Should You Give or Lend?

It’s often said that it’s better to give than to receive. But what about lending? Many folks are fortunate enough to have money to share with family members or friends in need and enjoy being able to help out. But there are important considerations you need to understand to make sure you not only make the best use of your money, but to also prevent you from tripping over IRS rules. The IRS views gifts and loans differently for tax and gifting purposes and you need to understand the difference before writing that check.

I had this very conversation recently with a buddy of mine, “Chuck”, over a couple of beers and buffalo wings at the Quahog. Chuck and his wife Sarah are about my age, from North Falmouth and have three boys in their mid to late 20’s.  They are both good hard-working folks who have been savers their whole lives.  They are in the enviable position of being able to help their oldest son put a substantial down payment on a new home. While they didn’t really need the money to be paid back, Chuck wanted to better understand the financial repercussions of a gift vs a loan so that they didn’t make any mistakes and end up with the IRS at their door.

I explained to Chuck that when determining how to characterize the transfer of funds, one important factor, naturally, is your family dynamics and the strength of your familial relationships. Giving money to friends and family can carry emotional baggage and have the potential to create unnecessary stress and tension – especially if the expectations are not clear. Often these arrangements are informal, but both parties need to be on the same page about whether or not the money will be paid back. 

When money is transferred with the expectation of repayment, it’s a loan. The IRS defines this as an “intrafamily loan”, where one family member loans money to another and creates a formal creditor-debtor relationship. In this case, the person who loans the money can expect to be repaid (typically in interest payments), and they actually enforce the debt. In fact, the IRS mandates that any loan between family members be made with a signed written agreement, a fixed repayment schedule, and a minimum interest rate. Currently, the intrafamily loan rate set by the IRS is 3.35%. If this minimal amount of interest is not charged, the loan could be considered a gift loan and have gift tax consequences, although there is an exception for de minimis loans of up to $10,000 between individuals.

A gift, on the other hand, is an amount given without any obligation or expectation that it will be paid back. Gifts of $16,000 or less per recipient fall under the annual “gift exclusion” for tax purposes. If your gift exceeds that amount, you must report it to the IRS. But this doesn’t necessarily mean you’ll owe taxes on it, thanks to the lifetime gift tax exemption, which is the total amount you can give away tax-free during your life. The current gift and estate tax exemption for 2022 is $12.06 million per individual. This amount is indexed for inflation through December 31, 2025, when it’s slated to decrease by 50% under current law. It’s also important to note that paying tuition or medical expenses for someone are not considered reportable gifts.

Now it goes without saying that you need to be sure that you can financially afford to give money away. You also need to understand that you may not agree with how the giftee plans to use the money. If, for example, there are strings or a contract on what they’ll use it for, it’s not considered a gift. 

Many folks do understand the gifting rules well and it’s part of their annual gifting and estate planning strategy. Obviously, the best assets to give will depend on your goals and situation and that of your recipient. For example, if you believe you’re near the end of your life and won’t live much longer, then cash might be best. If you give an asset that has cost basis, like a property or stock, the tax consequences differ depending on whether you pass it by gift or at your death. If you give a gift while you’re alive, the recipient gets your cost basis. If you pass it at your death, the cost basis steps up to the value on the date of your death which can save your beneficiary a great deal on taxes.

If you’re unsure what path is best for you, make sure to consult with a qualified financial and tax advisor. And whichever path you take, keep the lines of communication open with the recipient to ensure you’re setting the correct expectations.

So as always – be vigilant and stay alert, because you deserve more!

Have a great week.

Jeff Cutter, CPA/PFS is President of Cutter Financial Group, LLC, an SEC Registered Investment Advisor with offices in Falmouth, Duxbury, and Mansfield, MA. Insurance offered through its affiliate, CutterInsure, Inc. 

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