Making Intrafamily Loans and Creating a Family Bank01/14/2021
Estate planning allows you to put in writing how you want your wealth distributed to loved ones after your death. What if you want to use that wealth to help a family member in need while you’re still alive? This has been an increasingly common and pressing issue in 2020 because of the COVID-19 pandemic and its impact on the U.S. economy.
One way you can help family members with heavy debt loads or those hit hard by job loss is through an intrafamily loan or even establishing a full-fledged family bank (yes, that is a thing!).
Structure loans carefully
Lending money to loved ones is a good way to provide financial assistance without triggering unwanted gift taxes. But you must structure the loan in a manner similar to an arm’s-length loan between unrelated parties so it won’t be treated as a taxable gift.
This means, among other things, documenting the loan with a promissory note and charging interest at or above the applicable federal rate (which is now historically low). You must also establish a fixed repayment schedule and ensure that the borrower has a reasonable prospect of repaying the loan.
Even if taxes aren’t a concern, intrafamily loans offer important benefits. For example, they allow you to help your family financially without depleting your wealth or creating a sense of entitlement. Done right, these loans can promote accountability and help cultivate the younger generation’s entrepreneurial capabilities by providing financing to start a business.
Consider establishing a family bank
Too often, however, people lend money to family members with little planning or regard for potential unintended consequences. Rash lending decisions can lead to misunderstandings, hurt feelings, conflicts among family members and false expectations. For some, a family bank can add the necessary structure to keep any loans on the up and up.
A family bank is a family-owned and funded entity — such as a dynasty trust, a family limited partnership or a combination of the two — designed for the sole purpose of making intrafamily loans. In many cases, family banks can offer financing to offspring who may have difficulty obtaining a loan from a bank or other traditional funding sources, and allows them to secure a loan at more favorable terms.
By “professionalizing” family lending activities, a family bank can preserve the tax-saving power of intrafamily loans while minimizing negative consequences. The key to avoiding family conflicts and resentment is to build a strong governance structure that promotes communication, decision making and transparency.
Establishing guidelines regarding the types of loans the family bank is authorized to make — and allowing all family members to participate in the decision-making process — ensures that family members are treated fairly and avoids false expectations.
We can help
More than likely, someone in your extended family has faced difficult financial circumstances this year. Contact us to learn more about intrafamily loans and family banks.