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Should You Loan to Family?

What do you do when a family member has financial difficulties?

You may have taken all the steps to get your financial house in order, but it’s possible that you have family members who have not been so careful. Or perhaps you have a family member who is suffering financial hardship through no fault of their own—death in the family, loss of a job, sudden medical bills, or major car repairs.

You want to help, but should you? You need to guard not only your money, but also your family relationships.

If someone in your family comes to you requesting a loan, think carefully and make sure you have a thorough and frank discussion with them. Ask specifically why they need the loan. If it’s for something that will improve your family member’s financial situation (like college tuition, or help with the purchase of a home), you will probably feel better about making the loan. But think carefully about lending to a family member who has a history of poor financial decisions. It could be very likely you will never see that money again, and you will have damaged your family’s relationship. Ask for a credit report (they can get one for free each year here). Be clear about your financial situation and what your expectations will be if you decide to make a loan.

Proceed only if you feel reassured and confident that your loan will be paid back on schedule.

Only lend what you can easily–and without hardship—afford. Check your budget and your expenses to double-check your financial situation.

Decide now what you will do if your family member doesn’t pay you back, and you have to collect on the debt. Your choices can range from getting nothing back—just writing off the whole experience—to trying to collect it yourself, all the way to going to court. Best to make that decision now before you go any further. If you decide that you will do your best to collect on the debt, if necessary, be sure to document your process and keep meticulous records.

Put it in writing! It seems like an inconvenience and unnecessary, but making a loan agreement formalizes the loan, and makes it a loan, not a gift. The IRS will want to see the loan document if they question your taxes, as will your tax preparer. Don’t make the loan if your family member doesn’t want to put everything in writing—remember that it IS your money at stake here. Nolo is a good source for standard promissory notes and information.

In your loan agreement, spell everything out: Who is borrowing and who is lending, the amount of the loan, the interest rate, payment amounts and dates of payments, and penalties for late or missed payments, or default of the loan.

Be sure to find out what the tax implications are for a loan to a family member. In some cases you may need to charge a minimal amount of interest to avoid tax complications for both of you (and to make sure the IRS views it as a loan and not a gift). The minimum is usually the current applicable federal rate (AFR). Find out more about it from the IRS here.

Remember that once you’ve granted the loan, the process is in your family member’s hands. It’s not up to you how they handle the money, how they handle their finances, or their relationships. Think about how non-intrusive a bank loan is—once you get the loan, all the bank cares about is having you meet the payment schedule. Do, however, keep your communication lines open.

Loaning to a family member is never an easy decision, for either of you. But by following some reasonable guidelines, you can avoid trouble and hard feelings down the road.

Questions? Stop by one of our convenient locations and speak to a tax advisor.

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