In today’s economic environment, many people are finding personal loans to be a useful tool for financing. This situation is especially true for friends and family members who want to buy a first home, start a new business or just pay off some personal debt. If you are planning on borrowing money from a friend or family member there are a couple of important tax ramifications that you need to keep in mind.
The Internal Revenue Service is the ultimate authority on the tax implications of borrowing in a personal loan. If you have any special questions not covered in this article, you should contact a local accountant for advice or visit the
Key Interest Rates page. The AFR rates are the minimum interest rates that parties may use in order for the transaction to be considered a loan. Otherwise, the foregone interest generated by the difference between the accepted rate and the lower rate will be treated as if actually paid and received. This situation could have income tax or gift tax consequences. Demand loans require the AFR as listed in the schedule for short term. The rates for a term loan must come from either the short, mid or long-term chart depending on the term of the loan.
If a loan is determined to be a gift by the IRS then the lender could be liable to pay gift taxes on the loan amount. For related party loans, the Internal Revenue Service considers any departure from market rates to be a gift. There are certain exceptions to the Gift Tax rules for borrowers. The first exception is a de minimus loan, which is one under $10,000 as long as the loan is not used to buy income-producing assets like stock. The second exception is a loan under $100,000 to a borrower with less than $1,000 in investment income.
Record Keeping
It is critical that a borrower keeps good records of their loan transaction in the event the IRS audits them. A clear record of payments made and a signed promissory note can help a borrower prove that the transaction was a legitimate loan and not a monetary gift. Using LoanBack to formalize your loan will provide you with everything you need to document your loan for future reference.
More Information
Loans to Friends and Family - The Motley Fool
Topic 453 - Bad Debt Deduction - IRS Government
Tax Topics - Internal Revenue Service
