Loan to my wife was not reported in our tax returns. Is it violation? How to fix now?

[henrick5]

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

I gave $25,000 as loan to my wife on 0% interest. She paid it back over 4 years time (the last payment is in 2017), in installments (we both recently testified, in another mater, that this $25,000 was a loan but not gift. Therefore, we cannot claim this $25,000 as a gift).

Neither I nor my wife reported this loan in our tax returns (we have been always filing joint tax returns): I/We did not submit 1098 or 1099 forms ever on this $25,000 loan. Did I/we violate any law? If I/we violate, can I/we submit 1098 or 1099 forms now, for the last 3-4 years (along with any applicable penalties for late reporting) to IRS?

I read that IRC section 7872(f)(7) and it states that a husband and wife shall be treated as 1 person, but still I am confused on what I need to do about the forms 1098 or 1099?

Did I/we violate any IRS/tax law and if so how to fix it now?

 

[STEPHAN]

A loan is not income and therefore not a matter for taxes.

 

[Stephen1]

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

I gave $25,000 as loan to my wife on 0% interest. She paid it back over 4 years time (the last payment is in 2017), in installments (we both recently testified, in another mater, that this $25,000 was a loan but not gift. Therefore, we cannot claim this $25,000 as a gift).

Neither I nor my wife reported this loan in our tax returns (we have been always filing joint tax returns): I/We did not submit 1098 or 1099 forms ever on this $25,000 loan. Did I/we violate any law? If I/we violate, can I/we submit 1098 or 1099 forms now, for the last 3-4 years (along with any applicable penalties for late reporting) to IRS?

I read that IRC section 7872(f)(7) and it states that a husband and wife shall be treated as 1 person, but still I am confused on what I need to do about the forms 1098 or 1099?

Did I/we violate any IRS/tax law and if so how to fix it now?

On your tax returns you and your wife need to report INCOME. Loans are not income. Interest paid on that loan is income to the receiver of that interest income (but you received none). If you forgave the loan that would be income to your wife (but you didn't forgive the loan and she paid it off). So, no income = nothing to report on either tax form - yours or hers.

Remember when you bought your house and got a loan from a bank? Did the bank send you a 1098/1099 reporting the full amount of the loan to you for you to include as income on your tax form? No? That was correct. No such reporting. Your loan to your wife would be the same.

 

[Taxing Matters]

Did I/we violate any IRS/tax law and if so how to fix it now?

No, you did not violate the tax law. While below market interest loans can result in imputed interest under IRC 7872, a married couple are treated as one person under subsection (f)(7) which means the loan between you and your spouse is ignored for this purpose. Had the loan been between you and someone other than your spouse you may have had an issue.

 

[Taxing Matters]

On your tax returns you and your wife need to report INCOME. Loans are not income. Interest paid on that loan is income to the receiver of that interest income (but you received none). If you forgave the loan that would be income to your wife (but you didn't forgive the loan and she paid it off). So, no income = nothing to report on either tax form - yours or hers.

The problem the OP is addressing here is that the tax law imputes interest on significant below market interest loans. Thus, even if the loan states there is no interest charged under the tax law there may be imputed interest. A lot of taxpayers are not aware of the interest imputation rules.

 

[Stephen1]

The problem the OP is addressing here is that the tax law imputes interest on significant below market interest loans. Thus, even if the loan states there is no interest charged under the tax law there may be imputed interest. A lot of taxpayers are not aware of the interest imputation rules.

So as I understand this, the issue (and what may have needed to be reported) was never the loan but the imputed amount of the interest on that loan. I make this statement so others who read the thread may understand that they don't have to report loans but do have to report interest (either actual or imputed).

 

[henrick5]

I highly appreciate the insightful responses. This gave me a real relief. Just for confirmation purposes: Neither I nor my wife did not violate any IRS/IRC/tax law due to this $25,000 loan transactions and that we do not need to report this matter to IRS/IRC/tax agency in the future as well. Please let me know if I am incorrect.

Unfortunately, my issue is not yet over: I have two children.

(i). For one of my children, John, I gave $14,500 loan with 0% interest (we have loan agreement and we cannot say that it is a gift) for his college fee and car during early 2016. John paid part of that amount during 2016 without any interest. He paid me back the remaining money in 2017 without interest.

(ii). For my other child, Joshua, I gave $9,500 loan with 0% interest (we have loan agreement and we cannot say that it is a gift) for his college fee and for application fee for graduate schools, cell phone, etc. during 2016. Joshua did not pay any money back to me in 2016 but paid part of the loan in 2017 and is planning to pay the remaining amount in 2018.

We all (i.e., I, John, Joshua, and my wife) filed our joint tax returns (i.e., “married filing jointly&#8221 in April 2017 (and we all filed joint tax returns in all previous years as well). I and my wife claimed John and Joshua as our dependents in our tax returns that we filed in April 2017 (John is now 21 years and Joshua is now 23 years). We did not report any of these loan matters in our tax returns that we already filed in April 2017 (and we did not submit 1098 or 1099 forms as well). John and Joshua are ready to voluntarily pay me (or to IRS) any interest, if there are any legal issues (such as IRC 7872) otherwise.

Now my question is: Did any of us violate any IRC/IRS/tax law and if so how to fix it now? I am (or my children or wife) ready to pay any penalty if needed but need peace of mind as I am facing serious health issues.

I have no more tax issues.

 

[Taxing Matters]

I highly appreciate the insightful responses. This gave me a real relief. Just for confirmation purposes: Neither I nor my wife did not violate any IRS/IRC/tax law due to this $25,000 loan transactions and that we do not need to report this matter to IRS/IRC/tax agency in the future as well. Please let me know if I am incorrect.

Unfortunately, my issue is not yet over: I have two children.

(ii). For my other child, Joshua, I gave $9,500 loan with 0% interest (we have loan agreement and we cannot say that it is a gift) for his college fee and for application fee for graduate schools, cell phone, etc. during 2016. Joshua did not pay any money back to me in 2016 but paid part of the loan in 2017 and is planning to pay the remaining amount in 2018.

I’m starting with Joshua here because that’s the easier of the two. Under IRC § 7872(c)(2)(A) if the total of the below market loans between you and the other person amount to no more than $10,000 the imputed interest rules will not apply. So if your only below interest loan made by you and/or your wife (since the two of you are treated as one person for the imputation rules) to Joshua was this loan for $9,500 then the interest imputation rules will not apply and you have no income from the loan to report.

Now to the loan for John:

(i). For one of my children, John, I gave $14,500 loan with 0% interest (we have loan agreement and we cannot say that it is a gift) for his college fee and car during early 2016. John paid part of that amount during 2016 without any interest. He paid me back the remaining money in 2017 without interest.

This loan did exceed $10,000 and thus for at least 2016 you need to consider the interest imputation rules. If he paid off enough of the loan in 2016 to bring the balance under $10,000 then there won’t be any imputed interest in 2017. For 2016 (and in 2017 if the balance owed was more than $10,000 on any day in 2017) you have to determine what the imputed interest is. That amount of imputed interest is then treated as though you gave that amount of money to John as a gift on 12/31/16 and then that same day John transferred that amount back to you as a payment of interest.

Now, it gets a bit more complicated from here because of a special rule. The special rule is that for income tax purposes the amount of imputed interest John paid you is limited to John’s net investment interest for the year. So if his net investment interest was zero, then there is no imputed interest to include on your return. (Note that this limitation on the imputed interest does not apply if the total loans between you and the borrower exceed $100,000 or if the purpose of the loan was tax avoidance, neither of which seems applicable here). A second special rule says that if John’s net investment income does not exceed $1,000 then his net investment income for the purpose of the imputed interest rule is considered to be zero.

So, if John had $1,000 or less of net investment income then there is no imputed interest received by you and there is nothing you need to do with your 2016 return. If John had more than $1,000 of net investment income then you have imputed interest income from the loan and may need to amend your return to include it. That amount of imputed interest will be quite low, so it may make little, if any, difference in your tax. There would almost certainly be no penalty for this given the small amount of that would be involved.

Now, the net investment limitation rule I discussed above only applies for income tax. It does not apply for gift tax. Thus, you are considered to have made a gift to John on 12/31/16 in the amount of the imputed interest. If that gift along with all the other gifts you gave him during the year totaled more than $14,000 then you were required to file a federal gift tax return. Otherwise, the gift part of this is not an issue for you. Even if you have to file the gift tax return you still do not owe any actual gift tax unless you have given away well more than $5 million in taxable gifts over your lifetime.

Note that even if you had imputed interest income you were not required to issue any Forms 1098 or 1099.

So at worst you may need to amend your 2016 return to include a small bit of imputed interest income and might (if you gave anyone gifts totaling $14,000 or more during the year) file a gift tax return. This is not, however, something you should stress much over.

 

[Taxing Matters]

So as I understand this, the issue (and what may have needed to be reported) was never the loan but the imputed amount of the interest on that loan. I make this statement so others who read the thread may understand that they don't have to report loans but do have to report interest (either actual or imputed).

Correct. It is the interest income (imputed or actual) and potentially an imputed gift that may need to be reported.

 

[henrick5]

Thank you very much for your in-depth and valuable details.

I have no issues with Joshua and I will not report his loan matter to IRS/tax forever and I do not need to collect any interest from him (please correct me if I am incorrect).

I also understand the situation with John. I wish to amend my 2016 return to include that small bit of imputed interest income, to avoid any benefit of doubt. I will pay another small tax on imputed interest income during my 2017 tax returns as well.

If you could provide a link on the rule "Note that even if you had imputed interest income you were not required to issue any Forms 1098 or 1099." it would be great.

 

[henrick5]

Can Taxing Matters or someone provide a link on the rule "Note that even if you had imputed interest income you were not required to issue any Forms 1098 or 1099." ?

 

[PayrollHRGuy]

There are no generally rules on when a person or entity doesn't have to do things only when they do.

This link is an overview of when a person or entity does have to issue a 1099 or other information return.

https://www.irs.gov/businesses/small-businesses-self-employed/am-i-required-to-file-a-form-1099-or-other-information-return

 

[LdiJ]

Thank you very much for your in-depth and valuable details.

I have no issues with Joshua and I will not report his loan matter to IRS/tax forever and I do not need to collect any interest from him (please correct me if I am incorrect).

I also understand the situation with John. I wish to amend my 2016 return to include that small bit of imputed interest income, to avoid any benefit of doubt. I will pay another small tax on imputed interest income during my 2017 tax returns as well.

So you are saying that John had investment income that was greater than $1000.00? I highly doubt that. If he had enough investments to create more than $1000.00 in investment income, he would not have needed to borrow any money from you.

If you could provide a link on the rule "Note that even if you had imputed interest income you were not required to issue any Forms 1098 or 1099." it would be great.

Taxing matters is a tax attorney. Do you really need a tax attorney to PROVE to you that you do not have to issue a 1099 or 1098? I am a tax professional and I am going to tell you the same thing. However I will also tell you that I am not going take the time to go find the proof of something I know off the top of my head.

We are all volunteers here. Nobody pays us to provide advice.

 

[Taxing Matters]

If you could provide a link on the rule "Note that even if you had imputed interest income you were not required to issue any Forms 1098 or 1099." it would be great.

In general only businesses and nominee recipients (a person who received a 1099 for income actually paid to someone else) are required to issue Forms 1098 and 1099. Moreover, even if you were subject to reporting your situation would not be one that is reportable. You did not pay out any interest (you received it) you would not have to issue a Form 1099-INT and as you did not receive any payments of mortgage interest you would not have to file a Form 1098. There is no link I can give you that says expressly you are not required to do it; rather that is the result of working through the various rules that say who is required to file and determining none of those impose such a requirement here.

 

[henrick5]

Many thanks, appreciate.

This forum, specifically Tax sub-forum, is a valuable resource for people looking for advise!

Do I or John need to submit any other tax forms?