Family Loans

[Craigcorneau]

My mother leant me and my wife $38,200 in November to help us pay off our high interest credit cards then pay her back monthly. We haven’t started the regular payments yet and I wonder what tax rules, if any apply to our situation for me and my wife and my mother. I don’t want to end up with a surprise audit. Do either of us need to claim the loan money given or received on our taxes? I don’t know how that works.

[DavidD66]

You do not need to claim anything on your tax returns; however, you mother will need to report interest received on her tax return.  In a family loan, when there is no interest rate or a rate below the IRS-determined minimum rate, the interest that isn’t charged is assumed to be income to the parent from the child. In other words, there is imputed interest income or phantom income.  Your mother should report interest income at the Applicable Federal Rate as income, even though no cash was received.

Your mother should charge, and you should pay an interest rate equal to the “applicable federal rate” (AFR). As long as you do that, the IRS will be satisfied and you won't have to worry about any tricky tax rules biting you. As the lender, your mother will report as taxable income the interest she receives. 

You should send your mother a Form 1099-INT showing he amount of interest paid and/or accrued.

You can get AFR rates by going to the following IRS webpage:  Applicable Federal Rates (AFRs).  

[Opus 17]

If your parents charge interest, they must report the interest they received as taxable income.  If you make fixed payments, there are various web sites that can calculate an amortization schedule (how much of each payment is interest vs premium).  If you make variable payments, there are other ways to calculate the interest portion of each payment.

If your parents don't charge interest, they must still report the interest they could have charged as taxable income.  This is called imputed interest.  They must use at least the applicable federal minimum rate.  (The federal minimum rate for a long term loan made in November 2022 is 3.85%.). This rule is because the IRS expects taxpayers to conduct their affairs in a businesslike manner.

The principal portion of the payments is not taxable income, because it is just a your mother's money returning to her.

If your agreement was that payments would not start until some time in 2023, it is not necessary for your parents to report any imputed interest on their 2022 tax return. 

You do not need to issue a 1099-INT or any other documents to your parents for the interest you pay, because the loan was not made in the course of a business or trade.  (If you borrowed money to start a business, you would issue a 1099, but since this was to pay off personal debts, you don't issue a 1099.)