The 2011 federal law taxes estates greater than $1 million for an individual or $2 million for a married couple at up to 55 percent. Any gift to a person of more than $13,000 in a given year may also be taxed up to 45 percent, with the exception of a lifetime exclusion of $1 million per donor. For anyone concerned about these tax consequences, intra-family loans can be used for estate planning purposes as any gains made will be treated as free of all inheritance and gift taxes.
During our preliminary consultation with all of our estate planning clients, our firm will determine if our client is subject to estate tax and can use intra-family loans to reduce the value of their estates. The appreciation of any investment made with the loan accumulates outside of our client’s equity, as long as it is above the IRS rate. Rates on intrafamily loans have dropped by as much as 53 percent since 2008. With interest rates low and the value of most assets like stocks and real estate depressed, there’s a much greater chance of that any investment purchased with an intrafamily loan in 2010 will appreciate more than the cost of the loan.
The rate for a three-year intrafamily loan made in January 2010 is currently 0.57 percent. The rate is 2.45 percent for a loan of three to nine years and 4.11 percent for a loan of nine years or more. These rates compare favorably with an average rate of 10.55 percent for a personal bank loan and 12.51 percent for a credit union loan.
Parents can lend their children money to buy a business, and the children can repay the loan using the profits of the business. Any future appreciation or business income beyond the loan amount is considered part of the children’s estate and the parents’ estate remains protected. Additionally, any amount above the 1.65 interest rate will pass to the children free of all estate and gift taxes.
Family members should know that loans must be repaid in full with interest at the rate specified by the IRS. If the borrower defaults, it may be considered a gift subject to gift tax.