Financial Affairs

Intra-family loans and tax strategy: October updates

Intra-family loans are ideal for parents and grandparents who want to help the younger generations of their families through a direct cash loan or loan to a trust for the benefit of the family member. Intra-family loans provide clients with an excellent tax planning strategy which, if successful, will transfer growth and income without any wealth transfer tax. In order to prevent part of an intra-family loan from being considered a gift for tax purposes, specific guidelines should be followed, including imposing a minimum interest rate, documenting the loan, and repayment requirement according to the terms of the loan. The loan must bear interest at a rate greater than or equal to the Applicable Federal Rate (“AFR”), as published monthly by the IRS.

The AFR is broken down into three installments according to the duration of the loan: the short-term rate applies to loans up to three (3) years, the medium-term rate applies to loans with a duration of between three (3) ) and nine (9) years, and the long-term rate applies to loans with a repayment term of more than nine (9) years.

For October 2020, the short, medium and long term AFRs are 0.14%, 0.38% and 1.12% respectively. Thus, for an intra-family loan granted in October for a term of less than three years, an annual interest of only 0.14% must be charged to prevent part of this loan from being treated as a grant. These low rates make intra-family loans a particularly beneficial estate planning strategy as long as the low interest rate climate persists. Customers with existing promissory notes should also consider refinancing those notes to take advantage of current rates. We also see many clients helping children and grandchildren purchase homes by providing some or all of the financing for the purchase through a loan.

This article presents contributions from David W. Kesner, Charles C. Kingsley, Leonard Leader, Rani Newman Mathura, Carolyn A. Reers, Matthew E. Smith, Arsineh Kazazian, Mary Margaret Colleary, Mi-Hae Kim, Erin D. Nicholls, Kaitlyn A. Pacelli and Beth A. Scharpf.