Tax Considerations of Supporting Family Members
Last month I wrote about some basic rules to frame a decision of whether and how to lend money to a family member. Here are some additional considerations, with this very important caveat: giving a gift or lending money to a family member can have very important tax and estate planning implications. You should discuss these gifts with your tax and estate advisors to ensure you are making the right decisions for your situation.
So here are six points to consider when (financially) supporting family members.
Document the support. This is kind of a repeat from last month, but it is that important. If you give more than $14,000, you may need to file a gift tax return. If you lend more than $10,000 to a family member, you need to document the transaction and the terms of the loan. Interest paid to you may be taxable income to you and deductible by your child. Even if you plan to forgive the interest (a gift), you still need to document it.
Update your Estate Plan. If you lend your child enough to, say, buy a house, you should evaluate how that will impact other gifts or support in your estate planning. Maybe forgiving that loan is the child’s inheritance. Maybe you want your son to have to pay it back to his siblings. Unless you document the loan (or gift) and spell out your intentions in your will and other documents, it’s unlikely that things will unfold the way you had hoped.
The IRS has rules for large family loans. It’s important to understand the rules for loans over $10,000. For one thing, the IRS assumes you charge interest, and a market rate interest at that. Whether or not you do collect interest, the IRS assumes that you do and can adjust your tax return to show the interest you should have received as taxable income. Not charging the market rate of interest can also show up as a gift for gift tax purposes.
You can deduct a bad debt. One advantage to documenting your family loan is that if the borrower defaults on the loan, you may be able to deduct the bad debt on your tax return. But only if you have the documentation to prove that it was a loan instead of a gift.
Gifting assets can have a tax advantages. Properly structured, gifts to support family members can reduce the overall tax burden when an asset is sold. For example, a child could gift appreciated stock to help support a parent with high medical expenses which could offset the realized gains from selling the asset. Or an independent child who is just starting a new job could sell gifted stock at a lower capital gains rate than a parent. These are two simple examples, but you get the idea.
Paying an institution directly isn’t considered a gift. Current tax regulations allow gifts of up to $14,000 without having to file a gift tax return. However, grandparents (or rich aunts and uncles) who want to support a child in college can pay the institution directly and the IRS won’t count that amount against the annual gift limit.
Gifting or lending to your children is one way to support them as they get started in today’s competitive and complex economy. My parents’ support has been critical to my success, and I fully expect to help give my own children a leg up if they ever need it. It’s important to me that they learn to stand up on their own, but like most parents, I want them to know they can count on my support when they need it. But it’s just as important that I protect myself in the process by understanding the rules and properly structuring any assistance.
This column is prepared by Rick Brooks, CFA®, CFP®. Brooks is Director and Chief Investment Officer with Blankinship & Foster, LLC, a wealth advisory firm specializing in comprehensive financial planning and investment management. Brooks can be reached at (858) 755-5166, or by email at brooks@bfadvisors.com. Brooks and his family live in Mission Hills.
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