Family Business: A Loan Is a Loan
by , CFP®, President, Charles Schwab Foundation; Senior Vice President, Schwab Community Services, Charles Schwab & Co., Inc.
September 8, 2010
Last year I loaned my brother $10,000 when he lost his job. We created a loan document with a payment schedule, but even though he’s back at work he hasn’t started paying me. How can I get him to start making his monthly payments without hurting our relationship?
To my way of thinking, no area of personal finance is trickier than transactions with family members—especially siblings—and your question is a perfect example.
But before I give you some guidance about how to broach this delicate subject with your brother, I want to point out that there are significant practical and tax implications when you lend money to your friends or family. The IRS is particularly interested in loans of more than $10,000, so you’re off the hook there—but of course a loan of any size can also trigger other family issues. To minimize problems down the road, I highly recommend that anyone considering making a family loan think about the following:
I realize these are technical issues, but when the amount is substantial (and at $10,000 you’re right on the cusp of having the IRS care), they are important.
- Don’t risk your own financial security or loan money that you can’t afford to lose. We’ve all heard about the road to ruin being paved by good intentions—and that certainly can apply to a family loan. Think carefully before you write that check.
- Document the loan (as you've done). This demonstrates that you expect to be repaid and are not making a gift; otherwise, the IRS could count the loan against your annual $13,000 annual gift tax exclusion as well as your $1 million lifetime exclusion. Documentation also gives you the ability to deduct an unpaid loan on your income tax return if your borrower cannot pay you back.
- You don’t have to charge market rates, but set an interest rate at least equal to what the IRS refers to as the “applicable federal rate” (AFR). This is especially important if the loan is over $10,000. Otherwise you could get hit with having to pay taxes on the “imputed interest” you never received. AFR rates are set monthly and vary depending on the type and term of the loan; you can find them at . The tax implications of imputed interest can be tricky (involving the borrower's investment income); check with a tax advisor if you're unsure about how to proceed.
Now back to your original question of how best to get your brother to start paying you back.
First, don't feel guilty. You did your brother a favor by lending him money at a time when he was in need—and now it’s time for him to be responsible about paying you back. Of course he may not be thrilled to be reminded of his obligation, but you'll certainly feel some resentment yourself if you pretend the loan doesn't exist. Open, forthright communication is generally always better than avoidance.
Second, think about whether you can be flexible. Maybe it is taking him longer to regain his financial footing; he may need some extra time to start paying or a lower rate or a longer term. If that’s the case, see what you can work out. (If you agree to change the terms of the loan, document the changes in a new loan agreement.)
But being flexible doesn't mean being a pushover. I think it's vital for both of you that he honor his obligation, even if on more lenient terms than originally outlined. That way, this transaction will cease to be a bone of contention between the two of you.
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