Because of the COVID-19 pandemic and the resulting economic turndown in some areas, you may have family members in need of financial support. If you are interested in lending money to loved ones in need, consider establishing a ‘family bank.’ These entities enhance the benefits of intrafamily loans, while reducing unintended consequences.
Lending can be an effective way to provide your family with financial assistance without triggering unwanted gift taxes. So long as a loan is structured in a manner similar to an arm’s-length loan between unrelated parties, it will not be treated as a taxable gift. This means, among other things, documenting the loan with a promissory note, charging interest at or above the applicable federal rate, establishing a fixed repayment schedule, and ensuring that the borrower has a reasonable prospect of repaying the loan.
Even if taxes are not 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 encourage responsible financial behavior, promote accountability, and help cultivate the younger generation’s entrepreneurial capabilities by providing financing to start a business.
Too often, however, people lend money to family members with little planning and regard for potential unintended consequences. Rash lending decisions can lead to misunderstandings, hurt feelings, conflicts among family members, and false expectations. That is where the family bank comes into play.
A family bank is a family-owned, family-funded entity designed for the sole purpose of making intrafamily loans. Often, family banks are able to make financing available to family members who might have difficulty obtaining a loan from a bank or other traditional funding sources or to lend at more favorable terms. By ‘professionalizing’ family lending activities, a family bank can preserve the tax-saving power of intrafamily loans while reducing negative consequences.
Build a Strong Governance Structure
The key to avoiding family conflicts and resentment is to build a strong family governance structure that promotes communication, group decision-making, and transparency. It is important to establish clear guidelines regarding the types of loans the family bank is authorized to make and allow all family members to participate in the decision-making process. This helps to make sure that family members are treated fairly and avoids false expectations.
Ease Financial Hardships
It is possible that someone in your extended family has faced difficult financial circumstances recently. Contact us to learn more about intrafamily loans and family banks.