Loaning Money to Family Members

 

By Michael Kelly, Attorney at Law

Kelly Law and Tax

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:

  1. 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.

 

  1. 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.

 

For Example:

 

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.”