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  1. #1
    jk527 is offline Junior Member
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    Demand Loan - Gift & Income tax implications

    What is the name of your state (only U.S. law)? California

    If one enters into a personal loan with someone and draws up a demand loan agreement (with AFR interest), could the lender reduce the amount owed by $10,000 in any given year without any gift and/or income tax consequences? Or would such a gift subject the lender to income tax consequences in the year the $10k gift was given?
  2. #2
    davew128 is offline Senior Member
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    Quote Originally Posted by jk527 View Post
    What is the name of your state (only U.S. law)? California

    If one enters into a personal loan with someone and draws up a demand loan agreement (with AFR interest), could the lender reduce the amount owed by $10,000 in any given year without any gift and/or income tax consequences? Or would such a gift subject the lender to income tax consequences in the year the $10k gift was given?
    Gift tax? Yes. Income tax? No.
  3. #3
    tranquility is offline Senior Member
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    It could depend on the relationship between the parties and the agreement at the time of the "loan" and the purpose for the loan. Who is everyone and what is happening?
  4. #4
    LdiJ is offline Senior Member
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    Quote Originally Posted by jk527 View Post
    What is the name of your state (only U.S. law)? California

    If one enters into a personal loan with someone and draws up a demand loan agreement (with AFR interest), could the lender reduce the amount owed by $10,000 in any given year without any gift and/or income tax consequences? Or would such a gift subject the lender to income tax consequences in the year the $10k gift was given?
    If this is a personal situation, between friends or family members, then yes, up to 13k (10k was the figure quite a few years ago) of a personal loan could be forgiven annually, without triggering any gift or income tax issues for either party.

    However since you did not give any details of the transactions there may be something in there that would change that advice.
  5. #5
    jk527 is offline Junior Member
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    Demand Loan - Gift & Income tax implications clarification

    To help clarify my original question....

    The two parties are unrelated friends and the borrower would use the money to pay a tax bill. For discussion purposes, lets say that the demand loan is for $150k plus interest accrued annually (calculated using the blended annual AFR).

    So, it seems clear to me that any gift from the Lender to the Borrower that is less than the annual gift limit (currently $13k) would prevent the Lender from paying gift taxes, but it is unclear to me whether the Lender must pay income taxes (i.e., Is the $13k gift equivalent to the Lender writing a check to the Borrower for $13k, and Borrower making a $13k prepayment to the Lender?) Does the answer depend upon how the Note describes how prepayments are applied (i.e., first applied to interest and then to principal)? Can the Note state that prepayments are first applied to the principal and then to interest?
  6. #6
    Zigner is offline Senior Member
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    It is not taxable "income" to the borrower.
  7. #7
    LdiJ is offline Senior Member
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    Quote Originally Posted by jk527 View Post
    To help clarify my original question....

    The two parties are unrelated friends and the borrower would use the money to pay a tax bill. For discussion purposes, lets say that the demand loan is for $150k plus interest accrued annually (calculated using the blended annual AFR).

    So, it seems clear to me that any gift from the Lender to the Borrower that is less than the annual gift limit (currently $13k) would prevent the Lender from paying gift taxes, but it is unclear to me whether the Lender must pay income taxes (i.e., Is the $13k gift equivalent to the Lender writing a check to the Borrower for $13k, and Borrower making a $13k prepayment to the Lender?) Does the answer depend upon how the Note describes how prepayments are applied (i.e., first applied to interest and then to principal)? Can the Note state that prepayments are first applied to the principal and then to interest?
    Ok, lets break it down....

    Any gift that anyone gives anyone is made from after tax income.

    The only thing taxable to a lender, in any loan transaction is the interest the borrower pays on the loan. So, if the lender forgives interest owed, its still going to be taxable income to the lender.

    Only the giver of a gift is ever subject to gift tax, and again, as long as any annual gifts to one single party are under 13k, that's irrelevant.

    Loan proceeds are never taxable, and gifts to the receiver are never taxable.

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