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Was that Money from Mom and Dad a Gift or a Loan?

by | Oct 17, 2024 | Firm News

Have you ever received or given a “loan” from or to a family member with the expectation that it would be paid back with interest and a promissory note was signed for the funds?  Not likely.  A new Ninth Circuit Court of Appeals case – Estate of Bolles (9th Cir. 2024) No. 22-70192 – provides some guidelines to follow when you want the money that you give to a family to be considered a loan.  In the Bolles case, the mother advanced funds to each of her children.  She loaned over $1 million dollars to one son over the years.  The mother kept records of first loans such as the amount, accrued interest, and any repayments.  No promissory notes were executed, and none were secured by collateral.  The mother never attempted to collect on the loans.

When the mother in Bolles did her estate planning, she specifically excluded the one son who received the bulk of the loans.  Later she amended her plan for distribution to all her kids, but the one son was to receive less based on the amount of loans she had given him. And the mother continued to give funds to the one son after this amendment, but no records were kept for the later transactions like they were for the first ones.  When the mother died and her estate tax return was filed, the transactions were reported as gifts. But the IRS treated some of the transactions as loans and some as gifts.

The importance of difference between the treatment of these transactions as loans or gifts has to do with whether the loans (plus accrued interest) are treated as assets of an estate.  Another important aspect is with the calculation of the gifts and how that fits in with the estate tax exemption – does it leave enough exemption left for the mother to be able to pass her assets free of estate taxes at her death.

The tax court did provide some guidelines in determining whether exchange of funds between family members were loans or gifts include: whether there was a writing evidencing the indebtedness such as a promissory note; whether interest was charged; whether there was security or collateral; whether there was a fixed maturity date; whether a demand for repayment was made; whether actual repayment was made; whether the recipient of the funds had the ability to repay; whether records were maintained by either party to reflect the transaction as a loan; and how was the transaction reported for Federal tax purposes and if those were consistent with a loan.

The Ninth Circuit, when affirming the Tax Court’s decision, emphasized that intrafamily loans are presumed to be gifts unless there is a bona fide creditor-debtor relationship between the two parties (characterized by a real expectation of repayment and intent to enforce the collection of indebtedness).

So, what does this mean for your estate plan?  If you want financial transactions with your family members to be considered loans, then take the steps to document the transaction utilizing all the factors mentioned above.  But if you want the financial transactions to be a gift, then also document that somehow such as mentioning it in your estate plan.  Also, it is important to note it in writing if you want any financial transaction to be treated as an advancement on someone’s inheritance from you, that you also mention that in your estate plan and more importantly, detail who that will calculate out when it comes to distributing your assets.