What to include in the family loan agreement. The family loan agreement should include details such as a time frame for when the sum is expected to be paid back by, any interest (if applicable) and any consequences for missed payments – you may choose to set a fixed penalty or an interest charge for example.
Like any loan contract, you're legally on the hook for the debt. If you fail to abide by the terms of the agreement, your lender — in this case, your loved one — can take legal action against you.
Include key terms of the loan, such as the lender and borrower's contact information, the reason for the loan, what is being loaned, the interest rate, the repayment plan, what would happen if the borrower can't make the payments, and more. The amount of the loan, also known as the principal amount.
The IRS mandates that any loan between family members be made with a signed written agreement, a fixed repayment schedule, and a minimum interest rate. (The IRS publishes Applicable Federal Rates (AFRs) monthly.)
For small loans under $10,000, the answer is simple — no. The IRS isn't concerned with most personal loans to your son, daughter, stepchild, or other immediate family member. They also don't care how often loans are handed out, whether interest is charged, or if you get paid back.
Tax implications: If the family loan is interest-free and over a certain amount ($17,000 in 2023 or $18,000 in 2024), the lender may need to file a gift tax return. If the loan includes interest, the lender must follow IRS interest rate guidelines and potentially report it as income.
While you can write your own agreement from scratch, there are several templates that can make it easier to create a personal loan agreement document.
You can write up a personal loan agreement by hand, with pen and paper, or draft it on your computer. Once the document looks good, it can be printed out and signed by both parties.
Do you need to notarize a Loan Agreement? First and foremost, understand that personal loan agreements fall into the classification of contracts. Technically, you don't have to notarize these documents. But if you want to make this document legally binding, then notarization is the best course of action.
AFRs are published monthly and represent the minimum interest rates that should be charged for family loans to avoid tax complications. The Section 7520 interest rate for January 2023 is 4.60 percent.
How much money can you lend a family member? It is not advised to lend more than you can afford. However, when lending a large amount of money, you should be aware that the interest you charge on the loan could be subject to income tax.
6 Let's say you were giving a loan to a family member for $10,000 to be paid back in one year. You would need to charge the borrower a minimum interest rate of 4.30% for the loan. In other words, you should receive $430 in interest from the loan. In our example above, any rate below 4.30% could trigger a taxable event.
Tax implications of loans to family members
While family members can charge interest rates below current market rates, the applicable federal rate is the minimum interest the lender can charge for loans more than $10,000. If you charge less than this rate, you'll have to pay taxes on the unearned interest.
For a personal loan agreement to be enforceable, it must be documented in writing, as well as signed and dated by all parties involved. It's also a good idea to have the document notarized or signed by a witness.
There are no legal differences between typed and handwritten agreements when it comes to enforceability. When most people think of a contract, a formally typed, the professional contract usually comes to mind. Nonetheless, a handwritten contract can be as valid as one that's typed.
For example, if the note's terms are unclear or there is evidence that the note's maker did not intend to repay the debt, the court may invalidate the note. It is also possible for the payee to not be able to sign a promissory note if they knew the maker could not repay the debt at the time of signing it.
Promissory notes don't have to be notarized in most cases. You can typically sign a legally binding promissory note that contains unconditional pledges to pay a certain sum of money. However, you can strengthen the legality of a valid promissory note by having it notarized.
All loan agreements must specify general terms that define the legal obligations of each party. For instance, the terms regarding repayment schedule, default or contract breach, interest rate, loan security, as well as collateral offered, must be clearly outlined.
However, a loan agreement normally contains more specific and stringent terms, with greater obligations and restrictions placed on the borrower. It also often includes elements of security (eg putting up a house as collateral) whereas a promissory is typically unsecured.
Put simply: yes. From a legal standpoint, verbal contracts can be just as valid as written contracts. There are, of course, nuances and exceptions, and a verbal contract may be much more difficult to enforce in court should something go wrong.
If the IRS considers this transaction a qualifying loan, then it will typically have few (if any) tax implications. It doesn't count as income for the borrower, because they will pay this money back, nor does the loan count as a gift for the lender for the same reasons.
Unless you have gifted more than $12.92 million over your lifetime, you can almost certainly give a $50,000 down payment to your daughter or other family member and not owe gift taxes in 2023. Just be careful to do the paperwork right, otherwise, it could complicate the loan.
As the lender, you simply report as taxable income the interest you receive. On the other side of the deal, the borrower may be able to deduct the interest expense on his or her personal return, depending on how the loan proceeds are used.