Good Life

Money Matters | Loan, gift designations bring separate inheritance rules

Q: My father made gifts/loans to his children during his lifetime. Dad wants to have the gifts/loans paid back when he dies or have them count against a child’s share of his estate. What type of problems are there with this arrangement?

A: It is not uncommon for parents to make gifts/loans to their children during the parent’s lifetime. The parent often forgives the loan in his will or makes a statement that the gift/loan is to be deducted from the child’s share upon the parent’s death.

The first step is to determine whether the transfer of value is a gift or a loan. The parent must decide if the parent wants the loan repaid or if it is simply a true gift.

If it is a loan, there should be a note of some kind with interest indicated on the loan document. If it is a loan, the parent should keep a good record of payments being made and the balance. If it is a loan, upon the parent’s death, the will may state that the balance of the loan is forgiven or that the loan balance is to be deducted from any share the debtor child still owes to the parent at the time of death. In either case, the loan is included as an asset of the deceased parent’s estate and is taxable as an asset of the parent’s estate for Pennsylvania inheritance tax purposes.

Whether the item is a gift or a loan, such information should probably be shared with other children within the family to make sure all of the children are on the same page as to parent’s transfer of assets during their lifetime. It is much better that everyone knows the whole story before the parent dies. Once the parent dies, there is no one to say what the exact situation in terms of the loan/gift is, except the child who may have received the gift/loan. The child who receives the gift/loan has a self interest in making the gift/loan go away and not count against him or her.

It is important in the will to state what the loan or gift was with some specificity. If the item can be identified by date or value, that is helpful. It is even better if the item is a loan to have a note that can be referred to by the parties. Sloppiness in this area can cause consternation among the children after the parent’s death. Making the situation better among the children is to have equal gifts/loans being made to each of the children, with full knowledge of all the children as to all of the gifts. Everyone then knows that each of them is being treated fairly and equally and no sibling is receiving too much.

It is also helpful if the parent is keeping a record of the loans made to a child, and in particular if it is substantial to one child, that the record be shared with someone other than the parent. The idea is to make at least two people aware of the loan balances so the loan paperwork does not “go missing” after the parent’s death and the debtor child then states that there is no loan at all. If there is no paperwork, there could not have been a loan.

Another factor to consider in the loan/gift scenario is that once a gift is made by a parent to a child, that gift value is no longer in the parent’s estate and is not taxable by the state. Pennsylvania does not tax gifts, but the federal government does. Under the new federal gift and estate tax rules, the gift tax only begins to apply if one makes $5 million dollars worth of gifts during one’s lifetime.