My sister and her husband have been in severe financial distress due to COVID-19. I want to give my sister some money; however, my wife is against it; she thinks we should lend her the money, not give it to her.
To promote harmony at home, I decided to lend the money to my sister instead of giving it to her. I have some questions about it. The first is, if I lose my debt to my sister on the way, are there any tax consequences for me or my sister?
My wife also wants to know what happens if my sister and her husband file for bankruptcy; do we lose money? You should know that we plan to lend $ 50,000 to my sister and her husband, and my wife insists that everything must be written down.
First, I agree with your wife that whenever you lend money to family and friends, it is important that the agreement is put in writing. You don’t want misunderstandings, which can cause family disputes.
There are tax consequences as to whether you and your wife decide to forgive part or all of the loan. If you forgive the debt, you are in effect giving your sister and her husband a gift. Consequently, there are tax consequences on donations.
Under our gift tax laws, it is the person giving the gift, not the person receiving it, who is responsible for any tax consequences. The annual donation tax exclusion is currently $ 15,000. This means you can donate to anyone who wants $ 15,000 annually with no donation tax consequences. Additionally, a spouse can participate in the gift, which means that husband and wife can give up to $ 30,000 per year to whomever they choose without tax consequences on the donations.
Theoretically, if you choose to forgive the entire $ 50,000 and since the debt is in the name of your sister and her husband, you and your wife can give each of them $ 30,000. Therefore, if you forgave the entire $ 50,000 there would be no tax problems for you due to the annual exclusion. If you decide to forgive the debt along the way, neither your sister nor you will have negative tax problems.
If your sister and her husband file for bankruptcy, the loan would most likely be forgiven by the court and you and your wife would not be entitled to any compensation.
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From a fiscal point of view, it is possible that at that moment you may be able to write off the debt as a bad debt. This would be your only course of action, as you would be barred by law from attempting to collect the debt from your sister or husband.
I know that many of you think that it is not fair for someone to go bankrupt and have their debt paid off. It may be, but it is what it is. The only way to protect yourself is if the debt was secured by an asset.
For example, when someone takes out a mortgage, the mortgage is secured by the house. Therefore, if someone declares bankruptcy, he can be exempted from the obligation to legally pay the mortgage; however, the mortgage company would take ownership of the home. Typically, in most situations with family and friends, there is no security interest and therefore the loan is considered unsecured.
I can’t stress enough how important it is when lending money to family and friends that you cut the writing agreement and have a conversation to make sure it’s clear that you expect to be repaid and what the repayment terms are.
I know these can be awkward and difficult conversations at times; However, the last thing you want is disputes within the family. Make sure the agreement is in writing and the conversation is difficult, so it’s clear this is a loan, not a gift, and you expect the money to be repaid.
Rick Bloom is a paid financial advisor. His website is www.bloomadvisors.com. If you’d like Rick to answer your questions, please email Rick at [email protected]