By Michael Kelly
It has become increasingly common for seniors to be approached by family members for financial assistance, often in the form of a loan. Many seniors, out of kindness and love toward that family member, loan money to them informally (i.e. without a promissory note or other written promise to pay it back).
Informally lending money to anyone, let alone a loved one, is never a good idea. While it is admirable to help a loved one going through difficulty, it is also important to protect yourself. A properly drafted and executed promissory note can help you accomplish that in a number of ways:
- It puts the loan arrangement in writing, giving you a way to enforce it in court, if necessary. This is your money and you have every right and expectation that it will be returned to you. A formal writing is therefore appropriate.
- In the case of fraud or deceit by the relative (or any other person you loan money to) you can take a larger tax write off for the loss than you would be able to take if it were simply a personal loan that was not repaid. The writing helps to prove fraud was involved. Lack of a writing leaves the existence of a loan in doubt (was it a gift?) without even getting to fraud. At best you are relegated to a very limited loss write off for a personal bad debt.
Senior, retired and on a fixed income of $45,000 per year, loaned Junior $50,000 to start a business. Junior uses the money to go on exotic trips and for drugs.
Unless Senior has some evidence of a loan, the IRS is likely to consider the $50,000 a gift with no write-off. Even if he can prove it was a loan he is likely to get a deduction of no more than $3,000 under existing tax rules regarding bad personal debts. If there is a properly drafted and executed promissory note Senior may be able to write off almost 90% of the $50,000 as a casualty theft loss due to the existence of fraud and deceit, a huge tax savings for a person on a fixed-income.
The moral of this story is “Don’t let love and benevolence trump good common sense.”