Kelly Bullis
Perhaps your adult child would like to purchase a home, but they don’t have the money to make a down payment. Or perhaps they need funds to start a new business. Mom and Dad to the rescue!
Warning, there are hidden tax traps along the way.
Most of the trouble revolves around the interest you charge. If you make a zero percent loan (Hey! They’re your kids after all and you want to help them out) the IRS comes along and adds something called “imputed interest.” That is the amount that you must report as taxable interest income each year. Watch out, that might also be subject to the Net Investment Income tax (NIIT).
First, you can make a loan of less than $10,000 and there are no imputed interest rules that apply. We do still like to see such smaller loans put into writing and have a repayment plan outlined in that written agreement. You can’t teach your kids responsibility if you don’t make them honor their promises.
Second, you could make a loan of less than $100,000. The imputed interest rate is equal to the borrower’s net investment income. Most of our adult children do not have any NIIT to speak of or they wouldn’t need to borrow from us. But let’s say your child’s net investment income comes to $1,000, then your imputed interest for that year is also $1,000.
If you made a loan for more than $100,000 for 0% interest. Then the IRS imputes the interest at the Federal Funds Rate, with you having to pay tax on that. A way to get out of that is to build into the loan an interest rate equal to what the Federal Funds Rate is during the month that you make the loan. (You can Google “Fed Funds Rate” and find the latest news on that.
Also, any loan documents should spell out the key elements of the loan. They should include the original loan amount, the time for repayment and the designation of the collateral as well as the interest rate to be charged.
What to do if your child defaults on the loan? Your loss could be treated as a short-term capital loss when the loan becomes worthless. Thus, you can use this loss to offset capital gains realized during the year. Remember though, you must attempt to liquidate any named collateral. FYI, you don’t have to name any collateral in the original documents.
Have you heard? Psalms 115:14 says, “May Yahweh increase you more and more, you and your children.”
Kelly Bullis is a Certified Public Accountant in Carson City. Contact him at 775-882-4459. On the web at BullisAndCo.com. Also on Facebook.