Intrafamily loans allow you to help loved ones out financially while potentially lowering gift and estate taxes. However, what about families who don’t have the cash on hand to make these loans? If they have a trust, are there any other options? Borrowing money from a trust is also an option, but a less common one. This tactic necessitates careful planning since the trustee must consider their fiduciary duty to the trust and its other beneficiaries. That is, in sanctioning and arranging such a loan.

Benefits of intrafamily loans

An intrafamily loan can be an excellent way to transfer considerable wealth, free of gift and estate tax. Why not just give something directly? Of course, a gift is preferable if your unused exemption is sufficient to cover it and you don’t want the money or the interest income. But a loan can be a tempting alternative if transfer taxes are a concern or you aren’t yet ready to part with the money.

For the IRS to approve an intrafamily loan, the interest rate typically must be at least the applicable federal rate for the month the loan is made. If not, the IRS might interpret the loan as a disguised distribution, leading to several unpleasant tax snags. Therefore, the loan should be viewed as an arm’s-length transaction overall and supported by a promissory note.

Trust loans vs. distributions

A trust beneficiary might be able to get a loan from the trust if an intrafamily loan is not an option. Why a beneficiary would choose to borrow from the trust rather than accept a payout may be a mystery to you. A loan may be a requirement or preference in many circumstances, including:

• The trust’s terms place conditions on distributions that aren’t currently satisfied
• The borrower seeks an amount that exceeds limits on distributions imposed by the trust (an income-only trust, for example)
• The trust has multiple beneficiaries, and the borrower seeks an amount that would be unfair to other beneficiaries if taken as a distribution
• A loan is preferable for tax planning purposes

Make sure to confirm the legality of trust lending. Numerous trust structures expressly permit loans.

Borrowing from a trust

There is a significant distinction between intrafamily loans and loans from trusts. The trustee is responsible for administering the trust impartially and responsibly. You can generally organize a loan to a family member out of your personal assets in any way you see fit. However, when evaluating a loan request, a trustee must act in the trust’s and all of its beneficiaries’ best interests. For instance, a trustee who authorizes a loan to a current beneficiary with a high risk of financial default is probably violating their fiduciary duty to the remainder beneficiaries.

Contact our RRBB accountants and advisors for further information.

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