Donna Genie explains how to distinguish loans from gifts. Loans above $10,000 may trigger IRS interest rules (currently around 4%), so get a written agreement with repayment terms and a promissory note to protect both your relationship and your taxes.
July 5, 2024.
$10,000.
About 4%.
$20,000.
Have you taken a loan from friends, family to help you when your business was starting up or to help you expand? Or maybe cash was just plain old tight? It's understandable. Many times I see loans on the books. However, let's talk about the difference between a loan and a gift. If someone has loaned you money, that means there should be an agreement of when it's going to get paid back. It has terms. How long are you going to keep the money, when are you going to pay it back, how much you going to pay back, and what's the interest? So I had a situation the other day where I asked those same questions of one of my new clients that came on board, and they had a loan from a family member. Now, that loan didn't have any payments in the last year. It was just sitting on the books. Didn't have any interest on it. It was just sitting on the books. So when I asked these questions, I said, oh, yeah, that's a loan. I said, okay, what are the terms of the loan? Are they written or are they verbal? They say, oh, he just told us to pay them back when we could. Okay, folks, that's not a loan. The IRS won't see that as a loan. You need to have a document when it's a loan. And please, folks, we've seen so many issues. This is like the number one killer of family relationships when we start intermingling business and personal and people can't tell the difference. So do yourself a favor. If you're going to borrow money, write it down. Have a loan document. You'll make both of you feel better. Make sure everybody understands those terms and what they are, and it's documented in case you're ever asked about it. Gifts and loans are two completely different things and have very different tax effects. I will tell you, it's common knowledge. A lot of times they'll say, well, it was a loan, but there's no interest on it. Did you know that the IRS requires you to impute interest if your loan is above $10,000? So the IRS sets up rates and they actually update these rates every quarter, and they will tell you what this loan rate is. Currently, that loan rate can be around 4% or so. So what does imputed interest mean? That sounds like a terrible, complex accounting term. Well, it's not really. It means that you should be saying that you're paying interest. Even if you're not, you going to show that you paid interest and you get to deduct the expense on your business. But that person who made the loan is actually incurring income on the imputed interest. I know it's a terrible complex thing and it sounds really crazy because you don't see it in practice a lot, but that's really what should happen. So how do we fix this? Well, ultimately, let's fix it. Must do what's right. Lets write up a loan agreement and hey, if your family or friends gave you money, you probably ought to pay them interest. Come on, give them something in return and show them how much you appreciate they're taking a risk on you. I'm not saying you gotta pay them a 20% interest rate. How about 5? How about 6? Give them something I think you deserve, they deserve to receive it. So write up a loan agreement. I don't care how fancy it is, you don't have to talk to an attorney. Go out there on ChatGPT, folks. It can help you write up some simple agreements like this. Now obviously I'm going to tell you it's not a lawyer. So if you need something more complex, do seek out the services of an attorney. But a simple promissory note. I borrowed $20,000 from my father and I'm going to pay him back on these terms. Yeah, write it down. Save those family relationships and don't take a risk on that, Sam.
