Advanced Strategies for Family Gifting and Lending - Adviser Investments

Advanced Strategies for Family Gifting and Lending

December 20, 2021

Gifting money and offering intrafamily loans can be excellent ways to invest in a loved one’s future, whether during the holidays or any time of the year. But before you write that check, there are a few tax and financial planning points to bear in mind.

Direct gifting. The IRS has strict rules on how much you can gift untaxed. In 2021, the gift tax exclusion is $15,000 per person per year (or $30,000 per person annually if you file jointly with a partner or spouse). All in, the total lifetime gift tax exclusion for 2021 is $11.7 million for individuals.

That said, there are a few ways to gift more than the IRS rule allows when it comes to family.

For instance, the marital deduction allows you to give as much money as you want to your legal spouse without any gift or estate tax liabilities. Similarly, an irrevocable marital trust uses the unlimited marital deduction to pass your assets, including cash, on to your surviving spouse tax-free upon your death.

Another strategy to gift above the limit is to direct the funds toward the education or medical expenses of family members. For instance, you can make a five-year accelerated gift, totaling $75,000 ($150,000 for married couples), to a beneficiary’s 529 plan. This eliminates your $15,000 annual gift exclusion for the recipient for the next five years, but it allows the money to grow tax-free for a longer period of time.

Intrafamily loans. Most of us have visited the Bank of Mom and Dad at some point in our lives, but anything above $15,000 starts to eat away at the lifetime gift tax exclusion mentioned above. That’s where the very attractive Applicable Federal Rate (AFR) comes in.

An intrafamily loan allows family members to borrow money at a special interest rate, known as the AFR, without tax implications (though you do have to report the interest from AFR loans on your tax return). The AFR percentage depends on the duration of the loan: Short-term (less than three years), mid-term (three to nine years) or long-term (more than nine years). The AFR is typically much lower than the interest rate charged by a bank or other lenders.

This strategy can be used to help a family member purchase a home or even pass along a family business. And the “lender” then has an opportunity to use their annual gift limit ($15,000) to help the borrower pay back part of the loan.

This strategy can also be used to pass on assets—particularly if the borrower can invest the money and realize a rate of return that’s higher than the loan rate. This planning approach often employs a family trust. The trust would invest the money and repay the loan, and the remaining assets would be protected within the trust and distributed to the designated beneficiaries.

Clearly, some of these financial planning strategies are complex. As always, please contact your wealth management team if you have any questions about the best gifting option for your circumstances. We’re happy to help.

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