If a relative needs financial help, offering an intrafamily loan might seem like a good idea because they allow you to take advantage of low interest rates for wealth transfer purposes. But if not properly executed, such loans can carry negative tax consequences — such as unexpected taxable income, gift tax or both. Here are five tips to help avoid any unwelcome tax surprises:
1. Create a paper trail. In general, to avoid undesirable tax consequences, you need to be able to show that the loan was bona fide. To do so, document evidence of:
- The amount and terms of the debt,
- Interest charged,
- Fixed repayment schedules,
- Demands for repayment, and
- The borrower’s solvency at the time of the loan.
Be sure to make your intentions clear — and help avoid loan-related misunderstandings — by also documenting the loan payments received.
2. Demonstrate an intention to collect. Even if you think you may eventually forgive the loan, ensure the borrower makes at least a few payments. By having some repayment history, you’ll make it harder for the IRS to argue that the loan was really an outright gift. And if a would-be borrower has no realistic chance of repaying a loan, don’t make it. If you’re audited, the IRS is sure to treat such a loan as a gift.
3. Charge interest if the loan exceeds $10,000. If you lend more than $10,000 to a relative, charge at least the applicable federal interest rate (AFR). Be aware that interest on the loan will be taxable income to you. If no or below-AFR interest is charged, taxable interest is calculated under the complicated below-market-rate loan rules. In addition, all of the forgone interest over the term of the loan may have to be treated as a gift in the year the loan is made. This will increase your chances of having to use some of your lifetime exemption.
4. Use the annual gift tax exclusion. If you want to, say, help your daughter buy a house but don’t want to use up any of your lifetime gift and estate tax exemption, you can make the loan and charge interest and then forgive the interest, the principal payments or both each year under the annual gift tax exclusion. For 2020, you can forgive up to $15,000 per borrower ($30,000 if your spouse joins in the gift) without paying gift taxes or using any of your lifetime exemption. But you will still have interest income in the year of forgiveness.
Here is an example of how an intrafamily loan can save on taxes:
A $2 million interest-only loan is made from parent to child at an interest rate of 0.38%. If the loan proceeds are invested and grow at a rate of 5%, after repayment of interest and principal in year 5, the child is left with approximately $510,000 estate and gift tax-free. This arrangement also offers the flexibility to utilize the gift tax exemption at any time.
5. Forgive or file suit. If an intrafamily loan that you intended to collect is in default, don’t let it sit too long. To prove this was a legitimate loan that soured, you’ll need to take appropriate legal steps toward collection. If you know you’ll never collect and don’t want to file suit, begin forgiving the loan using the annual gift tax exclusion, if possible.
Americans share at least one dilemma when it comes to
retirement planning. From the worker to the employer to the policymaker,
everyone is living longer. On May 23, 2019, the House passed the Setting
Every Community Up for Retirement Enhancement (SECURE) Act. This legislation,
receiving almost unanimous bipartisan support, offers the most significant
shift to retirement plans and opportunities since the Pension Protection Act of
2006. In the bill, there are over 25 changes and provisions that expressly aim
to encourage retirement savings among all workers. This bill, along with the
Senate’s Retirement Enhancement Securities Act (RESA), addresses the apparent
need for a worker’s wealth to run (and finish) the race with them. These
documents may face modification before being signed into law, but one thing is
clear: change is coming. Below we have prepared a synopsis of the changes that
present the most opportunity.
Pooled Employer Plans
Many businesses are without affiliation and are too small to
offer a savings retirement plan on their own. The new bill will reduce
fiduciary responsibility and lower the overall costs associated with providing
401(k) plans by expanding the option to run multi-employer plans through a plan
administrator. Sec. 106 goes a step further to incentivize smaller businesses
to offer a retirement savings plan. The Act introduces a $500 tax credit for
automatic enrollment into their retirement plan.
The SECURE Act eases the liability concern over offering
annuities. Most businesses have shied away from annuity providers because of
their inherent risk. Section 204 updates safe harbor provisions, thus opening
the door for employees to take advantage of converting their 401(k) balances to
a pension-like payout plan. Another provision of the bill will allow workers to
transfer a defunct annuity contract to an IRA while maintaining contributions.
The only criticism on this update is the broad guidelines surrounding annuity
providers. Some fear that ambiguity will lead to insurance companies offering
Required Minimum Distribution (RMD) Age
The current law requires that most individuals begin
withdrawing a minimum distribution from their retirement savings at the age of
70.5. Six-months-past-70 has invited an unnecessary amount of confusion since
its inception in the Tax Reform Act of 1986. The SECURE Act seeks to simplify
matters by raising the RMD age to 72. If the RESA Act passes in the Senate, the
age requirement will be raised even higher to 75.
One of the most confounding retirement rules is the age
limitation on IRA contributions, currently set at 70.5. The SECURE Act repeals
the age limitation for traditional IRA contributions.
Benefit to Parents
Section 113 removes the 10 percent penalty tax from qualified
early retirement plan withdrawals. Parents will be able to take an aggregate
amount of $5,000 within one year of the adoption or birth of a child, penalty
free. Section 302 expands section 529 plans by allowing withdrawals of as much
as $10,000 for repayments of some student loans.
Currently, beneficiaries of inherited retirement plans like
401(k), traditional IRAs, and Roth IRAs can spread the distributions until
their dying breath. The new revenue provisions (Section 401) changes the rules,
requiring most beneficiaries to distribute the account over a 10-year period
and pay any taxes due. The tax-generating change will accelerate the depletion
of many inherited accounts but will not affect surviving spouses and minor
Another administrative improvement provided in the Act
requires employers to provide a lifetime income disclosure once every 12
months. The disclosures are meant to show the amount of monthly payments the
participant or beneficiary would receive based on the total accrued benefit.
Under the current law, the unearned income of children would
be taxed at their parent’s marginal tax rate. Section 501 repeals the “kiddie
tax” measures that were added by the 2017 Tax Act. The new provision states
that unearned income of children would not be taxed at trust rates. Taxpayers can
retroactively elect to not pay the taxes. The bill benefits many Americans,
including families of deceased active-duty service members, survivors of first
responders, children who receive certain tribal payments, and college students
Other changes proposed in bill include increased penalties
for failures to file and the portability of lifetime income options. The SECURE
Act is as likely to pass as it is to undergo slight modifications. We will keep
an eye on the state of the bill and keep you abreast of its status. In the
meantime, our professionals are standing by to answer your questions and
address your concerns.
Personalized & Goal-Based Solutions to help you build life-long wealth
We all know the future will come, however we still put off financial planning for “a better time”. The truth is, a better time may never come or may come too late. There is no need to put off planning – the time is now.
The key to building lifelong wealth is strategic planning and collaboration from the various financial professionals in your life. Our Wealth Management, Asset Management, Legal, Tax, and Insurance Planning Services allow us to provide clients with thoughtful and highly individualized solutions.
We have assembled a team of experts to assist our clients in reaching their financial and life goals. By applying our service team approach to client needs, we identify a course of action needed for financial, tax and life management success.
We are dedicated to helping our clients maintain financial viability in the present while taking a proactive approach to achieve future goals. We accomplish this by systematically addressing 5 key areas.
Every day we face challenges managing our finances. Stock market swings, fluctuating interest rates, taxes, debt and inflation – the effects can be unsettling. Many put off financial planning for “a better time”. Unfortunately, a better time may never come or may come too late.
We can help you achieve your financial goals and will give you the guidance to:
- Save for retirement.
- Generate retirement income.
- Minimize your tax burden.
- Determine proper financial coverage.
- Help you develop strategies to protect your financial future.
- Offer personalized advice to help you achieve your unique goals.
In an ever-changing landscape, the global economy is swiftly becoming smarter and more nimble in many ways. We believe the management of your investment portfolio should be smarter and more nimble as well. Through our portfolio hedging techniques and focused “Building Block” strategies we seek to:
- Minimize our clients’ exposure to overall portfolio risk.
- Profit from global capital market volatility.
- Position our clients’ portfolios to benefit from both extremes in global investor sentiment and from extremely rapid technological advancement.
Effective tax planning and preparation require proactive involvement of a quality CPA. We can review your financial situation and develop thoughtful strategies to minimize your tax liability. Our comprehensive tax planning and preparation services include:
- Tax planning and preparation
- Accounting Services
- Mergers, Acquisitions and Sales
- Advanced Tax Strategies
- Gift and Estate Tax Planning
You will likely have different life insurance needs at different stages of your life. And with people working and living longer, customized solutions are more critical than ever. In fact, almost all insurance companies have now updated their life expectancy tables to reflect the fact that we are now living longer. If your policy is more than 2 years old, you should have your policy reviewed by a knowledgeable insurance professional. There is a very good chance, assuming the applicant is still in good health, they may be able to dramatically increase the amount of coverage at no additional cost or lower their cost of their current coverage.
We can create a customized plan that meets all your goals and objectives. Our Insurance Services include life insurance, long-term care and premium financing.
- Life Insurance
- Long-Term Care
- Premium Financing
Protecting your assets is another component of planning for the future. Building generational wealth requires proactive planning to mitigate and avoid adverse legal actions. We work closely with attorneys to help you build and safeguard your assets. Our legal services include
- Estate Planning
- Business and Corporate Law
- Securities Law
- Real Estate Law
- Mergers and Acquisitions
- Employment Law
- Charitable Planning
When you work with us you benefit from our unique perspective as a multi-disciplinary practice of law, wealth management, insurance, and asset management services and a full-service CPA Firm, we can identify opportunities that others may miss. You also get advisors who provide a hands-on approach to serving you. You’ll hear from us through-out the year, not just once a year at a review.
Contact us today to learn how we can help you live the life you want to live while building life-long wealth.
We believe our clients are best served by integrating the primary financial professional in their lives. Together, through our relationship with Heritage Family Offices, LLP and their family of companies, we can provide our clients with attorneys, financial advisors, insurance brokers, and business consultants. Please note, however, that not all professionals hold all professional licenses. Please carefully take note of our respective professional licenses, or ask for clarification, when engaging any professional in our firm. Our goal is to provide continuous full transparency to our clients and prospective clients. Hamilton Investment Advisors is a Registered Investment Advisory Firm. Investment advisory services are offered by Heritage Wealth Management, LLC – 2355 E. Camelback Road, Suite 425, Phoenix, Arizona 85016. Heritage Wealth Management is a Registered Investment Advisory firm. For further information please reference Heritage’s firm brochure and ADV: https://www.adviserinfo.sec.gov/IAPD/IAPDFirmSummary.aspx?ORG_PK=287909. Insurance services are offered through Heritage Insurance Advisors, LLC. Legal services are provided by HFO Law Group, LLP