Do I have to declare interest my brother paid me on a long over due debt?

[marlm]

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

I loaned my brother my share of my inheritance from my parents in 1997 ($1,000,000) since I didn't need use of the money at the time. As it turns out, this 5 year loan turned into 17 years (2014). The original handwritten note included 4% compounded annual interest. I knew eventually I would get the money back and now that I'm retired, we do want it for travel, grandkids etc. The compounded interest above on the original principle amount is almost $1,000,000. !! Yikes, if I hold him to the terms of the original note, is all this interest going to be taxed on this as ordinary income, long term capital gains...what ??? my husband and I have low income, social security checks only. Will I have to pay taxes to both the IRS and the state of California. What if I forgive most of the interest ??

 

[Ohiogal]

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

I loaned my brother my share of my inheritance from my parents in 1997 ($1,000,000) since I didn't need use of the money at the time. As it turns out, this 5 year loan turned into 17 years (2014). The original handwritten note included 4% compounded annual interest. I knew eventually I would get the money back and now that I'm retired, we do want it for travel, grandkids etc. The compounded interest above on the original principle amount is almost $1,000,000. !! Yikes, if I hold him to the terms of the original note, is all this interest going to be taxed on this as ordinary income, long term capital gains...what ??? my husband and I have low income, social security checks only. Will I have to pay taxes to both the IRS and the state of California. What if I forgive most of the interest ??

You have a contract. Guess what? You have income. 1M is NOT low income. You should have been claiming the interest EVERY year it was paid.

 

[marlm]

You have a contract. Guess what? You have income. 1M is NOT low income. You should have been claiming the interest EVERY year it was paid.

Thank you Ohiogal,
But I never received any interest payments during this time. What was I suppose to be declaring? I never declared the inheritance in 1997 since it went directly to my brother (with my approval), as if it never happened. Is the original principle taxed as inheritance or ?

 

[Ohiogal]

Thank you Ohiogal,
But I never received any interest payments during this time. What was I suppose to be declaring? I never declared the inheritance in 1997 since it went directly to my brother (with my approval), as if it never happened. Is the original principle taxed as inheritance or ?

Did you disclaim the inheritance? Did you have a loan agreement in writing?

 

[davew128]

Did you disclaim the inheritance? Did you have a loan agreement in writing?

You're missing a lot of posted items here. This is an interfamily loan with written loan terms. Apparently brother hasn't been making payments. Disclaiming the inheritance at the time would have required a specific written acknowledgment, clearly that is not the case with a loan showing compound interest and payment terms.

OP, since you have a bona fide loan with acceptable market terms, you report interest income AS interest income when you RECEIVE the interest income. If you decide to forgive the loan, you need to either issue a 1099-C to your brother or decide if you made a gift in the current amount of the loan.

 

[Ohiogal]

You're missing a lot of posted items here. This is an interfamily loan with written loan terms. Apparently brother hasn't been making payments. Disclaiming the inheritance at the time would have required a specific written acknowledgment, clearly that is not the case with a loan showing compound interest and payment terms.

OP, since you have a bona fide loan with acceptable market terms, you report interest income AS interest income when you RECEIVE the interest income. If you decide to forgive the loan, you need to either issue a 1099-C to your brother or decide if you made a gift in the current amount of the loan.

Yes I did miss that. And I appreciate you pointing that out to me. Thank you.

 

[marlm]

Yes I did miss that. And I appreciate you pointing that out to me. Thank you.

Thanks to all. One final question please...should I decide to amend the note and take less interest or should I keep the note as originally written, either way...is this interest earned treated as a long term investment with long term capital gains or is it treated as ordinary income? This may make a difference in my decision.

 

[FlyingRon]

Rewriting it doesn't really have any bearing on you. Any money you take in over and above what you lent him is interest no matter how you slice it. Interest isn't a capital gain, it figures in on your schedule B and ends up as ordinary income. You were obliged to report it and pay taxes on it as you received it.

 

[Zigner]

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

I loaned my brother my share of my inheritance from my parents in 1997 ($1,000,000) since I didn't need use of the money at the time. As it turns out, this 5 year loan turned into 17 years (2014). The original handwritten note included 4% compounded annual interest. I knew eventually I would get the money back and now that I'm retired, we do want it for travel, grandkids etc. The compounded interest above on the original principle amount is almost $1,000,000. !! Yikes, if I hold him to the terms of the original note, is all this interest going to be taxed on this as ordinary income, long term capital gains...what ??? my husband and I have low income, social security checks only. Will I have to pay taxes to both the IRS and the state of California. What if I forgive most of the interest ??

Has your brother actually made any payments?

 

[marlm]

Has your brother actually made any payments?

No, not yet. He's finally in a position to repay me after refinancing an apartment building.

 

[Zigner]

Does your brother know that the statute of limitations has long-since expired on this contract and that you have no legal means by which to force him to pay?

 

[marlm]

Does your brother know that the statute of limitations has long-since expired on this contract and that you have no legal means by which to force him to pay?

I haven't received any repayment yet. I am not aware whether he knows this or not; maybe ? as he has a law degree (nothing to do with taxation). This isn't a concern to me as we've always had a close, honest sibling relationship. In fact he was the one informing me of his ability to finally repay me.

I'm thinking that perhaps he can make the annual tax free "gift" allowance (I think it's approximately $14,000 per person per year) to our adult children, grandchildren, charities of our choice to lessen my tax burden. Maybe this could be an option. Working within legal limits, I would sure like to lessen my tax burden (Duh).

 

[tranquility]

Thank you Ohiogal,
But I never received any interest payments during this time. What was I suppose to be declaring? I never declared the inheritance in 1997 since it went directly to my brother (with my approval), as if it never happened. Is the original principle taxed as inheritance or ?

Google "imputed interest". Not only do you need to report interest every year for the money lent to your brother, you have to do it at federal applicable rates. The IRS will impute the income to you if you did not receive it and increase the amount you do receive to reach the AFR. On a million dollars, that is going to be a large amount each year. (Although with the low interest rates from the fed of late, it might be around your 4% for the latter years.) That you did not collect it either means you made a gift (Did you report the gift?) or should be added back into the principal and would increase the amount to be repaid and the interest owed. While the normal SOL on auditing returns is 3 years, this substantial under-reporting of your income will probably extend the statute to 6 years.

You desperately need to see a tax professional. In this case, I think you need to see a tax attorney as the amounts are getting up to the range where the IRS may consider more than mere interest and penalties (although those will be huge) on the amount. This may rise to criminal levels.

 

[Zigner]

Google "imputed interest". Not only do you need to report interest every year for the money lent to your brother, you have to do it at federal applicable rates. The IRS will impute the income to you if you did not receive it and increase the amount you do receive to reach the AFR. On a million dollars, that is going to be a large amount each year. (Although with the low interest rates from the fed of late, it might be around your 4% for the latter years.) That you did not collect it either means you made a gift (Did you report the gift?) or should be added back into the principal and would increase the amount to be repaid and the interest owed. While the normal SOL on auditing returns is 3 years, this substantial under-reporting of your income will probably extend the statute to 6 years.

You desperately need to see a tax professional. In this case, I think you need to see a tax attorney as the amounts are getting up to the range where the IRS may consider more than mere interest and penalties (although those will be huge) on the amount. This may rise to criminal levels.

Tranq -

This is complicated by the fact that this was an inheritance that never passed to the OP. The brother simply got a larger inheritance from his parents. This may need to be considered a straight-forward gift of the $1 million and the "interest" when the brother pays.

ETA: I agree that the OP needs to speak to pros on this.

 

[marlm]

Boy are you right...I need a professional to help me out of this mess. The last thing I could have ever considered it that this could elevate to criminal levels. Geez, I haven't even had a traffic ticket in 30 years.

Again, I really appreciate your responses.