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Client Profile

Daniel’s sister recently approached him and floated the possibility of borrowing from him to expand her business. Daniel knows that a loan from him could help his sister’s company grow and is willing to consider helping. However, he still has some concerns about how much he can afford to lend and the tax consequences of the loan.

As with any other important financial decision, lending money to a family member or friend requires some caution. Daniel is wise to carefully consider his decision.

The first thing Daniel should do before making a decision is to assess his own financial situation. While it could possibly place a strain on his relationship with his sister, he should probably rule out making the loan if it will severely strain his budget — now or in the future. After all, there’s no guarantee that his sister will be able to pay him back on schedule. If Daniel can comfortably make the loan, he’ll want to make sure that his sister has — and shares with him — a detailed business plan, for her protection as well as his own.

There can be complicated income, gift, and estate tax consequences associated with family loans. If Daniel agrees to lend his sister money, he should have a formal loan agreement drawn up that spells out the interest rate and repayment terms. The IRS could argue that the transaction was a gift rather than a bona fide loan if there isn’t documentation of the agreement.

The whole issue of loaning money to a family member or friend can be difficult emotionally for all involved. Be sure to weigh the financial factors and structure the loan so that it will withstand IRS scrutiny.

Client Profile is based on a hypothetical situation. The solutions we discuss may or may not be appropriate for you.

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