Intrafamily loans are ideal for parents and grandparents who want to assist younger generations of their family through either a direct loan of cash or a loan to a trust for the family member’s benefit. Intrafamily loans provide clients with an excellent tax planning strategy which, if successful, will transfer growth and income free of any wealth transfer taxes. In order to avoid having any part of an intrafamily loan considered a gift for tax purposes, specific guidelines must be followed, including charging a minimum interest rate, documenting the loan, and requiring repayment under the loan terms. The loan must bear interest at a rate greater than or equal to the Applicable Federal Rate (“AFR”), as published each month by the IRS.

The AFR is broken into three tiers depending on the term of the loan:  the short-term rate applies to loans of up to three (3) years, the mid-term rate applies to loans with a term between three (3) and nine (9) years, and the long-term rate applies to loans with repayment terms of greater than nine (9) years. 

For October 2020, the short-, mid-, and long-term AFRs are 0.14%, 0.38%, and 1.12%, respectively. Thus, for an intrafamily loan made in October with a term of less than three years, annual interest of only 0.14% must be charged to avoid any portion of that loan being treated as a gift. These low rates make intrafamily loans an especially beneficial estate planning strategy while the low interest rate climate lasts. Clients with existing promissory notes should also consider refinancing those notes to take advantage of the current rates. We also see many clients assisting children and grandchildren with home purchases by providing a portion or all of the funding for the purchase through a loan.

This article features contributions from David W. Kesner, Charles C. Kingsley, Leonard Leader,  Rani Newman Mathura,  Carolyn A. Reers,  Matthew E. Smith,  Arsineh Kazazian,  Mary Margaret Colleary,  Mi-Hae Kim, Erin D. Nicholls,  Kaitlyn A. Pacelli and Beth A. Scharpf.