Let’s say you’ve decided to give money to your friend, or to someone in your family.
It’s taken you a while to come to the decision, but now that you’ve made it, you feel good about it. You’ve put together the money, all the paperwork seems to be in order, and you’re ready to move forward with letting that money change hands.
Then, suddenly, a thought crosses your mind:
Will I be taxed for this?
The short answer is “probably not,” but there are a few important exceptions that are good to keep in mind.
If you’re only lending (or even just gifting) small amounts of money, odds are that the IRS isn’t going to concern itself with you. For the record, “small amounts” are, in the eyes of the IRS, any amount less than $15,000 per year to any individual.
If you lend someone more than that, it’s still fine, but you need to make things official, and part of that is charging interest.
Making a loan official is sometimes as simple as drawing up a document that both parties sign, but family and friends loans can also be made through more official channels (like this very website you're on right now -- say, who put this link here?).
The reason for this is that giving an amount of money greater than $15,000 is taxable under the “gift tax.” You can’t just get around it by calling it a loan -- the IRS will be on you like Judge Dredd if you try.
For a loan to be “official,” it has to be enforceable; that means drawing up a document, and that also means charging interest.
FYI: Zero percent interest loans over $15,000 could potentially be considered a “gift” by the IRS, so if you’re concerned, always consult an accountant for tax advice.
It’s also important to bear in mind that student loans are different from other kinds of loans. Because of the fact that student loan interest can be deducted from the borrower’s taxes, the lender will have to pay taxes on that same interest.
Alternatively, if you just pay for that borrower’s tuition outright, then there are special tax breaks in place you can take advantage of.
The amount mentioned above, $15,000, is what’s called you “annual gift tax exemption.”
That’s the full amount of money you can legally give to another individual without being taxed. If you’re married and your partner agrees to do a joint gift, you can give twice as much for a total of $30,000.
But if you exceed this amount, you can still choose to tap into something called your “Lifetime Estate and Gift Tax Exemption” -- which you can use to legally avoid taxes for (as of 2018) up to $5.6 million worth of gifts.
The downside to tapping into this is that this is the same pool you can use to be exempted from estate taxes at the end of your life, so the more you avoid being taxed for gifts while you’re alive, the more taxes you’ll pay out of inheritance once you’ve passed on.
But again, a lot of the above applies to loans that the IRS considers to be gifts.
As long as you go through the process of creating an official loan document, and as long as you make sure to keep gift tax laws in mind when figuring out how much to lend, the tax implications of lending money should be minimal to non-existent for you.