Before writing any checks, it pays to know a little tax law, especially if you’re not planning on charging interest. Small loans under $14,000 over the course of a year probably won’t be on the IRS’ radar, but you could wind up paying taxes on interest-free payouts above that amount. One way to sidestep gift tax is by charging interest on family loans, says Beth Kobliner, author of Make Your Kid a Money Genius (Even If You’re Not).
“The IRS sets a minimum interest rate—the applicable federal rate (AFR)—that family members and friends are required to charge on certain types of loans,” she says. “…if you’re lending more than $14,000, you may be expected to charge interest.”
Applicable federal rates vary depending on the length of the payment period, but the federal government generally keeps the rates significantly lower than what banks and lending institutions charge. You can find the most current rate at Irs.gov.
One exception is if you’re lending money for education or medical expenses. Education and medical expenses that are paid directly to an institution are exempt from yearly gift tax limits. If you’d like to make a no-interest loan to relatives to pay tuition or hospital bills, you can avoid gift tax by cutting the check directly to the school or institution.