Do I Have to Worry About Taxes if I Loan a Family Member $45,000?

It’s common for family members to lend money amongst themselves, and many choose to charge less than market interest rates as a favor to loved ones. However, the IRS does care about these transactions so there are some things to think about as you’re planning such a loan. While the IRS does afford a break for many of these transactions, a handful of circumstances can affect the tax implications, and gift tax rules also come into play. If you’re considering making a sizable loan to a family member, talk it over with a financial advisor to make sure you set the transaction up properly.

Table of Contents

Loan Or Gift?

The first question to answer is whether this will be seen as a gift or a loan by the IRS. If it’s considered a gift that won’t have to be paid back, the IRS will apply any amount over the annual gift exclusion to your lifetime gift tax exclusion.

The annual exclusion amount is currently $18,000, which means for a $45,000 gift you’d have to file a gift tax form reporting it to the IRS. Then the $27,000 that is in excess of the annual gift tax amount would be applied to your lifetime gift tax exclusion. However, since the lifetime gift tax exclusion for 2024 is $13.61 million for an individual, this isn’t likely to be a concern for most people.

If it’s a loan that you expect to be paid back, the gift provisions won’t apply and your lifetime gift tax exclusion won’t be affected. You will, however, have to report any interest you receive as income and probably pay income taxes on it.

How to Establish a Loan

In order to set the loan up so that it’s recognized as a loan, you need a written loan agreement setting out a schedule for paying the money back. You should specify the interest rate charged.

In many cases, family members won’t charge market interest rates on loans, giving their loved ones a break. But the IRS has rules regarding such transactions. The IRS sets out applicable federal rate (AFRs), which are the minimum interest rates you’ll have to charge on your loan to make sure it’s not considered a gift loan. These rates may change frequently.

Gift loans may or may not trigger tax consequences, depending on the situation.

Thinking about giving a gift or loan? Talk to a financial advisor about the tax implications and ways to structure it.

Taxes on Interest

Any interest you receive will be treated as income for tax purposes. For instance, if you loan a family member $45,000 for a year, and the applicable federal rate for that kind of loan is 4% and that’s how much you charge, you’ll receive approximately $1,800 in interest to report as income and pay any taxes due.

If you don’t charge at least the minimum AFR, you may have to pay taxes on the amount of interest you would have received if you’d used the AFR to set the rate. This is called imputed interest. At a high level, if you charged 1% on the loan when the AFR was 4% you would receive $450 in income and also owe taxes on $1,350 in imputed interest. But for a $45,000 loan between family members, special rules can help reduce your tax liability.

Loan Exclusions

If the loan had been for less than $10,000, the IRS would consider it below the threshold of its concern. You don’t have to collect interest on a loan of that size or have pay imputed interest if you charged no interest.

Another exclusion applies to loans like the one you are asking about for loans under $100,000. This exclusion lets you charge either the required AFR or an amount equal to the borrower’s net investment income for the year, whichever is less, as long as the loan is less than $100,000 As an added wrinkle, if the family member receiving the loan had less than $1,000 in investment income for the year, the loan can be free of any interest.

While a loan like this may trigger a tax bill for you, it could also potentially provide a tax deduction. That would occur if the family member failed to pay back the loan. In that case, you could write the unpaid amount off as a loss and claim a deduction from income on your taxes.

A financial advisor can help you navigate loans, gifts and tax mitigation strategies. Get matched with up to three fiduciary advisors today.

Bottom Line

Making a $45,000 loan to a family member could impact your taxes by reducing your lifetime gift tax exclusion, by generating taxable current income from interest charged on the loan and possibly by requiring you to pay interest in some cases even if you didn’t receive any. If the loan never get paid back, on the other hand, you might be able to reduce your taxes by writing it off as a loss.

Tips

A financial advisor can help you figure out the potential tax consequences of making a loan to a family member. SmartAsset’s free tool matches you with up to three financial advisors in your area, and you can interview your advisor matches at no cost to decide which one is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Use SmartAsset’s income tax calculator to estimate how much federal income tax, FICA, state and local taxes you will owe next time you file.

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