting another child? Your generosity is impressive. Your daughter certainly agrees. The IRS… not as much.
The Internal Revenue Code actually prohibits interest free loans. The IRS views such an arrangement as a lost opportunity to tax the income you (should have) earned. So the IRS requires that you charge a minimum interest rate, which is different for Short, Medium, or Long term loans. Currently 2.21% for September, 2019, the long term Applicable Federal Rate (or AFR) is fixed for the life of the loan. AFRs change each month, based on many economic factors. Also, there are some exemptions for loans under $10,000 or $100,000 in certain circumstances.
Still want to give an interest free loan? What is the worst that can happen? The IRS can “impute” income, charging you tax on income you never earned. Here, they use the AFR in place at the outset of the loan, and calculate what the interest should have been. This can be a significant amount of extra income in a single year, possibly raising your tax bracket.
So charge the AFR, and collect the interest. This will benefit your daughter’s tax filing. Still feeling generous? Remember you can give her up to $15,000.00 in gifts each year, without reporting to the IRS.
Attorney James Haroutunian runs the Haroutunian Law Office and its new estate planning division, Priority Law at 790 Boston Road, Billerica. Visit www.prioritylaw.com to begin your pain-free estate plan, today. Or call 978-671-0711. To reach Attorney James Haroutunian through email, use firstname.lastname@example.org.