When one family member lends money to another, both parties often believe that the deal they make is just between the two of them. But in the eyes of legal and tax authorities, the lending business is just that—a business. These seemingly private activities can come with some very business-like strings attached.
Here you’ll learn a few items that you should keep in mind if and when you decide to make a loan to a family member, friend or some other individual in your life.
Think About How the IRS Treats Interest
In a deal between relatives or friends, the “lender” sometimes decides not to charge interest on the loan. Perhaps the loan amount is small, or perhaps there is a feeling of ill will that parties tie to the thought of interest.
But if you do not charge interest, or if you charge a rate lower than something called the Applicable Federal Rate (AFR), be prepared for tax consequences. The IRS will tax the maker of the loan on the amount of interest that the lender should have charged.
On top of that, you may have to file a gift tax return. This occurs when you charge interest at a rate that is lower than the AFR, and the borrower’s unpaid interest is applied toward your annual gift tax exclusion, causing your total annual gift to exceed said exclusion.
The Challenge of Getting Things in Writing
When you get a loan from a bank, there’s no question that the bank will have you sign loan documents. But when you give a loan to a loved one, you may not see the need to make the arrangement so formal. Instead, you may think that a simple handshake will suffice.
Dealing with any formalities and accompanying awkwardness up front, however, can make things much clearer later on. Consider the consequences if something happens to you or the other party, such as a serious injury or death. Having your agreement in writing can help reduce the “he-said, she-said” arguments that are all too common between family members. A written agreement is also necessary if the borrower is unable to repay the loan and the lender wants to claim a deduction on his or her income tax return.
Family Loans and Medicaid Eligibility
Finally, Wisconsin laws are acutely specific about how they view these loans when it comes to the loan maker’s eligibility for Medicaid. Depending on the specific terms of the loan and the timing of when you made the loan, you may find a negative impact on your Medicaid eligibility.
- In some situations, Wisconsin law may consider your loan to a family member a “divestment”. Essentially, that means the government may suspect that you gave the money away as a means of reducing your assets so you could qualify for Medicaid. In these cases, the government would assess a penalty period, during which you would be ineligible for Medicaid.
- Under other circumstances, the government may view the balance due to you as an asset, which could push you over the asset limit for Medicaid eligibility.
Questions or Concerns? We’re Here to Help.
Whether a family member has asked for a loan or you have already lent money and are now facing challenges, seek the advice of an experienced Wisconsin attorney. At Kosa Law, we would be happy to speak with you about your situation, and provide you with the advice and guidance you need. Contact us any time.