Gift or Loan?

• Are you giving money to a family member or extending a loan? The Internal Revenue Service (IRS) allows tax free gifts of up to $13,000 per year per person. That means you can write out a check for up to that amount, hand it to your relative, and nothing more needs to be done. If you gift above that amount then you're responsible for paying a tax to the IRS.
  
  If the money you are giving is clearly not a gift as in you telling your relative that you want the funds back, then you have a loan agreement instead.
  
  

Loan Agreement

• Some people extend family loans informally, by verbal agreement, and without IRS knowledge. Though the IRS will probably never know about this kind of loan unless you tell them, you are legally required to document the loan by securing a note and outlining terms just as you would on any loan agreement with a bank, credit union, or other lender.
  
  With your loan agreement, you may decide not to charge interest. Yet that may not sit well with the IRS who wants you to charge your family member for the loan. To avoid the wrath of the IRS, consider charging an interest rate close to the market rate and be prepared to declare your interest income on your taxes.
  
  See the resource section for a sample personal loan agreement. Search online for other examples, including those that you may download and modify according to your needs. Have both parties sign and date the agreement; consider doing same in front of a notary public. Keep one copy of the loan agreement for yourself; extend another copy to the family member.
  
  

Tips and Warnings

• Although many family loans never get reported, in the event that the borrower defaults on the loan, the lender could be out of that money. You won't be able to show a loss when you file your income tax returns if this information remains undocumented. If the IRS discovers that you have lent money without documenting same, you could be forced to pay a penalty including back taxes and interest. Your state may also want to tax a portion of the interest earned.
  
  Finally, consider the impact of a family loan that goes unpaid. How will that impact your relationship with this person?