An often overlooked technique when it comes to family planning is the interfamily loan. For a number of years, the primary focus with respect to transfers between family members was the potential tax for gift and estate tax purposes which could be generated thereby. With the increased exemptions now available and portability of unused exemptions between spouses, there is far less pressure regarding taxation of interfamily transactions. However, Interfamily loans remain a viable technique in a large number of circumstances.
Such loans can provide for the provision of significant capital to a younger generation for a wide variety of purposes including starting a business, purchasing real estate, and other long term strategies and can also provide income for the older generation in the form of interest to be paid. While related party transactions such as interfamily loans are typically going to attract greater scrutiny by the Internal Revenue Service and other taxing authorities, these techniques are not precluded by law so long as they are properly structured.
It is both necessary and appropriate in planning a family transaction that the loan be interest-bearing and that the interest rate be at least as high as the applicable federal rate for the relevant term on interfamily debt. Selection of financing terms should be carefully tailored to the specific situation, but the flexibility of loans between family members as opposed to third-party institutions can make this technique extremely attractive.
Once put in place, sometimes the question arises as to whether the family loan can be refinanced with, for example, lower interest rates, or if it can otherwise be restructured in such a way that the debt burden on the obligor is reduced for a variety of reasons.
The relevant tax laws do allow for a restructuring of an existing debt without the triggering of untoward tax consequences in a variety of circumstances. It is possible, for example, to adjust the interest rates as well as payment structures on an interfamily note. So long as the old and the new note will pass muster from the standpoint of the original issue discount rules and the new note remains a valid and enforceable obligation with a reasonable expectancy that the obligation will be paid at some point in the future, it is possible to restructure family debt in a variety of ways.
It is even possible under the right circumstances to provide that outstanding debt throughout the lifetime of the senior generation can be automatically cancelled on the death of the Noteholder. Such notes are referred to self-cancelling installment notes. Again, in the right circumstances and with careful planning, this is a viable technique to provide capital to the younger generation while deferring any tax consequences to the death of the individual and eliminating the remaining balance of the note as an asset in the hands of the senior generation.
The potential uses for family debt are so varied that it is very difficult to describe all the potential uses in a short article. Suffice to say, this group of techniques can be, in the right circumstances, a necessary and useful part of estate and asset protection planning. We at Wolcott Rivers Gates can assist you in crafting plans which use these techniques to optimize your estate plan.
