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When is a Loan Considered a Gift in the Eyes of IRS?

July 4, 2014 by Ed Becker

When you borrow money from family or friends for your business, it can get taxed as income if you are not specific about it actually being a loan. A gift to your business is considered income when a friendly loan does not meet IRS criteria.

When_is_a_Loan_Considered_a_Gift_in_the_Eyes_of_IRSA friendly loan can be bad news for your family member or friend as well. If you default on the loan or your business goes belly up, they may not be able to write it off as bad debt. It is legal to write off a worthless loan, but if it is considered a gift it is not deductible. The IRS looks very closely at loans between related parties on both ends of the spectrum.

If a family member or close friend is going to give you a business loan, there are steps you need to take to ensure that you are both safeguarded from being taxed incorrectly.

Ensure that you draw up the proper paperwork

Take the time and spend the minimal cost of having an attorney draw up the paperwork for your loan, with legal guidelines on both sides. A business attorney will know what details and specifics need to be in the loan agreement to safeguard all parties.

Set up a repayment plan

A written repayment plan should be part of your loan agreement, for the good of all parties. If something happens it helps that it is ensured as a real loan and not a gift. Make your payments on time and write and keep receipts. Even if you are receiving the loan from family, it is important to keep the receipts just in case.

Charge a reasonable interest rate or ROI

For a loan to be considered a valid loan for the IRS you need to have a reasonable rate of interest or your benefactor should have some type of reasonable return on investment. You cannot write off interest paid if it is not spelled out, and your family or friend would have to prove that it was a loan to write it off as bad debt.
The IRS looks very closely at loans between related parties, or loans from friends, that are not drawn up correctly and have no real repayment plan or interest rate. It is okay for your family or friends to help you out or invest in you through your business, as long as you ensure that it is done properly to safeguard all parties.

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