To Satisfy IRS, Family Loan Rules & Regulations Can be Tricky
Note: As of July 2023, AFR rates have increased from less than 1% when this article was posted to now 3-4%. With the nature of changing prescribed rates, it's an even better reason to consult with a trusted advisor - such as those at 415 Group - to ensure compliance and the most optimal tax return results.
On the surface, providing a loan to a friend or family member may seem like a fairly straightforward process. However, the Internal Revenue Service (IRS) has several rules and regulations that must be followed to ensure compliance. 415 Group Senior Manager Kristine Giannetti, CPA, sheds some light on lending best practices and potential family loan interest rates.
Individuals thinking about loaning their family members, or even friends for that matter, money need to consider the tax implications first. The IRS mandates that lenders charge their borrowers a minimum interest rate. This family loan interest rate is known as the ‘applicable federal rate,’ or AFR for short. However, if you decide to charge a family member less than this rate, you open yourself up to complications such as the gift tax, which may work against the tax strategies you’ve already set in place.
Many people mistakenly think they are helping out their family members by avoiding loan interest altogether. But truth be told, these AFRs are very reasonable, making the cost of compliance relatively low. Plus, when you create an IRS-approved loan, your borrower may be able to deduct the interest expense on their personal tax return.
With today’s favorable AFRs, it’s a good time to review any undocumented or below-market loans you currently have or may be considering to ensure they follow IRS family loan rules. While the specific tax rules that govern these situations can be quite complex, we have the expertise and experience to help you structure your loans to make sure you and your borrowers are reaping the greatest tax benefits.