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July 2006

The estate tax law is probably a topic you are tired of hearing about. The whole idea of giving away your hard earned money in order to save on taxes gives you the willies. You have heard them so often that you can recite the basic rules. First, you can give $12,000 a year to as many different people as you want. Second, you can give away $1 million during your lifetime without paying any gift tax.  Third, you can leave $2 million at your death without paying estate tax.  The fourth rule is a doozy:  if you die in 2010, the estate tax does not apply at all, but if you live until 2011, the rules go all the way back to “old law” levels, i.e. only $600,000 is passed at death without paying estate tax. So, give, give, give; a less than comforting thought.  This month’s lunch byte provides some new information and a more palatable expansion of rule number 1, giving $12,000 a year.

The IRS code is filled with general rules and then exceptions. A basic rule, you can loan money to your heirs, and charge interest at IRS established rates. An exception:  you can loan less than $10,000 and not charge interest because the loan is consider de minimus. There is a further exception to this rule that allows an individual to loan up to $100,000 to an heir. The lender only has to charge interest equal to the investment income of the borrower. And finally, if the borrower’s investment income is less than $1,000, investment income is considered to be zero. And, investment income does not include dividend income or long term capital gains.  In effect, you can make a $100,000 loan to an heir and not charge interest as long as their interest income doesn’t exceed $1,000. And even if it does, it isn’t so bad. You would have to pick up interest income on your tax return equal to your heir’s interest income.

Think about it, a $100,000 non interest bearing loan is equal to a $7,000 a year gift year in and year out. You can then also give the $12,000 a year to all of your heirs and anyone else you want.  For those of you with enough wealth that you cannot give it away fast enough, you can make a one-time $100,000 loan to each heir in addition to the annual $12,000 gift exclusion. You can loan your heirs $100,000 in which they can invest in a basket of securities. As a result, the income on $100,000 a year and the growth on your children’s investments will not be in your estate.

But what about those of you who have done well, but the concept of loaning $100,000 or giving away $12,000 gives you pause as you consider living out your retirement assets. As an alternative, a non interest bearing loan is an ideal way to allow your children to purchase their first home. Financially, it allows them to buy a bigger home and all likelihood a higher amount of appreciation. As well, the ultimate sale of the house will probably be tax free using the $250,000/$500,000 personal residence exemption. The existence of the secured loan will be an added complication in your children getting mortgage financing.  A non interest bearing loan is also good for you. If you execute a valid secured loan agreement, you will get the funds back upon the likely sale of their first home.  This provision is particularly good in the event of a loutish son-in-law.  

The use of a non interest bearing loan is a good estate planning technique and gives you greater control over the assets than normal gifting.  

Call Geoff Langdon at 302-656-6632 or email glangdon@coverrossiter.com for more information on these or any other tax planning matters.