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Rethink Your Loan To Family Members

posted on February 01, 2020 by Willingham & Cote

by Torree J. Breen, Estate & Gifts

Throughout my years of practicing law, I have grown to appreciate that most families consist of similar family dynamics often involving the some of the same trials and tribulations. Life is life and we all know life happens when we are not properly prepared for it. 

You realize that you son and his wife need a brand new car because they are having problems running their children to school and other various extracurricular activities throughout the State of Michigan with the 15 year old wagon that is in the shop more now than ever.  You think it would be a great idea to lend them money to buy a car to help them get ahead of their other monthly expenses and to pay the extra club fees for indoor soccer so that your grandchild has the chance to earn a much needed scholarship to college to play soccer someday.  In the kindness of your heart, you discuss lending money with your son and his wife at the dinner table and issue a check to them as they are walking out the door to purchase the latest van with all the latest features to entertain their four children without insisting that they enter into a written contract with you. 

An Ounce of Prevention

You may want to think twice about this informal exchange and formalize that loan in writing to ensure it is either paid back in full or that it is set-off against any inheritance in the future. Your family will thank you for it.  If the money exceeds the $15,000 gift tax exemption, if you do not have an arms-length transaction in which you require the repayment of the money based on a certain time schedule, and if you do not charge interest, the IRS may consider the loan a disguised gift to your son.  This may trigger consequences based on the gift and estate taxes.

Unintended Consequences

After lending the money to your son and your daughter-in-law, you realize that they were unhappy in the marriage and have now filed for divorce.  You wonder who is going to repay that loan and if you will ever see your money again. Now that your daughter-in-law is in an adverse role with your son, she will likely deny that the loan ever existed and declare it was a gift from you.  If the loan is not in writing, the courts are less likely to enforce the loan.  You also cannot claim this debt in their divorce because you are not a party to their divorce case.  Just like any other third party creditor, you will be forced to file litigation against both your son and your “soon to be” ex-daughter-in-law in efforts to collect your money.  If there is no written evidence of this loan, more likely than not, the court will dismiss the case and your son will be left holding the bag.  You are beside yourself knowing that your ex-daughter-in-law will never repay her share of that loan to you and she took the van pursuant to the Judgment of Divorce. 

If you die before the loan is repaid to you by your son, this loan could create an area of contention between your son and your other children after your death.  If you did not make any arrangements for the repayment of the loan by your son against his share of your estate, the other children may become resentful of your son and they have no remedy to ensure that he repays his loan. Your other children are not allowed to take that loan against his share of your estate unless the loan is in writing or it is discussed in your estate plan.  Unfortunately, a dispute over this loan to your son and ex-daughter-in-law may be the thing that divides your family for the rest of their lives.

What Should You Do?

The best thing to do if you plan to loan money to your family is to prepare a written document that outlines the terms of your agreement and have them sign the document acknowledging their responsibility for the loan.  If you are not comfortable setting forth this arrangement in writing, perhaps consider giving a gift and ensuring a credit against any future inheritance in your estate plan. You can all arrange to forgive the loan as well; however, if you do nothing, it may become a huge area of contention. After all, this whole idea started with your good intentions of trying to help your struggling son and daughter-in-law to buy reliable transportation, so please do not allow your good intentions to create unintended angst.  

Torree J. Breen is an attorney and shareholder at Willingham & Cote’, P.C. in East Lansing, Michigan.  She specializes in the areas of estate planning and family law  Mr. Breen may be reached at 517-351-6200 or tbreen@willinghamcote.com.

Photo by Guillaume M. on Unsplash

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