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Changes to IRS Tax Rules Now Let You Borrow From Family At Ultra Low Interest Rates

Changes to IRS Tax Rules Now Let You Borrow From Family At Ultra Low Interest Rates

The Internal Revenue Service announces special interest rates (applicable federal rates or AFRs) monthly, and for August

Desperate small business owners seeking cash to keep their businesses alive during the coronavirus pandemic are turning to their families for loans. The loans, with ultra low interest rates are a lifeline. “People are risking their own money for their brother, sister, kids, grandkids,” says Rebecca MacGregor, an estate planning lawyer with Bowditch & Dewey in Boston, Massachusetts. She’s recently set up intra-family loans in the case of clients trying to hold onto a gas station, a third-generation Italian restaurant and a fifth-generation insurance agency. “No one is singing the praises of the family and friends who are saving these small businesses,” she says. “They’re unsung heroes.”

How common is this intergenerational generosity? An overwhelming 71% of retirees said they would offer financial support to their family needed due to Covid-19 even if it could jeopardize their own financial future, a recent retirement study by Edward Jones and AgeWave found.

The Internal Revenue Service announces special interest rates (applicable federal rates or AFRs) monthly, and for August, per IRS Revenue Ruling 2020-15, here’s how low they are:

  • Short-term — Three years or less: 0.17%

  • Mid-term — More than three years and less than nine years: 0.41%

  • Long-term — More than nine years: 1.12%

Some business owners first got CARES Act paycheck protection program loans, and now they’re turning to family members. “PPP loans are a bandaid and not enough, and that’s only if you can get a loan,” MacGregor says. Families are lending money to keep businesses afloat in the hopes that once Covid-19 passes, customers will return.

The restaurateur got an $80,000 loan from his parents in June, and now he’s back to get another round. “When do you keep putting money in and when do you give up? It’s a really difficult conversation for these families,” MacGregor says.

For the lender, it’s important to consider how much you’re comfortable giving. Do you have enough saved for your lifetime? Do you want to combine a loan and a gift? You can give anyone $15,000 a year without gift tax consequences. A couple could give a child $30,000.

An intra-family loan is a private loan, instead of a loan through a known bank lender, but if it’s for more than $10,000, you need the same type of documents as for a bank loan. These are real loans, meant to be paid back. You can make the loan interest only, or make it a payment of interest and principle. You can structure it so the lender gifts part of the principle. If you stay under the $15,000/$30,000, you don’t need to file a gift tax return. If the gift is more, you file a gift tax return and use your lifetime gift tax exclusion ($11.58 million per person), so there’s a tax return but no gift tax due.

Intrafamily loans work well for real estate purchases too. MacGregor has a few families where the older generation has helped the younger generation buy a dream vacation home outside of the city. Now, with the coronavirus, they want out now. One couple did a $1 million-gift $1-million-loan combo to help their San Francisco-based daughter buy a $2 million house in Colorado. The daughter put in $200,000. The couple’s net worth falls between $10 million and $20 million, so they were comfortable whittling down their estate, knowing that the federal estate tax exemption is scheduled to revert to $5 million (adjusted for inflation) in 2026.

With the small business loans, they’re usually short-term, so the families are getting the lowest short-term rate. With larger dollar amounts involved in the real estate loans, MacGregor says most clients are locking in the mid-term or long-term rates. If you go with the short-term loan for the lowest rate from a family member and have to refinance it in three years because you can’t pay it bak, you risk whatever interest rate is applicable at that time.

Tim K. Dean, Credi Founder | Commentator & Expert on Family Lending, Bank of Mum & Dad and Neo-Credit Scores is available for media interviews and appearances. More…

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