The $10,000 Tax Rule For Loaning Money to Family and Friends
Have you contemplated loaning money to family or even to friends? Did you know that there is a threshold after which the IRS gets involved?
According to the U.S. Code, that figure is $10,000. It’s referred to as the “de minimis exception” — referring to small loans from the tax agency’s perspective. The person receiving the money must not use the loan to generate income: As the U.S. Code states, “De minimis exception not to apply to loans attributable to acquisition of income-producing assets.” So, if you’re planning to lend loved ones some financial support, keeping it under $10,000 (and making sure the loan funds are not set to generate income) is wise……or else.
If you have decided that you want to loan more than $10,000, then there are some specific rules you have to follow. You’ll want to charge interest and it should be at least the same amount (or greater) than the current applicable federal rate (AFR) of the month during which you begin the loan agreement. The interest rate set should be reflective of the length of the loan term (short, mid or long) that you set up with your beneficiary. This is an example chart from the IRS and can change month to month.
Applicable Federal Rates (AFR) for May 2023
Period for Compounding
Annual Semiannual Quarterly Monthly
Short-term
AFR 4.30% 4.25% 4.23% 4.21%
Mid-term
AFR 3.57% 3.54% 3.52% 3.51%
Long-term
AFR 3.72% 3.69% 3.67% 3.66%
It’s important to establish an interest rate with your borrower because the IRS can tax you (as the lender) on what is referred to as “imputed interest” and — if you aren’t charging interest to your family or friend — you could suffer a net loss from the transaction.
In every case, you’re going to want to document the terms of the loan with your borrower(s) and have a signed agreement involving any relevant parties. The agreement should clearly list full details of the arrangement in case you are questioned by the IRS. This is also imperative if you “forgive” the loan due to unexpected circumstances.
“Some kind of agreement is great for you and great for the person who’s borrowing from you because in a loving and caring way it kind of forces their hand when it comes to repayment.”
It is important to be clear on expectations in the agreement. The agreement should note how much money is being borrowed, if it’s a lump sum or paid out in installments, and how (and when, of course) it’s to be repaid. In addition, it’s wise to note when payments will start and end, the day of the month they will be paid and how much each payment will be.
