Tax

Business Tax

Lending Money to Family? Make it a Tax-Smart Loan

Lending money to a cash-strapped family member or friend is a noble and generous offer that just might make a difference. But before you hand over the cash, you need to plan ahead to avoid tax complications down the road.

Let’s say you decide to loan $5,000 to your daughter who’s been out of work for over a year and is having difficulty keeping up with the mortgage payments on her condo. While you may be tempted to charge an interest rate of zero percent, you should resist the temptation. Here’s why.

When you make an interest-free loan to someone, you will be subject to “below market interest rules”. IRS rules state that you need to calculate imaginary interest payments from the borrower. These imaginary interest payments are then payable to you and you will need to pay taxes on these interest payments when you file a tax return. Further, if the imaginary interest payments exceed $13,000 for the year, there may be adverse gift and estate tax consequences.

Exception: The IRS lets you ignore the rules for small loans ($10,000 or less), as long as the aggregate loan amounts to a single borrower are less than $10,000 and the borrower doesn’t use the loan proceeds to buy or carry income-producing assets.

In addition, if you don’t charge any interest, or charge interest that is below market rate (more on this below), then the IRS might consider your loan a gift, especially if there is no formal documentation (i.e. written agreement with payment schedule) and you go to make a nonbusiness bad debt deduction if the borrower defaults on the loan–or the IRS decides to audit you and decides your loan is really a gift.

Formal documentation generally refers to a written promissory note that includes the interest rate, a repayment schedule showing dates and amounts for all principal and interest, and security or collateral for the loan, such as a residence (see below). Make sure that all parties sign the note so that it’s legally binding.

As long as you charge an interest rate that is at least equal to the applicable federal rate (AFR) approved by the Internal Revenue Service, you can avoid tax complications and unfavorable tax consequences.

AFRs for term loans, that is, loans with a defined repayment schedule, are updated monthly by the IRS and published in the IRS Bulletin. AFRs are based on the bond market, which change frequently. For term loans, use the AFR published in the same month that you make the loan. The AFR is a fixed rate for the duration of the loan.

Any interest income that you make from the term loan is included on your Form 1040. In general, the borrower, in this case your daughter cannot deduct interest paid, but there is one exception: if the loan is secured by her home, then the interest can be deducted as qualified residence interest–as long as the promissory note for the loan was secured by the residence.

If you have questions about the tax implications of loaning a family member money, don’t hesitate to call us. We’re here to help.

Asset Protection Tax

Tax Relief for Those Affected By Natural Disasters

With hurricanes, tornadoes, floods, wildfires, and other natural disasters affecting so many people throughout the US this year, many have been left wondering how they’re going to pay for the cleanup or when their businesses will be able to reopen. The good news is that there is some relief for tax payers–but only if you meet certain conditions.

Recovery efforts after natural disasters can be costly. For instance, when Hurricane Irene struck last year causing widespread flooding, many homeowners were not covered because most standard insurance policies do not cover flood damage.

Tax Relief for Homeowners

Fortunately, personal casualty losses are deductible on your tax return as long as the property is located in a federally declared disaster zone AND these four conditions are met:

1. The loss was caused by a sudden, unexplained, or unusual event. 
Natural disasters such as flooding, hurricanes, tornadoes, and wildfires all qualify as sudden, unexplained, or unusual events.

2. The damages were not covered by insurance.
You can only claim a deduction for casualty losses that are not covered or reimbursed by your insurance company. The catch here is that if you submit a claim to your insurance company late in the year, your claim could still be pending come tax time. If that happens you can file an extension on your taxes. Call us if you need help filing an extension or have any questions about what losses you can deduct.

3. Your losses were sufficient to overcome reductions required by the IRS.
The IRS requires several “reductions” in order to claim casualty losses on your tax forms. The first is that effective December 31, 2009 you must subtract $100 from the total loss amount. This is referred to as the $100 loss limit.

Second, you must reduce the amount by 10 percent of your adjusted gross income (AGI) or adjusted gross income. For example, if your AGI is $25,000 and your insurance company paid for all of the losses you incurred as a result of flooding except $3,100 you would first subtract $100 and then reduce that amount by $2500. The amount you could deduct as a loss would be $500.

4. You must itemize.
As it now stands, you must itemize your taxes in order to claim the deduction. If you normally don’t itemize, but have a large casualty loss you can calculate your taxes both ways to figure out which one gives you the lowest tax bill. Contact us if you need assistance figuring out which method is best for your circumstances.

Tax Relief for Individuals and Business Owners

The IRS often provides tax relief for those affected by natural disasters. For example, individuals and businesses affected by Hurricane Isaac with tax filing and payment deadlines that occurred on or after August 26, 2012 have until January 11, 2013 to file their returns and pay any taxes due. This includes corporations and businesses that previously obtained an extension until September 17, 2012, to file their 2011 returns and individuals and businesses that received a similar extension until October 15. It also includes the estimated tax payment for the third quarter of 2012, normally due September 17. If you’ve been affected by a natural disaster, please call our office. We’ll help you figure out when your tax payments are due.

Tax Relief Tips

The IRS also states that you have two options when it comes to deducting casualty losses on your tax returns. You can deduct the losses in the year in which they occurred or claim them for the prior year’s return. So if you were affected by a natural disaster this year you can claim your losses on your 2012 tax return or amend your 2011 tax return and deduct your losses. If you choose to deduct losses on your 2011 tax return, then you have one year from the date the tax return was due to file it.

Confused about whether you qualify for tax relief after a recent natural disaster? Give us a call. We’ll help you figure out the best way to handle casualty losses related to hurricanes and other natural disasters.

Tax

Tax Due Dates for October 2012

Note: September due dates were extended to January 2013 for areas impacted by Hurricane Isaac. See article “Tax Relief for Those Affected By Natural Disasters” in this newsletter.

October 10 Employees who work for tips – If you received $20 or more in tips during September, report them to your employer. You can use Form 4070.
October 15 Individuals – If you have an automatic 6-month extension to file your income tax return for 2011, file Form 1040, 1040A, or 1040EZ and pay any tax, interest, and penalties due.

Electing Large Partnerships – File a 2011 calendar-year return (Form 1065-B). This due date applies only if you were given an additional 6-month extension. See March 15 for the due date for furnishing the Schedules K-1 to the partners.

Employers (nonpayroll withholding) – If the monthly deposit rule applies, deposit the tax for payments in September.

Employers (Social Security, Medicare, and withheld income tax) – If the monthly deposit rule applies, deposit the tax for payments in September.
October 31 Employers – Social Security, Medicare, and withheld income tax. File form 941 for the third quarter of 2012. Deposit any undeposited tax. (If your tax liability is less than $2,500, you can pay it in full with a timely filed return.) If you deposited the tax for the quarter in full and on time, you have until November 13 to file the return.

Certain Small Employers – Deposit any undeposited tax if your tax liability is $2,500 or more for 2012 but less than $2,500 for the third quarter.

Employers – Federal Unemployment Tax. Deposit the tax owed through September if more than $500.