Sunday, November 22, 2020
If you made intrafamily loans to family members in the past, or even more recently due to the COVID-19 pandemic, you should consider forgiving those loans. Here's why, as of now, the gift and estate tax exemption rates are at an all-time high. Also, the interest rates are at a record breaking low.
It is possible that intrafamily loans can be used as an estate planning tool due to the ability to transfer wealth to your loved ones tax free so long as the loan proceeds reach a certain level of returns.
"Generally, to ensure the desired tax outcome, an intrafamily loan must have an interest rate that equals or exceeds the applicable federal rate (AFR) at the time the loan is made. The principal and interest are included in the lender’s estate, so the key to transferring wealth tax-free is for the borrower to invest the loan proceeds in a business, real estate or another opportunity whose returns outperform the AFR."
Any excess from these investment returns over the interest expense will work as a tax-free gift to the borrower. With low interest rates, it is much easier to outperform the APR.
If have some leftover exemption, forgiving an intrafamily loan will allow you to transfer the entire loan principal plus any accrued interest tax-free. This will allow you to take advantage of the $11.58 million exemption amount before it is gone.
There are also income tax considerations. Typically, forgiving intrafamily loans will be considered a gift, which carries with it no income tax consequences.
In deciding whether or not you should forgive an intrafamily loan, you should speak with your financial and/or estate planning advisor.
See Joseph R. Marion, III & David T. Riedel, Is Now the Right Time to Forgive Intrafamily Loans?, Adler, Pollock, & Sheehan P.C.: Insight on Estate Planning, October 27, 2020.
Special thanks to Jim Hillhouse (Professional Legal Marketing (PLM, Inc.)) for bringing this article to my attention.