These are trying economic times for many. We see friends in need and many of us have been asked by family and friends for financial help. I commend you if you have the means during this time and you choose to demonstrate your generosity in this form. At the same time, I do advise you to plan ahead and have a clear understanding that lending money to friends and family has taxable implications down the road.
For example, if you loan your friend $15,0000 to help you may be tempted to not charge an interest rate, but you should resist this temptation. By making an “interest-free” loan you are subject to “below-market” interest rate rules. IRS rules state that you need to calculate imaginary interest payments from the borrower. These payments are then payable to you, and you will need to pay taxes on these interest payments when you file a tax return.
If you don’t charge any interest, or charge interest that is below market rate, then the IRS might consider your loan a gift, especially if there is no formal documentation. Formal documentation refers to a written promissory note that includes an interest rate, repayment schedule, and security or collateral for the loan. In addition all parties must sign the note. If the IRS decides to audit you and you do not have the proper documentation they may decide that your loan is really a gift.
As long as you charge an interest rate that is at least equal to the applicable federal rate (AFR) approved by the Internal Revenue Service, you can avoid tax complications and unfavorable tax consequences. I would highly suggest that you talk to a CPA or refer to the IRS guidelines in regards to this matter. Needing to learn more about lending to friends and family? Here is a quick read to understand more on this topic from Market Watch.
