The question of lending money to friends and family is complex, however, It is important to remember the limit from which the IRS can demand the payment of corresponding taxes.
Under the United States Code, the established limit is $10,000 and is known as the ‘de minimis exception’. This exception refers to the possibility of making small loans that are allowed by the tax agency.
The IRS states that the person who receives the loan must not use it to generate income, which is established in the United States Code. The code states that the “de minimis exception” does not apply to loans intended for the acquisition of income-generating assets.
Therefore, if you intend to provide financial aid to your loved ones, it would be advisable to keep it under $10,000 and ensure that loan proceeds are not used to generate income.
If your intention is to lend an amount greater than $10,000, there are certain specific rules that you must follow.
You will be required to charge interest, which must be at least equal to (or greater than) the current Applicable Federal Rate (AFR) for the month in which the loan agreement is established.
The established interest rate should reflect the duration of the loan term (short, medium or long) that you establish with your beneficiary. An AFR record can be found on the official IRS.gov website.
Remember: the AFR is an interest rate determined by the United States government and is used for certain tax purposes, such as to calculate the interest owed on loans between the individuals involved in the loan.
The AFR is updated monthly and is based on market rates for US Treasury bonds.
Getting back to the loan, it’s essential to agree on an interest rate with the person receiving the loan, because the IRS may tax you, as the lender, on what is known as ‘imputed interest’.
If you’re not charging a friend or family member interest, you could have a net loss on the transaction as a lender.
In all cases, it is necessary to document the terms of the loan with the person who receives it, through a signed agreement that involves both parties.
This agreement should clearly spell out all aspects of the loan, in case the IRS questions you about it.
The loan agreement must establish the amount of money borrowed, whether it will be made in a single payment or in installments, and specify the conditions of the repaymentincluding how and when payments will be made.
It is also advisable to define the start and end date of the payment, the day of the month on which the payments will be made and the exact amount to be paid in each of them.
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