|
 The Holiday Season is at our doorstep and many of us are facing tough economic times. Here's a tough one: Would you – should you – lend money to a family member or friend in need? Parents are often asked to be "bankers" for a loan to a family member who may need some bucks to get through a period of unemployment, or maybe to make a down payment on a home.
Whatever your reaction to such a request for financial assistance
DON'T LET YOUR HEART OVERRULE BASIC GOOD SENSE. Get some necessary protection.
We're not saying don't lend the money if you can, but we are saying consider what you are doing before you make the final decision. We've all lost count of how many family loans have gone very bad!
Lending money is a touchy subject. So you need to be honest with yourself and your family member. In some cases, everyone might be better off if you simply view the transaction as a gift. If you don't really expect or even want to be repaid, call it a gift and everyone will feel better. No misunderstandings, no disappointments. (Remember, parents can gift up to $24,000 - $12,000 a piece - to their children or anyone each year with no tax repercussions.)
Before You Write That Check…
But let's suppose this really is a loan. For starters, ask yourself a few tough questions:
* Do you like and trust the borrower?
* Can you afford to lose the money if the loan is not repaid?
* Can you afford to suffer loss of income because that money is not invested?
* Is the borrower realistically able to repay the loan in a reasonable period of time?
* Have you lent money to this friend or relative before – and has it been repaid?
* Does the borrower have a specific plan on how to use the money? Is there a business plan you can read over, a home you can look at, a household budget you can review?
Asking these questions will help both you and the borrower. By making sure that you can afford to lend the money without resentment and by asking the borrower to plan ahead for reasonable repayment, you're much more likely to avoid disputes and disappointments later on.
Keeping the IRS Off Your Back
If you do choose to lend the money, your next step is to draw up an enforceable note. It may sound cold, but without adequate proof, the IRS may interpret the loan as a gift, which has all sorts of potentially negative repercussions.
The note should contain a fixed loan amount, a stated rate of interest, a specific period of repayment and security or collateral.
The minimum rate of interest you must charge is determined by the IRS. If you charge no interest or below the IRS-dictated levels, the IRS will tax you as if you had received their prescribed amount anyway.
C'mon … an official promissory note to be signed by a family member?
We're not talking about not loving your family. We are talking about protecting the money for which you have worked so hard, and protecting the trust and affection you share with the borrower. No matter how much you trust your family member, what happens to your money if there is a divorce, loss of employment, a bankruptcy, a serious disability or a death?
Another important reason for proper documentation is the fact that if your loan is not repaid, you may be able to take a "bad debt" tax deduction.
When lending money to start or expand a family member's business, the proper paperwork becomes even more important because, in the case of unpaid debt, you may be able to take a dollar-for-dollar deduction as a short-term capital loss on Schedule D, form 1040.
Again, if the IRS calls it a gift because of no/inadequate documentation, you may lose that important deduction … not to mention losing your money!
The final decision "to lend or not to lend" is, of course, as much a question of emotions as it is one of money. Just be aware of the many ramifications of this seemingly simple transaction. Don't let your heart overrule common sense – and get you all into trouble.
|
