The 2011 federal law taxes estates greater than $1 million for an individual or $2 million for a married couple by up to 55 percent. Any gift to an individual of more than $13,000 in any given year may also be subject to tax of up to 45 percent, with the exception of a lifetime exclusion of $1 million per donor. For anyone concerned about these tax consequences, intrafamily loans can be used for estate planning purposes, as any gains realized 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 intrafamily loans to reduce the value of their estate. 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. Intrafamily loan rates have fallen 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 a family 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 money to their children to buy a business, and the children can repay the loan using profits from the business. Any future appreciation or income derived from the business beyond the loan amount is considered part of the children’s estate and the parents’ estate remains protected. Additionally, any amounts above the 1.65 interest rate will pass to the children free of all inheritance 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 does not pay, it may be considered a gift subject to gift tax.