How do I handle lending money to friends and family and what are the tax issues related to making those loans?

Ralph
00:00:00

Have you ever been caught in that awkward situation of a family member asking for money?

Ralph
00:00:05

The tension, the guilt, the fear of damaging relationships.

Ralph
00:00:09

It's enough to make anyone uncomfortable.

Ralph
00:00:12

But what if I told you there's a way to navigate this minefield with grace, wisdom, and financial savvy?

Ralph
00:00:18

Stay tuned as we dive into the tricky world of lending money to friends and family and uncover the tax implication you need to know.

Ralph
00:00:25

Today on the Ask Ralph show, we're answering the question, how do I handle lending money to friends and family?

Ralph
00:00:31

And what are the tax issues related to making those loans?

Askgrow Makeshi
00:00:34

Welcome to the Ask Ralph podcast, where listening to an experienced financial professional with over 30 years of experience can help you make sense of confusing questions, current headlines and industry trends about taxes, small business, financial decision making, investment strategies, and even the art of proper budgeting.

Askgrow Makeshi
00:00:54

Askgrow Makeshi the complex simple by sharing his real world knowledge from a christian perspective with all things financial.

Askgrow Makeshi
00:01:01

Now here's your host, Ralph estep Junior.

Ralph
00:01:04

Well, if you missed yesterday's show, we explored seven ways your bank can help you stick to your budget.

Ralph
00:01:08

So if you miss it, I want you to go back and listen because I shared some really game changing strategies that could really revolutionize your budgeting process.

Ralph
00:01:16

Remember, all of our previous episodes are right there.

Ralph
00:01:19

You can catch up at any time.

Ralph
00:01:21

Well, now lets dive into todays topic with a message from one of our listeners.

Ralph
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This one actually comes from Alex.

Ralph
00:01:25

And Alex writes this dear Ralph, Im in a tough spot.

Ralph
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My sister recently asked me for a $10,000 loan to help with her small business.

Ralph
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I want to help, but Im worried about the potential consequences.

Ralph
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What if she cant pay me back?

Ralph
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Will this affect our relationship?

Ralph
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And honestly, Im not even sure how to handle this from a tax perspective.

Ralph
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I feel lost and anxious about the whole situation.

Ralph
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Can you please help me navigate this?

Ralph
00:01:51

Alex?

Ralph
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This is one of the things I hear about all the time.

Ralph
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So I hear your concern.

Ralph
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I can sense it in the tone of what you wrote me.

Ralph
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And I want you to know you're not alone in this struggle.

Ralph
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A lot of us deal with this.

Ralph
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I've dealt with this in my own life, in my own family.

Ralph
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It's a dilemma.

Ralph
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And at some point in our lives, it's a situation that we're going to find ourselves in.

Ralph
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And here's the thing, it requires careful consideration because the truth is, this is both a financial and an emotional decision.

Ralph
00:02:17

So let's unpack this together.

Ralph
00:02:19

Let's find a path forward that aligns with our financial goals and our faith.

Ralph
00:02:23

Now remember, I want to remind you, at this point, the heart of the show is answering your questions.

Ralph
00:02:28

So if you've got a burning financial question or a situation you need guidance on, please send it in.

Ralph
00:02:33

You can go to justaskraph.com.

Ralph
00:02:35

because the truth is your questions.

Ralph
00:02:37

Those questions we get every day, they shape our show, and my goal is to help you navigate your financial journey.

Ralph
00:02:44

I was thinking about it.

Ralph
00:02:45

We got to consider Alex's situation.

Ralph
00:02:47

It reminded me of a powerful verse from the Bible that speaks directly to this issue, and it can provide us some guidance on how to approach these financial matters, especially when it comes to helping others.

Ralph
00:02:58

So let's go to the book of proverbs 22 seven, which says, the rich rule over the poor and the borrower is slave to the lender.

Ralph
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The truth is, this verse gives us profound insight into the nature of lending and borrowing.

Ralph
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See, it's not just about the money, it's about the power dynamic it creates.

Ralph
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As we dive into Alex's question, let's keep this wisdom in mind and explore how we can handle lending situations in a way that honors both our financial stewardship and our relationship.

Ralph
00:03:28

So Alex, that's my goal for today.

Ralph
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So here we go.

Ralph
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Let me start by sharing a story with you that I think a lot of people will relate to.

Ralph
00:03:36

I think it'll resonate with you.

Ralph
00:03:38

And it's about my client, Stephanie.

Ralph
00:03:40

And Stephanie's story I'm going to share with you.

Ralph
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It illustrates those potential pitfalls when you're lending money to family members.

Ralph
00:03:47

Now picture Stephanie.

Ralph
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She thought she was doing the right thing.

Ralph
00:03:50

Her brother came to her and asked for $20,000 for his business.

Ralph
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Now, the time was supposed to be a short term loan, as he said, just to help him through a rough patch.

Ralph
00:03:59

Stephanie was smart.

Ralph
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She drew up a simple agreement.

Ralph
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She thought this would be enough to protect her relationship, but more importantly, protect her investment.

Ralph
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Because again, were balancing finances and emotion.

Ralph
00:04:10

And she told me at first, Rob, everything seemed fine.

Ralph
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Her brother made the first few payments on time.

Ralph
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He was a great borrower.

Ralph
00:04:17

But then the payments started coming late.

Ralph
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Stephanie would say to him, hey dude, when are you going to pay me?

Ralph
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And he would always have an excuse.

Ralph
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I'm short this week, I'm sure this week.

Ralph
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And then all of a sudden, they stopped coming all together.

Ralph
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Now, Stephanie tried to be understanding.

Ralph
00:04:32

She tried to say to him, look, I get it.

Ralph
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Let's catch back up next week or let's catch back up in two weeks.

Ralph
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But then all of a sudden, the months went by and without any money coming in, she began to worry.

Ralph
00:04:44

She tried again.

Ralph
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She tried reaching out to her brother.

Ralph
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She tried to call him, have that face to face meetings.

Ralph
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And what she noticed is he became really defensive.

Ralph
00:04:52

And all of a sudden, he came out with this accusation.

Ralph
00:04:55

He said to her, I don't think you believe in me.

Ralph
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You're not supporting my dream.

Ralph
00:04:59

And the sad part of it was, she told me, they were once super close.

Ralph
00:05:03

And with this situation, they just began to argue and fuss and fight and more and more.

Ralph
00:05:09

And Stephanie tells me, Ralph, finally I get to the point where I had no other choice.

Ralph
00:05:14

She said, I needed this money.

Ralph
00:05:16

So she took her brother to court.

Ralph
00:05:17

And I know what all you thinking, ouch, that's brutal.

Ralph
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When you're taking a family member to court, that is brutal.

Ralph
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We've reached Defcon five.

Ralph
00:05:25

And the truth is, the legal battle was long and expensive.

Ralph
00:05:29

But more than that, it tore her family apart.

Ralph
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Her parents, her siblings, each of them took their sides.

Ralph
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One said, stephen, I can't believe you're taking your brother to court.

Ralph
00:05:40

And with that, these family gatherings became tense affairs.

Ralph
00:05:44

And the truth is, Stephanie wouldn't come or her brother wouldn't come.

Ralph
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And when they did show up at the same place, because they had to, they completely avoided each other.

Ralph
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Now, listen, in the end, Stephanie says, hey, ralph, I went to court.

Ralph
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I want the case.

Ralph
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I had the documents.

Ralph
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I could prove that he wasn't paying me.

Ralph
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So she won her case.

Ralph
00:06:01

But when she looked back at it, she said, ralph, this is a hollow victory, because not soon after, the judge stamped the paper that said that her brother needed to pay her, her brother went and declared bankruptcy.

Ralph
00:06:13

And guess what?

Ralph
00:06:14

She never saw a dime of the money she lent him.

Ralph
00:06:18

And she said, ralph, you think that was bad enough?

Ralph
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But the real cost, she told me, was the destruction of her relationship with her brother and the division it caused in her family.

Ralph
00:06:28

There were really two camps because of this situation.

Ralph
00:06:32

Stephanie's story is a powerful reminder of the risk involved in lending money to family and friends.

Ralph
00:06:38

It's not just about the financial risk, as I've said, it's about the emotional and the relational risks as well.

Ralph
00:06:45

So you might ask, Ralph, what can we learn from Stephanie's experience?

Ralph
00:06:48

How can we navigate these tricky waters?

Ralph
00:06:51

First, let's address the question of whether to lender give in the first place.

Ralph
00:06:56

And this is a question I've had to face in my own life, and I'm sure people listen.

Ralph
00:07:00

You're listening to this right now.

Ralph
00:07:01

I bet you have to.

Ralph
00:07:03

And I'm going to say this.

Ralph
00:07:04

In many cases, especially with family, it might be better.

Ralph
00:07:06

Consider any money you provide as a gift rather than a loan, because here's the way I look at it.

Ralph
00:07:11

If you can afford to give the money without expectation of repayment, you remove that potential for resentment.

Ralph
00:07:17

You remove that potential for damaged relationships that can come with those unpaid loans.

Ralph
00:07:23

If you feel you've got to value the relationship over the money first, then you might want to just consider it a gift.

Ralph
00:07:30

And you've also got to take this mindset.

Ralph
00:07:32

You've got to be willing and able to completely lose the money.

Ralph
00:07:35

That's just a fact.

Ralph
00:07:37

And if you do decide to give a gift, it's important to understand the tax implications that I'm not going to spend a lot of time talking about that, but I want to take a minute here.

Ralph
00:07:44

So as of 2024, you can give up to $18,000 per person per year without having to report it to the IR's.

Ralph
00:07:52

Now, there's also this thing known as the annual gift tax exclusion.

Ralph
00:07:56

So anything above this amount needs to be reported on the gift tax return.

Ralph
00:08:00

But the truth is you likely won't owe any tax unless you've exceeded your lifetime gifts tax exemption, which is currently like $13 million.

Ralph
00:08:07

Now I did a show about gift taxes on May 2 of 2024, and I'll put a link to it in the show notes.

Ralph
00:08:12

You can also find it@askgroudpodcast.com explanation of gift taxes so I encourage you to go check it out.

Ralph
00:08:20

Now, let's say you decide that a loan is the best option.

Ralph
00:08:22

You don't want to take my advice.

Ralph
00:08:23

You don't want to do that gift thing, but you really want to do a loan.

Ralph
00:08:27

Here are some steps you can use to formalize and protect itself.

Ralph
00:08:29

And the first thing I'm going to tell you to do, put everything in writing.

Ralph
00:08:34

Create that promissory note that outlines the loan amount you want to talk about.

Ralph
00:08:38

What is the interest rate?

Ralph
00:08:39

What are the repayment terms and any consequences for later missed payment.

Ralph
00:08:43

You've got to treat this as a business transaction, just like if you were going to a bank or a credit union or some other lending institution.

Ralph
00:08:51

Lay it out in writing in black and white.

Ralph
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Here's the amount you're borrowing, here's the interest rate, here's the repayment terms, and then talk about what happens if they don't pay.

Ralph
00:09:00

Second thing, I'm going to encourage you charge interest.

Ralph
00:09:04

The IR's requires that you charge a minimum interest rate on loans over $10,000 to avoid it being considered a gift.

Ralph
00:09:10

See, that's a thing.

Ralph
00:09:11

The IR's could say this is really a gift and then trigger that whole gift tax return, which I don't think is going to impact you.

Ralph
00:09:17

But they use this thing called the applicable federal rate, and that's a monthly rate set by the IR's.

Ralph
00:09:22

But I think you should charge interest anyway because your goal is to get them to repay you in a short period of time.

Ralph
00:09:28

Number three, as Stephanie learned, keep good records.

Ralph
00:09:32

You got to document all the payments received and keep copies of all loan related documents.

Ralph
00:09:36

Like I said, treat this like the business loan that it is, and make sure you have all the records in order with the expectation that this will result in a court case.

Ralph
00:09:44

So start off with it with the thought of, and I know this stinks with family, but it's a business decision.

Ralph
00:09:49

So start off with the expectation that you're going to have to prove this in court, because, again, this is a business decision at this point, not a personal decision.

Ralph
00:10:00

Another thing, I worked in lending for a long time.

Ralph
00:10:02

Number four, consider collateral.

Ralph
00:10:04

Listen, if it's a significant amount of money you're loaning, you might want to secure the loan with collateral, such as a car or property or some sort of collateral to protect yourself, because you've already decided you can't afford to gift the money.

Ralph
00:10:17

So now you've decided to loan it.

Ralph
00:10:19

You want to get paid.

Ralph
00:10:21

And number five, you got to do this as a tax thing.

Ralph
00:10:24

Again, be prepared to report the interest you receive as income on your tax return.

Ralph
00:10:28

So someone's paying you interest even on what we'll call a personal loan.

Ralph
00:10:31

You've got to report that on your tax return.

Ralph
00:10:33

And remember, even with all these precautions, lending money to family or friends carries risk.

Ralph
00:10:40

So it's crucial to go into with your eyes open.

Ralph
00:10:42

You got to understand it.

Ralph
00:10:43

You might not get that money back, but bigger than that, like Stephanie learned, that relationship could be strained or completely destroyed.

Ralph
00:10:51

It might bring out ugly in people.

Ralph
00:10:52

It might cause family rifts and all that kind of stuff.

Ralph
00:10:55

So let's take a few minutes to just recap the key points we covered today.

Ralph
00:10:58

Number one, as I said, this is Ralph's biggest takeaway.

Ralph
00:11:02

If you don't listen to anything else I said today, consider giving rather than lending.

Ralph
00:11:07

When it comes to family and friends, just give it to them.

Ralph
00:11:10

Now, it depends on the amount, obviously, and you don't want to become an enabler, but I think that's where you got to start.

Ralph
00:11:15

Second thing, understand the tax implications of gifts and loans.

Ralph
00:11:19

I put that link to my show where you can go find out about that.

Ralph
00:11:23

Number three, if you do lend money, I think I stress this a lot.

Ralph
00:11:27

Formalize that agreement and be prepared for potential consequences.

Ralph
00:11:31

Start off with the expectation this is going to land in front of a judge.

Ralph
00:11:35

I hate to say that, and that stinks.

Ralph
00:11:37

You're dealing with family and friends, but that's the truth.

Ralph
00:11:40

And number four, again, if you don't listen to anything else I've said, prioritize your relationship over that.

Ralph
00:11:46

Money.

Ralph
00:11:47

That's what it comes down to.

Ralph
00:11:48

Money goes away.

Ralph
00:11:49

But relationships are something you really want to focus in on.

Ralph
00:11:53

And I've seen this happen so many times with my clients, even with friends and family.

Ralph
00:11:58

Somebody approached them and said, can you help me out, Ralph?

Ralph
00:12:02

Can you help me?

Ralph
00:12:02

I got a saying, and you're probably gonna like this kind of harsh.

Ralph
00:12:06

I've had family members come up to me and say, hey, can I borrow some money?

Ralph
00:12:09

I said, look, I don't feed cats.

Ralph
00:12:11

A lot of people say, wow, that's harsh.

Ralph
00:12:13

But here's the truth.

Ralph
00:12:15

If somebody wants to come to me and say, ralph, I'm having a hard time, I'm struggling, you know what?

Ralph
00:12:19

I will go with them to the grocery store and get them some groceries.

Ralph
00:12:22

I'll go fill up their tank of gas.

Ralph
00:12:24

But I'm not going to sit there and continue to enable them, if they need to, find a way to fix this in their own lives.

Ralph
00:12:31

Because the truth is, if you just help them and help them and help them, and I think Stephanie learns with her brother.

Ralph
00:12:37

Honestly, I didn't know the brother, but I think he went into it with the intention that he's just going to get this money from his sister and never have to pay it back.

Ralph
00:12:45

That, that's pretty much what we talked about today.

Ralph
00:12:47

Now, tomorrow we're going to be talking about why states with no income tax aren't as affordable as they may seem.

Ralph
00:12:53

I have a lot of clients that approach me, say, Ralph, I'm going to move to such and such state because they have no state income tax.

Ralph
00:12:59

But when I looked at it, it's not that simple.

Ralph
00:13:01

A lot of people just think that's in a vacuum, like it's in a silo by itself.

Ralph
00:13:05

So I'm going to handle that on tomorrow's show.

Ralph
00:13:07

And you don't want to miss that.

Ralph
00:13:09

Now, maybe you're struggling with a situation like Alex's or Stephanie's.

Ralph
00:13:12

You're feeling the weight of financial decisions and you're worried about hate, how they can impact your relationships.

Ralph
00:13:18

Here's the first thing I'm going to tell you, don't go it alone.

Ralph
00:13:21

I'm here to help you navigate these complex waters.

Ralph
00:13:24

Maybe overall you're feeling overwhelmed by your financial situation.

Ralph
00:13:28

Maybe you just want to check and make sure you're on the right track.

Ralph
00:13:31

I deal with clients every day that just come in for a temperature check.

Ralph
00:13:34

They want to make sure they're doing the right things.

Ralph
00:13:37

I'd love to help you, and I can help you.

Ralph
00:13:39

When you go, schedule an appointment with me by going to ask raft.com.

Ralph
00:13:43

click on the banner that reads, book a call with Ralph and I will work with you.

Ralph
00:13:47

I will help you move from living paycheck to paycheck.

Ralph
00:13:50

Maybe you feel like you're moving three steps forward only to get shoved far back four steps back.

Ralph
00:13:55

They say, I will help you achieve financial freedom because my goal is to help you break free from the financial bondage.

Ralph
00:14:03

I want you to improve your personal finances.

Ralph
00:14:05

And maybe you're saying, Ralph, look, I'm good on the personal side, but my business is struggling.

Ralph
00:14:09

I need somebody to help me.

Ralph
00:14:11

I need a coach to help me get that business to the next level.

Ralph
00:14:14

Maybe it's organize your finances or grow your business.

Ralph
00:14:17

My overall goal is to help you achieve all of your financial goals.

Ralph
00:14:21

And I do that by creating a personalized plan just for you, not some cookie cutter approach of do this, do this.

Ralph
00:14:28

Here's my top three things.

Ralph
00:14:29

Those things are great, but you need to work with someone one on one to do that.

Ralph
00:14:35

So here's my takeaway from this.

Ralph
00:14:37

Don't let financial stress strain your relationships or hold you back from your dreams.

Ralph
00:14:41

Schedule today, and let's create a plan tailored just for you.

Ralph
00:14:45

And if we're not able to find a personalized plan for you, I will refund your money.

Ralph
00:14:50

Remember this, my passion is to help you achieve financial success.

Ralph
00:14:54

This is why I turn the microphone on.

Ralph
00:14:55

I turn the camera on.

Ralph
00:14:57

I plan out these episodes because I want you to live out your dreams.

Ralph
00:15:00

And more importantly, I grow that faith that comes alongside of this.

Ralph
00:15:04

It's not just finances.

Ralph
00:15:06

It's not just faith.

Ralph
00:15:07

It's when those two things come together.

Ralph
00:15:09

And I know working together, we can master your finances from a christian perspective.

Ralph
00:15:14

So, as always on this show, stay financially savvy and may God bless.