Papering a note to a family member so it survives review.
A loan between a trust and a beneficiary is the transaction most likely to be recharacterized later as a gift, a distribution, or a breach of duty. What prevents that is ordinary documentation, done at the time. This guide covers whether the trust may lend at all, what the note has to say, why the interest rate is not a free choice, and how the note ends.
The guide follows the transaction as it actually happens rather than as it is filed. Each section names what has to be true before the next one starts.
One section, unedited, so you can see what you are getting before you type an address. The other 9 sections read like this one.
An intra-family loan at no interest, or at a token rate, is the most common way one of these becomes a tax problem. US tax law treats a below-market loan between related parties as though the forgone interest had been paid anyway: imputed to the lender as income, and treated as a gift to the borrower. The rules live in Internal Revenue Code sections 7872 and 1274, and there are exceptions that turn on the size of the loan and how the borrower uses it.
The floor is the applicable federal rate, published monthly by the IRS, in short, mid, and long term tiers by loan duration. Which tier applies, which month’s table governs, and whether any exception helps you are questions for your accountant and your counsel. Get the answer before the note is signed, because the rate is written into the document.
If the note charges interest, the interest is generally income to the trust, and the trust generally reports it. A note that is documented perfectly and then never appears on a return is only half papered.
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