Taxation & Estate Planning

Loans to Family Members, Part 1

By Joel A. Schoenmeyer

Want to make an estate planner cringe? Mention that you made a loan to a family member at a below-market interest rate (or, even better, a no interest loan). Why do estate planners hate this type of arrangement? The main reason is Internal Revenue Code Section 7872 (and the failure of most people to realize that these arrangements create income tax issues). That section imputes interest to a person who makes a loan at a below-market rate. For instance, if in January 2008 you made a $33,000 loan to your brother and his wife at 0%, Section 7872 would require us to:

1. Figure out the market interest rate for that loan. Assuming that the loan is considered short-term loan (less than 3 years), the January 2008 market rate would be 3.18%;

2. Deem you to have income equal to that amount (3.18% of $33,000, or $1,049.40); and

3. Deem you to have made a gift to your brother and his wife of the amount of deemed income ($1,049.40).

That's a lot of work for not a lot of money, isn't it?

Full post as published by Death and Taxes Blog on March 10, 2009 (boomark / email).