Family Loans
If you are concerned about potential gift or estate tax exposure and reporting, and believe the stock market (or any other investment) has the potential to appreciate from here, then now is a great time to consider family loans.
Consider this simplistic example:
You would like to make a gift to a trust for the benefit of your children, and do not want to pay any gift tax or report any taxable gift.
You decide to loan the trust $1,000,000 for nine years, with interest paid at the IRS required interest rate for May 2025, which is 4.1%. Over the nine year period, the trust invests the $1,000,000 in an investment portfolio netting (after tax) 8% appreciation, paying you interest each year $41,000.
After the nine year period, the $1,000,000 loan is repaid by the trust to you.
The trust is left with $487,000 (representing the 8% growth rate, less the 4.1% interest rate). The $487,000 is effectively transferred to the trust with no required gift tax reporting, and no taxable gift.
Details to keep in mind:
- Doing a cashflow and investment analysis is important to ensure the success of the transaction.
- The risk associated with this strategy is that the trust’s investment vehicle underperforms the interest payment requirement. Regular monitoring and proactive planning is important.
- Properly papering the transaction is important to ensure the intended tax treatment.
- Making the required interest payments on time, is important to ensure the intended tax treatment.
- If you would like to loan non-cash assets, consult your tax advisor to avoid triggering income tax on the execution of the loan.
- Using a trust that is treated as a “grantor trust” to you for income tax purposes is likely preferrable for income (and gift) tax purposes.
This strategy can “freeze” the growth of assets includable in your taxable estate for estate tax purposes to 4.1%, reducing future estate tax exposure. If you are expecting to be subject to estate tax – even far into the future, this strategy can help minimize estate tax while giving you access to your assets.
If you have yet to do any gift or estate tax planning, and are interested in well-established yet simple strategies, this technique is a good place to start.
By: Elyse W. Germack, Attorney and CPA
This information is not professional advice and is for educational purposes and should not be relied upon without consultation with your personal wealth advisors.
