Interest rates have hit a low point this summer. Low interest rates set each month by the IRS (the applicable federal rate (AFR) and the 7520 rate) make some estate tax planning strategies particularly effective. For this reason, it may be a good time to take a break from the heat and sun this August to do some estate tax planning. It will save your family some money, and perhaps pay for next year’s summer vacation.
One estate tax planning strategy that is very effective when interest rates are low are intra-family loans. Intra-family loans are loans to family members. They can be made outright to a family member or to a trust for his or her benefit. Often parents or grandparents wish to loan money to children or grandchildren to buy a new home, renovate an existing home, or make a business investment. The loans can be forgiven over time to take advantage of the lender’s gift tax annual exclusion and to maximize wealth transfer planning.
The IRS requires that the lender charge interest on an intra-family loan at the applicable federal rate (AFR). This rate is set each month by the IRS, and has been trending downward since early 2019. The August 2019 AFR for a mid-term loan (with up to a 9 year term) is very low – 1.85%. In fact, quite surprisingly, the mid-term AFR (1.85%) is lower than the short-term AFR (1.89%) which means the loan can be for a longer term with a lower rate.
A low interest rate makes intra-family loans an appealing estate tax planning strategy. If you are considering a loan to your children or grandchildren, this may be a good time to make one. In addition, if you have an existing outstanding loan, this may be a good time to refinance it. But be careful, and get good advice. The loan must be documented by a Promissory Note and the lender must charge interest at the AFR. Otherwise the IRS may view it as a taxable gift.