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Should I worry about taxes if I lend a family member $45,000?

It is common for family members to borrow money among themselves, and many choose to charge less than market interest rates as a favor to their loved ones. However, the IRS does care about these transactions, so there are some things to think about if you’re planning such a loan. While the IRS does offer a break on many of these transactions, a handful of circumstances can affect the tax implications, and gift tax rules also play a role. If you are considering making a significant loan to a family member, discuss it with a financial advisor to ensure you get the transaction right.

Loan or gift?

The first question to be answered is whether this will be considered a gift or a loan by the IRS. If it is considered a gift that does not have to be repaid, the IRS will apply any amount above the annual gift exclusion to your lifetime gift tax exclusion.

The annual exclusion amount is currently $18,000, which means that for a gift of $45,000, you will need to file a gift tax form to report it to the IRS. Then, the $27,000 in excess of the annual gift tax amount is applied to your lifetime gift tax exclusion. However, since the lifetime gift tax exclusion for 2024 is $13.61 million for an individual, this likely won’t be an issue for most people.

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If it is a loan that you expect to be repaid, the gift provisions do not apply and your lifetime gift tax exclusion is not affected. You must declare the interest you receive as income and probably pay income tax on it.

How to take out a loan

To set up the loan so that it is recognized as a loan, you need a written loan agreement that sets out a schedule for repaying the money. You must specify the interest rate.

In many cases, family members will not be charged market interest rates on loans, giving their loved ones a break. But the IRS has rules regarding such transactions. The IRS sets the applicable federal interest rates (AFRs). These are the minimum interest rates you must charge on your loan to ensure it is not considered a grant loan. These rates can change regularly.

Gift loans may or may not have tax implications, depending on the situation.

Are you thinking about giving a gift or loan? Talk to a financial advisor about the tax implications and ways to structure them.

Taxes on interest

Any interest you receive is considered income for tax purposes. For example, if you lend a family member $45,000 for a year, and the applicable federal rate for that type of loan is 4% and that is the amount you charge, you will receive approximately $1,800 in interest to report as income and any taxes to pay. because of.

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If you don’t charge at least the minimum AFR, you may have to pay taxes on the amount of interest you would have received if you had used the AFR to determine the rate. This is called imputed interest. At a high level, if you charged 1% on the loan when the AFR was 4%, you would receive $450 in income and also owe taxes on $1,350 in imputed interest. But for a $45,000 loan between family members, special rules can help reduce your tax liability.

Loan exclusions

If the loan had lasted less than $10,000, the IRS would consider it below the threshold of its concern. For a loan of that size, you don’t have to collect any interest and you don’t have to pay any imputed interest if you weren’t charged any interest.

Another exclusion applies to loans like the one you’re asking about for loans under $100,000. This exclusion allows you to charge the required AFR, or an amount equal to the borrower’s net investment income for the year, whichever is less, as long as the loan is less than $100,000. As an added wrinkle, if the family member who received the loan had less than $1,000 in investment income for the year, the loan can be interest-free.

While a loan like this may result in a tax bill for you, it may also provide a tax deduction. This would happen if the family member did not repay the loan. Then you can write off the unpaid amount as a loss and claim a deduction from your income on your taxes.

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A financial advisor can help you navigate loan, grant, and tax reduction strategies. Get matched with up to three fiduciary advisors today.

In short

Providing a $45,000 loan to a family member can impact your taxes by reducing your lifetime gift tax exclusion, by generating taxable income from the interest charged on the loan, and potentially by to require you to pay interest in some cases, even if you have not received any interest. . On the other hand, if the loan is never repaid, you may be able to reduce your taxes by writing it off as a loss.

Tips

  • A financial advisor can help you figure out the potential tax consequences of making a loan to a family member. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisors for free to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.

  • Use SmartAsset’s income tax calculator to estimate how much federal income tax, FICA, state and local taxes you will owe the next time you file a return.

Photo credit: ©iStock.com/PeopleImages

The post Should I Worry About Taxes If I Lend a Family Member $45,000? first appeared on SmartReads by SmartAsset.

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