A Loan or Gift – What is It?
When money changes hands between family members it can sometimes be difficult to tell whether the transaction was a loan or a gift. This can cause tax problems and it can lead to disputes between family members. In the recent case of Estate of Bolles v. Commissioner, T.C. Memo. 2020-71, 119 T.C.M. (CCH) 1502 (June 1, 2020), the tax court weighed in on this vexing problem. In this case, Mary Bolles made numerous “loans” to each of her children. She kept a record of the loans and any payment received. However, she also forgave an amount equal to the annual gift tax exclusion each year. Between 1985 and 2007 Mary loaned more than $1 million to her son Peter. Peter had a lot of financial challenges at the time. Mary continued to loan him money even though it was clear early on that he would not be able to make payments on the loans. Additionally, Mary never took action to require Peter to pay the loans. Mary eventually amended her trust to include a formula to take into account the loans made to Peter in making distributions after her death. Following Mary’s death the IRS assessed the estate with a tax deficiency of $1.15 million based on their position that the loans were in fact gifts.
Based on existing precedent, the court considered the answers to the following questions in determining whether the transfers were truly loans or actually just disguised gifts:
1. Was there was a promissory note or other evidence of indebtedness?
2. Was interest charged?
3. Was there security or collateral?
4. Was there was a fixed maturity date?
5. Was a demand for repayment was made?
6. Was actual repayment made?
7. Did the transferee have the ability to repay?
8. Were records maintained by the transferor and/or the transferee reflecting the transaction as a loan?
9. Was the manner in which the transaction was reported for Federal tax purposes consistent with a loan?
The court emphasized that when the analysis involved a family loan, particular attention should be paid to whether there was an actual intent to re-pay and enforce the debt. In this case, the court determined that both Mary and Peter knew he would never be able to re-pay the loan and that Mary never intended to enforce the debt.
So what can we learn from this case? While intra-family loans can be a great estate planning tool, especially in our current low interest rate environment, attention to the details is important. Not just the documents, but how the parties act. In addition to properly documenting the loan, it is crucial that the parties treat the transaction consistent with how a loan to a third-party would be treated. If not, you run the risk that there will unexpected consequences down the road.
This post is for informational purposes only and not for the purpose of providing legal advice. You should contact an attorney to obtain advice with respect to any particular issue or problem. Nothing herein creates an attorney-client relationship between Hallock & Hallock and the reader.