While we all want to provide financial help to our loved ones—whether they are family or close friends—it is important to understand that how the money is classified will directly affect your estate planning. Accordingly, the intent behind the transfer of the money is key when determining if it will be considered a loan, gift, or advancement.
Understanding the Differences
Loan
If there is a mutual understanding that the money you gave to a loved one is to be paid back, this is considered a loan—whether the so-called loan was documented or not. If the money lent is not paid back before you pass away, the sum is still owed to your estate by the borrower. The loan becomes an asset of the estate. For this reason, it is key to ensure the proper documentation is drawn up so that both parties—the lender and the borrower—are aware that the transfer is a loan and will remain an outstanding obligation until it is paid in full.
Because there is a debt that is owed to you, there are a couple of ways you can handle it in your estate plan. First, you could decide that you will forgive the debt if it is still outstanding when you die. In order to do this, there needs to be specific language in your will or trust. Also, depending upon the amount to be forgiven, you may want to consult with your accountant or CPA to make sure that this will not bring about any undesirable consequences for either party. Alternatively, if you die while the debt is still outstanding, and the borrower is set to receive an inheritance from you, an arrangement can be made that his or her inheritance will be reduced by the amount of the loan. This will decrease the amount that the borrower will owe, and, depending upon the amount of the inheritance, may eliminate the debt.
In sum, if you are not expecting the loan to be paid back, the transfer of funds could be classified as a gift or an advancement depending upon what impact you would like the transfer to have on the individual’s inheritance.
Gift
If you transfer money to a loved one without the expectation of being paid back and without any additional considerations made with respect to your estate planning, it is deemed to be a gift. It is important to note, if the gift is for an amount over the annual exclusion, which is $15,000.00 in 2019, a gift tax return will need to be prepared and filed with the Internal Revenue Service. When deciding to make a gift to a loved one, it is important to consider what impact you would like it to have on your estate planning. If your estate planning goal is to make the same gifts to all of your beneficiaries, making a gift to one of them during your lifetime will upset this balance, because this one individual may ultimately receive more than the other beneficiaries.
Advancement
If you would like to give money to a beneficiary during your lifetime but you do not want it to disrupt the distribution scheme contained in your estate plan, you can consider the giving of the money to be an advancement. If the money transfer is classified as an advancement, then the person would in effect be receiving a portion of his or her inheritance ahead of time. In such a scenario, the beneficiary’s share of the estate will be reduced by the amount of the advancement when you pass away. In order for this to be properly carried out, however, there are particular provisions that must be contained in your estate planning documents. Additionally, accurate records must be kept regarding the transfer of funds, particularly if multiple advancements are made.
Estate Planning Help
If you are thinking about transferring money to a family member or friend, give us a call to schedule an appointment (Erica at 937-589-4144), so we can discuss how the transfer can or will affect your estate planning goals.