At one time or another, the request to borrow money has been made to many parents and grandparents by their adult children, grandchildren and other loved ones. However, in most instances parents and grandparents give to their families without properly documenting the transaction and its terms. Unfortunately, the lack of proper documentation may create unintended consequences and complexities, especially if long term care services and Medicaid are later needed.
Once the decision has been made to lend money to a loved one, the next step is to properly document the transfer as a loan. This will necessitate the execution of a promissory note or other loan agreement evidencing the amount loaned and repayment terms with interest. It may be advisable to consult with an accountant about the interest imputed by the IRS on intra family loans.
From an estate tax perspective, it is important to remember that, upon the death of the person making the loan, the principal balance due and accrued interest on the promissory note, mortgage or loan will be an asset includible in his or her estate for estate tax purposes. Additionally, the balance due to the estate on the loaned amount could be a probate asset against which Medicaid may have a lien or claim.
However, if the loan is not properly documented the issue that will arise is whether the transfer is a gift. Gifts in excess of the personal exclusion amount ($14,000 per person per year) will reduce an individual's $5.45 million federal estate and gift tax credit for 2016. While for the overwhelming majority of parents and grandparents the reduction of their federal gift and estate tax credits is of little or no consequence, for some, depending on the amount gifted and the size of their taxable estates, gifting beyond the exclusion amount could have an estate/gift tax impact. Additionally, those potentially affected should keep in mind the New York estate tax credit of $4,187,500 per person, effective April 1, 2016 to March 31, 2017.
The most significant unintended consequence to gifting assets is the effect it can have on Medicaid nursing home eligibility. Unless a promissory note or some other loan agreement was executed at the time of the transfer which evidences that the transfer was a loan, Medicaid will take the position that the transfer was an "uncompensated transfer." This creates a five-year look back period and a period of ineligibility for nursing home Medicaid. The onus falls upon the parent and/or grandparent to establish that the transfer was made exclusively for a purpose other than to qualify for Medicaid.
The gifting of assets also creates complexities for parents and grandparents who have more than one child or grandchild. If one child has been the beneficiary of a large gift, the question often becomes what can be done to equalize the amount gifted to or for the benefit of other children and grandchildren. Obviously, the gifting of an equivalent amount is the first option, but not necessarily the best option depending on finances and lifestyle. The next alternative would be to modify the estate plan (wills/trusts) to give the other children and/or grandchildren an amount equal to that received by the recipient of the gift. Again, this is often not addressed at the time of the gift, and, if it is addressed at all, occurs years after the gift was made.
To paraphrase what a wise person once stated, "no good deed goes unpunished." That may very well be the case if parents and grandparents don't fully review and understand the consequences of their decisions before making gifts or loans to their loved ones and/or friends.