Avoiding Tax Traps in Loans to Friends and Family

When loved ones need a little financial assistance, we often reach out a hand to help them. This may involve loaning them some money. Mixing “business with pleasure” can often prove to be tricky and put stress on relationships. It is because of this that it is important to do so the right way. When lending money, there are tax issues to keep in mind as well. Here are some tips to make sure the process is right in the eyes of the tax code:

Charge Interest

While it may feel uncomfortable, you should charge interest on loans made to family and friends. When it comes to money, it is important to remain professional. If you do not charge a minimum rate, the IRS will imply interest in the loan and tax you for the interest they assume you are receiving. 

Charge Enough Interest

When charging interest, it is important to make sure it is a reasonable amount in the eyes of the IRS. If you do not, the IRS will imply interest at their minimum applicable federal rates (AFRs). To ensure you are following the right procedure, it is good to charge an interest rate either at or above these AFRs. These are available on the IRS website. These interest rates are low and almost always below the prime interest rate.

Know the Exceptions

It is understandable that you may not want to charge interest when loaning money to a family member or friend. It is because of this that it is important to know that there are some exceptions in which you may not have to. This can include the following circumstances:

  •  The money is a gift. This can be done if you and your spouse can each give up to $15,000 to a loved one each year, this way the maximum remains that amount per year.
  • The loan is less than $10,000 and is not used to purchase an income-producing property. If you do not charge interest and the loan is used to purchase income-producing property, special tax rules apply. This may include capital equipment or to acquire a business.

Get it in Writing

Whenever you are making a decision regarding large sums of money, it is important to get the terms in writing. This includes giving a loan to a loved one. If you expect repayment, it should be written out in the terms of the loan. There are different types of basic loan document formats that can be found online. While this may seem unnecessary when dealing with a friend or family member, it is crucial for two reasons:

  • It documents tax code compliance. By writing down the terms and charging a stated interest rate, you can show you are within tax code rules.
  • Avoiding misunderstanding. A written document ensures that it is a real loan and not an informal gift. This way your loved one knows that you expect to be paid back and when this will happen.


Werdann DeVito LLC is an experienced Certified Public Accountant firm serving clients throughout New Jersey with all of their financial needs. If you need quality assistance with accounting, tax, or consulting services, contact Werdann DeVito LLC today.