Updated for tax year 2024.
Being a parent often involves lending money to your kids throughout their lives. Maybe you’re helping them buy their first car, assisting with higher education costs, or contributing toward a down payment on their first home. But when you fork over cash to your family, does the Internal Revenue Service (IRS) care about those loans?
At a glance:
- Small loans to your children are not a concern for the IRS.
- Charge interest on significant loans toavoid gift taximplications.
- If your child doesn’t pay back the loan, you can take a bad debt deduction.
Does the IRS care about me lending money to my kids?
For small loan amounts under $10,000, the answer is simple — no. The IRS isn’t concerned with most personal loans to your son, daughter, stepchild, or other immediate family member. They also don’t care how often loans are handed out, whether interest is charged, or if your loved one pays you back.
But, as with most things, there are exceptions.
Scenario: Interest-free loans
For tax purposes, if you loan a significant amount of money to your kids — over $10,000 — you should consider charging interest as a lender.
If you don’t charge interest, the IRS can say the amount of interest you should have charged was a gift based on current tax rules. In that case, the interest money goes toward your annual gift-giving limit of $18,000 per individual as of tax year 2024 (up from $17,000 in 2023). If you give more than $18,000 to one individual, even if the individual is your child, you are required to file a gift tax form. Since the limit is per person, married couples can have a combined annual limit of $36,000 before needing to file a gift tax return.
The minimum interest rate on the loan must be based on the lesser of applicable federal rates (AFRs) set by the IRS or the borrower’s net investment income for the year. You don’t need to charge interest if the borrower’s investment income is $1,000 or less. If you choose to charge interest lower than the AFR, it’s called a below-market loan, and there are tax implications. See the last section of this article for more information about this topic and some exceptions.
Scenario: Family loans that are really gifts
Some people may think they can give large amounts of money to their children and call it a loan to avoid the hassle of filing a gift tax return, but the IRS is wise to that. The loan must be legal and enforceable. Otherwise, it may be deemed a gift.
When loaning money to a family member, it’s good practice to seek legal advice and have a professional help you draw up an official loan agreement for both parties to sign. It may also be worth talking to a financial advisor if you are unsure of the full tax implications.
Scenario: Student loans for tuition
You can give “student loans” to help fund your kid’s higher education by drawing up a contract like any other loan. When they graduate and start a repayment schedule, your children can take the student loan interest deduction on any interest paid to you. Remember that interest income is taxable income, and you’ll need to pay income tax on interest payments and report them to the IRS.
Scenario: Take a bad debt deduction if your child doesn’t pay you back
One of the advantages of a written agreement for your loan is that if your child doesn’t pay you back, you can take a tax deduction for a non-business bad debt on your federal income tax return. Additionally, you don’t have to pay gift tax to the IRS on the amount you would have if you had gifted the money.
To take a bad debt deduction, you must prove that the debt is truly worthless and there is no chance of repayment. Have your child make a written statement that they cannot pay, and gather as much evidence that you tried to collect the debt as possible. Letters, invoices, and phone calls can all be used as proof in this instance.
Scenario: Filing a gift tax return for a loan
But what if you fail to document the loan properly and legally, the IRS decides your loan is actually a gift, and you need to file a gift tax return?
In most cases, you won’t have to pay taxes for a “loan” the IRS deemed a gift. Even if you exceed the $18,000 annual gift tax exemption we mentioned before, you only owe gift tax when your lifetime gifts to all individuals exceed the lifetime gift tax exclusion. For tax year 2024, the exemption limit is $13.61 million (up from $12.92 million in 2023). The lifetime exemption is per person, meaning married couples can exclude $27.22 million in lifetime gifts.
If you’re like most people, that means you’re probably safe, but you still need to keep track of and report any gifts that exceed the annual exclusion ($18,000 in 2024).
Other family loans that are safe from tax implications
You don’t have to worry about family loans being subject to federal tax consequences if:
- You lend a child $10,000 or less, and the child does not use the money for investments, such as stocks or bonds.
- You lend a child $100,000 or less, and the child’s net investment income is not more than $1,000 for the year.
If you don’t fall within the above exceptions, it might be a good idea to read up on below-market loans in IRS Publication 550 to determine the tax implications.
The bottom line
If you’re thinking about lending a significant sum to a family member, it’s smart to consider the potential tax consequences (a tool like TaxAct‘stax calculator can be very helpful here).
As an American taxpayer, when it comes to lending money to your kids, the IRS generally doesn’t take much interest unless larger sums are involved. While small loan amounts under $10,000 won’t raise any red flags, significant amounts can trigger gift tax implications if you’re not careful. Charging interest on these loans, documenting them properly, and understanding the exceptions can save you from unwanted tax consequences. As always, a little bit of financial planning now can prevent potential tax liability headaches later on.
