Q. My mother loaned $30,000 to her sister 10 years ago with no contract. My aunt recently gave us a check to repay the original loan. Is it taxable? Would it be better to receive three $10,000 gifts to both parents and myself? Would a cash payback be feasible? Should we see if my aunt is willing to pay interest on the amount at the Applicable Federal Rate?
— Repaid in full
A. Glad to hear your aunt has repaid this loan.
We hear all too often about family members who don’t repay loans, and it always leads to trouble.
The repayment of the loan to your parents is not a taxable transaction, said Howard Hook, a certified financial planner and certified public accountant with EKS Associates in Princeton.
The issue at hand really concerns the payment — or lack of payment — of interest on the amount borrowed.
Hook said the IRS requires that interest be paid when people borrow money from others.
“Realizing sometimes that family members will loan money to other family members and wish to not charge interest, the IRS provides guidance on the lowest rate that should be charged,” he said.
The Applicable Federal Rate (AFR) depends upon the repayment terms, and it’s lower for short-term loans and greater for longer-term loans, Hook said.
A 10-year repayment term is considered long term, he said.
The AFR in December 2007 for a long term loan was approximately 4.7 percent, Hook said, so interest of $470 should have been paid each year to your parents. Your parents would pay income tax on the $470 of interest income, Hook said.
“If your aunt wishes to pay them all the interest now she can do that,” he said. “The interest your parents receive would be subject to income taxes.”
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