US Tax Professionals caution that helping cash-strapped friends can have tax implications without proper planning
North Vancouver, BC -- (ReleaseWire) -- 12/10/2018 -- As a firm that specializes in cross-border taxation, the team at US Tax Professionals warns would-be lenders that without the right planning, unplanned generosity can result in extreme tax complications. To help avoid this, US Tax Accountants has published a new article about how to make tax-smart loans to friends and family. For more, go to: https://www.us-taxprofessionals.com/newsletter.php#4
Lending money to a cash-strapped friend or family member is a noble and generous offer that just might make a profound difference in the life of someone you care about. However, before handing over the cash, it's important to make sure there are no tax complications down the road.
For example, imagine lending $5000 to a child who is having problems keeping up with mortgage payments. It's important to not charge zero percent interest, and here's why:
Anyone who makes an interest-free loan will be subject to below-market interest rules. IRS rules state that you need to calculate imaginary interest payments from the borrower. These imaginary interest payments are then payable to you, and you will need to be paid during the next tax return. To complicate matters further, if the imaginary interest payments exceed $15,000 for the year, there may be adverse gift and estate tax consequences.
While the rules on small loans of $10,000 or less may be ignored, this is only applicable if the aggregate loan amounts to a single borrower are less than $10,000, and the borrower doesn't use the loan proceeds to buy or carry income-producing asset.
As mentioned previously, cash gifts that are not subject to interest (or low interest) may be considered a gift by the IRS. If this happens, especially if there is no documentation and it's necessary to make a bad debt deduction, the IRS could run an audit.
In most cases, misunderstandings can be avoided by charging interest equal to applicable federal rate (AFR) and a written promissory note that includes the interest rate, a repayment schedule showing dates and amounts for all principal and interest, and security or collateral for the loan, such as a residence (see below). Make sure that all parties sign the note so that it's legally binding.
AFRs for term loans—that is, loans with a defined repayment schedule—are updated monthly by the IRS and published in the IRS Bulletin. AFRs are based on the bond market, which changes frequently. For term loans, use the AFR published in the same month a loan is made. The AFR is a fixed rate for the duration of the loan.
Any interest income made from the term loan should be included on the Form 1040. In general, the borrower, who in this example is a child, cannot deduct interest paid, but there is one exception: If the loan is secured by his/her home, then the interest can be deducted as qualified residence interest—as long as the promissory note for the loan was secured by the residence.
To learn more about loaning to a friend or family member, or for any other cross-border tax-related matter, contact US Tax Professional s at (604) 281-3318.
About US Tax Professionals
US Tax Professionals provide tax services for dual American and Canadian citizens in Vancouver. Founded in 2013, they specialize in taxation for US citizens and expats, taxation and accounting for business, cross-border taxation for US and Canadian citizens, as well as accounting and taxation of alternative investments, including private equity funds and hedge funds.
For more information, visit https://www.us-taxprofessionals.com/ or call (604) 281-3318
US Tax Professionals
Company Website: https://www.us-taxprofessionals.com
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