There are times in life when we’re presented with opportunities to financially help our loved ones. But the tax code can also trip people up! When you have a generous spirit, it’s important to protect your own best interests too.
Make Sure You Protect Yourself
If you’re loaning money, the IRS requires you to charge interest. Without charging the minimum interest rate, the IRS will actually come back and put that interest responsibility on your own taxes. They’ll apply the minimum applicable federal rates (AFRs). Your tax professional may not be able to let you understand this ahead of time, so do your due diligence. You don’t want to let any surprises happens, and it’s crucial to make sure the other party is going to follow through with those repayments.
Fortunately, the current interest rates are relatively low. You shouldn’t feel like you’re putting an extra burden on that friend or family member. This is actually a pretty affordable and simple way for everyone to stay on the right side of the tax code.
The other piece of the puzzle? Get things in writing! When you’ve made an agreement to have that money paid back to you with interest, get all of the parties sign a loan document. You shouldn’t think of this as being too “formal” or going “overboard” with the loan. It’s a smart way to keep everyone accountable and get those terms crystal clear. Plus, it helps you document that you’re personally being compliant with the tax code.
The Special Tax Rules
Sometimes that “loan” might actually be a gift. In that case, married couples are able to give as much as $15,000 to a certain individual for the 2021 tax year. This option becomes available when you aren’t intending to charge interest.
Additionally, there are special tax rules that allow for loans of less than $10,000. You’ll be able to do this as long as someone isn’t going to use the money to purchase a property that produces income.
Meaning—that friend, family member, or other individuals can’t be spending that money to acquire a business or invest in capital equipment. Knowing the specifics can help keep you stay in the clear when you file your own tax return.
Planning Ahead for Your Taxes
As with most things in life, a little preparation goes a long way to avoid headaches down the road. We know it isn’t exactly fun or exciting to think about tax planning throughout the year, but it really does pay to plan ahead. If your financial situation has changed and you’ve decided to loan out some money to friends or family this year—or given money as a gift—it might be worthwhile to check in with your tax professionals in advance.
At NSO & Company, we’re happy to collaborate with clients year-round. You don’t have to wait for the official tax season to reach out to our team! Scheduling a conversation now can help you understand the implications of a loan, or even reorganize some of your funds to better protect yourself from tax trouble in the spring.
Please don’t hesitate to call our office at (317) 588-3131 if you’d like to schedule a conversation. Or just send us a message! We’re here to help give you peace of mind that you’re in the best possible position to lower your tax responsibility each and every year!