If capable, we all want to provide financial help to our loved ones. However, it is essential to understand how the money is classified will directly affect your estate planning. Accordingly, your intent behind the money transfer provides critical evidence of whether it is a loan, gift, or advancement. As an estate planning attorney focused on helping clients achieve their life and legacy goals, I can help you sort out how to achieve your intentions.
If there's an understanding that money you gave to someone needs to be paid back, the IRS considers this a loan. This is the case whether the parties to the so-called loan documented it or not. The loan becomes an asset of the estate. If the borrower does not pay the money back before you pass away, the borrower still owes the sum to your estate. For this reason, it is critical to ensure proper documentation. This is so that both parties—the lender and the borrower—are aware that the transfer is a loan. And that the balance will remain an outstanding obligation until the borrower pays it back in full.
Because the borrower owes you a debt, there are a couple of ways you can handle it in your estate plan. First, you could decide to forgive the debt if it is still outstanding when you die. There needs to be specific language in your will or trust. Also, depending upon the amount at issue, you may want to consult with your accountant or CPA to ensure that this will not bring about any undesirable consequences for either party. Alternatively, if you die while the debt is still outstanding and intend to provide a bequest to the borrower, you can arrange to reduce their inheritance by the loan amount. This will decrease the amount that the borrower will owe and, depending upon the amount of the inheritance, may eliminate the debt.
Suppose you are not expecting the borrower to pay the loan back. The IRS could consider the transfer of funds as a gift or an advancement, depending upon what impact you would like the transfer to have on the individual's inheritance.
Suppose you transfer money to a loved one without expecting them to pay you back. You also do so without any additional considerations made concerning your estate planning. In that case, the IRS will deem it to be a gift. Importantly, be careful if the gift is for an amount over the annual exclusion. In 2022, the annual gift exclusion is $16,000.00. In this case, you will need to prepare and file a gift tax return with the Internal Revenue Service.
When deciding to make a gift to a loved one, it is essential to consider what impact you would like it to have on your estate planning. If your estate planning goal is to make the same gifts to all of your beneficiaries, making a gift to one of them during your lifetime will upset this balance. This is because this individual may ultimately receive more than the other beneficiaries.
If you would like to give money to a beneficiary during your lifetime, but you do not want it to disrupt the distribution scheme contained in your estate plan, you can consider giving the money as an advancement. With an advancement, the person would, in effect, receive a portion of their inheritance ahead of time. In such a scenario, the executor will reduce the beneficiary's share of the estate by the amount of the advancement when you pass away. However, to correctly carry out an advancement, you need to include particular provisions in your estate planning documents. Additionally, you must keep accurate records regarding the funds' transfers, mainly if you make multiple advancements.
If you are thinking about transferring money to a family member or friend, I congratulate you on your generosity. But, you may need help determining your true intent. If you are unsure whether you are intending a loan, gift, or advancement, schedule a strategy session. We can discuss how the transfer can or will affect your estate planning goals.
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