Q: I want to give my daughter and son-in-law a gift of $ 175,000. I know I can give $ 15,000 each without tax filing. I was advised to give $ 30,000 this year and get them to sign a $ 145,000 bill. I will then forgive $ 30,000 each year until the loan is paid off. It’s supposed to be a donation of $ 30,000 every year. Do you think this is an effective strategy?
A: It’s an old planning idea that’s common enough to acquire its own name: an installment donation. When challenged, it was generally unsuccessful.
The question is what was planned when the funds were first transferred. A loan is a transfer with an expectation of repayment. If the transferor of funds never intends to demand repayment, there is no loan.
Abraham Lincoln used to ask, how many legs does a dog have if you call its tail a leg? The correct answer: four. Just calling a tail a leg doesn’t make it that way. Remember Lincoln was a lawyer.
The tax law does not respect the names that people attach to things unless the substance of the thing matches the name. Just calling a money transfer a loan doesn’t make it that way.
It is certainly possible for someone to transfer money with an initial expectation of a refund and then change their mind later and not ask for a refund. The challenge is to determine the intention.
When a large loan requires annual payments under the gift tax exclusion and every payment is waived, it can be difficult to pretend there was a loan. The less discounts, the better the argument that a loan existed.
People have been successful when the loan has been made to buy real estate and the loan is secured by a note and a mortgage. The ability to enforce terms enhances the appearance of a loan.
Ultimately, you are the one who knows your intention best. If your actions may seem at odds with your intention, you should document your original intention and why it changed, at least to the best of your ability.
Q: Are there special tax rules for deducting salary paid to a family member? I have owned my own business, which is an S corporation, for 35 years. My 32 year old son is very talented, has an MBA and earns $ 130,000 working for another company. I always wanted him to work for me and he resisted because he said he had to prove himself in the market. I’m trying to get him to come into my business so I can start to retire. We have been talking about this for a year and he says he would need a raise of $ 50,000 to change companies. I am willing to pay him $ 180,000, but I wonder if the IRS will claim that I am giving away part of his salary. How Does the IRS Determine What a Fair Wage Is?
A: There is no doubt that payments made to related parties are scrutinized more closely to determine the appropriate tax treatment. It’s not just for the salary.
Compensation paid to an employee is deductible if they are ordinary and necessary. The courts have held that there is an implicit requirement that remuneration be reasonable in order to be ordinary and necessary.
This problem is common in family businesses. You have a pretty strong position because your son has’ prove[d] himself ”worth $ 130,000 to a third-party employer.
With professional workers, it is common to require a higher salary to change jobs. I can’t say that $ 180,000 is reasonable for your son and neither is the IRS. The reasonable salary is never a single amount, but rather a range.
Your facts seem favorable. Your son is used to working for others at a high salary, and you seem to have negotiated over the past year to determine his “reservation” salary and what you are willing to pay.
Your question seems to imply that the same type of negotiations took place between you and your son that would have taken place between unrelated parties. So no guarantees, but you seem to be on a solid footing.
James R. Hamill is the Director of Tax Practice at Reynolds, Hix & Co. in Albuquerque. He can be reached at [email protected]