Charging Interest on Loans to Family

Many experts agree that interest should be charged when lending money to family members. Granted, family is family, but personal loans should still be treated as loans, not gifts. Therefore, it is financially advantageous to charge interest.

Lending Money to Family Responsibly

When it comes to helping a family member, it can be hard to say no. Money, however, has caused friction between loved ones for centuries. Therefore, it’s best to play it safe and set certain guidelines, and that includes charging interest. A legal contract can ensure that obligations are clearly stipulated and that both parties share a sense of responsibility. When deciding the amount of interest to be charged on a loan, one should consider the repayment timeline and the IRS-approved interest rates for family loans. Annual limits for tax-free gifts to family members are set at $14,000, so the minimum interest for sums that exceed that amount should be equal the IRS Applicable Federal Rate, which is currently 0.91% for loans of up to three years, 1.40% for loans from three to nine years, and 1.93% for loans over nine years.

Following Up On Family Loans

Adhering to IRS interest rates will avoid any unnecessary tax liabilities. Interest rates on family loans are much lower than rates charged by banks, so the issue of adding interest to a loan for a loved one should not be a sticking point. Failure to charge interest could result in being charged by the IRS for the interest that should have been collected. Also, the amount of unpaid interest could be considered part of an individual’s annual gift limit, meaning the lender could be penalized twice. Follow up on the loan by documenting payments or failure to pay so the unpaid amount can be deducted from personal income taxes.

Given that lenders bear greater responsibility than borrowers when lending money, it is important to document all transactions when lending said money. A paper trail also ensures that there will be no discrepancies when seeking repayment, either directly or through legal means.