With a three-day holiday weekend upon us, millions of Americans will be fleeing to their beach houses, lake retreats or mountain cabins to kick off the official start to summer. Parades, barbecues and traffic will be the main topics of conversation, but the subject of money (or lack thereof) inevitably surfaces whenever extended families spend time together.
Most parents of means want their adult children to start grown-up life on solid financial footing. They’ll gladly help them with a down payment on a first house, startup capital for a new business, tuition for grad school or assistance with major medical expenses. But, the lines between a loans, gifts and investments are always tricky when the funds are coming from the First National Bank of Mom & Dad.
Recently, several of our clients were interviewed about this topic in the national media. Here are excerpts of the advice they shared:
Blake Christian, CPA, a tax partner at HCVT, LLP in Park City, UT said intra-family gifts can be an excellent way for parents to test their kids’ financial capabilities before they give them larger sums to control. Even better, Christian said the tax code has many family-friendly provisions. For example, interest-free loans can be made to a family member for the purchase of a personal residence for up to $106,000. Christian also said direct medical payments to doctors, hospitals and insurance companies are unlimited and not subject to gift taxes. Further, “below-market loans can be made to family members – or others provided the rates fall under the IRS’s ‘Applicable Federal Rates’ which are published monthly,” said Christian. For April, annual rates were 2.52 percent for “demand loans” (no specified due date) and loans up to three years and 2.89 percent for loans greater than seven years.
“These types of loans are an excellent way to shift economic benefit to other family members without triggering gift taxes,” added Christian.
Instead of just giving the money away no-strings-attached, Dr. Guy Baker, founder of Wealth Teams Alliance (Irvine, CA) said the family can give or sell assets to a special trust that is set up for the benefit of children. “The trust removes assets from the estate but allows the family members to access the funds for homes, investments and even living expenses,” explained Baker. “The family patriarch can sell assets income tax free or give assets to the trust. Once the trust owns the assets, the income can be distributed to beneficiaries in either cash as income or as loans,” Baker added.
Christian said that loaning funds to kids the right way can enable parents to invest directly in family businesses or family real estate projects while shifting future appreciation to the next generation and avoid triggering gift tax or incurring more future estate tax. For example, a wealthy client recently loaned his daughter $500,000 to invest in a brewery. This allows the daughter to assist with marketing, sit on the board and develop her business skills (and allows her father to oversee the investment).
“If a properly documented loan is made to a family member and the family members ends up not paying the funds back, the lender can claim a business (ordinary loss) or non-business (capital loss) when the loan goes bad,” explained Christian. “Collection efforts must be documented, and the IRS will take a hard look, but the lender will generally be allowed a deduction if their facts are right.”
Remind your clients that making gifts and loans to adult children is always a tricky dance. Just make sure the money transfer has grown-up terms and obligations built in. That way, if the gift, loan or investment goes bad from the Bank of Mom & Dad, it doesn’t disrupt family harmony for years to come.
Enjoy your Holiday weekend. Get some R&R and take a moment to thank those who serve our country.
# Guy Baker #Blake Christian #loans to adult children