When Doing Something Nice Back Fires – Loans/Gifts

pIt’s not unusual for a family member to provide financial assistance to another family member by giving the recipient money to meet a need -- i.e. to help purchase a home, pay for medical expenses, etc./ph4What If You Classify It as a Loan?/h4pThe parties might want the transaction be structured as a loan. However, the IRS is known to police such transactions in order to verify that there is no “sham” transaction happening./ppOne of the terms that the IRS will be looking for is the existence of an interest rate. The IRS will expect to see the presence of an applicable interest rate as well as a pattern of interest that is actually being paid by the creditor. Put another way, the IRS will be looking for span style=text-decoration:underlinesubstance, not just form/span, to verify the true existence of a loan.  /ppIn the loan scenario, the recipient, or debtor, gets to claim a deduction for the interest expense he or she paid. The lender, on the other hand, will have to recognize the interest income received from the lender./ph4What If the IRS Decides It’s Not a Loan?/h4pIt is quite possible, however, that upon examination the IRS might discover that the parties did not provide for an interest factor when making the loan. In this case, the IRS will nullify the transaction’s characterization as a loan, and then “reclassify” and treat the transaction as a gift. The tax payers are “forced” to abide by this re-characterization and its consequential tax impact./ph4What Happens When It’s a Gift, Not a Loan?/h4pIn the gift scenario, one party transfers property to another party without payment of full consideration in return. There are no tax consequences to the done; the donee pays no taxes and has no reporting responsibilities./ppIf the gift is more than $14,000.00, a a href=https://law.freeadvice.com/tax_law/gift_tax_law/report_gift_tax.htm target=_blankgift tax return/a would have to be filed by the giver, and if the gift exceeded the a href=https://law.freeadvice.com/tax_law/tax_law/federal-gift-tax-rules-and-ex... target=_blank lifetime exclusion/a of $5.43 million (on gifts made in 2015), then gift tax would have to be paid by the giver. By exceeding the gift tax limit, the giver could end up owing the IRS up to approximately 40% in tax!/ppThus, a loan that “backfires” into a gift could end up being a costly gift!/p