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

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

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

It's enough to make anyone uncomfortable.

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

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.

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

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

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

Now here's your host, Ralph estep Junior.

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

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.

Remember, all of our previous episodes are right there.

You can catch up at any time.

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

This one actually comes from Alex.

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

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

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

What if she cant pay me back?

Will this affect our relationship?

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

I feel lost and anxious about the whole situation.

Can you please help me navigate this?

Alex?

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

So I hear your concern.

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

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

A lot of us deal with this.

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

It's a dilemma.

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

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

So let's unpack this together.

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

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

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

You can go to justaskraph.com.

because the truth is your questions.

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

I was thinking about it.

We got to consider Alex's situation.

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.

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.

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

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

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.

So Alex, that's my goal for today.

So here we go.

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

I think it'll resonate with you.

And it's about my client, Stephanie.

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

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

Now picture Stephanie.

She thought she was doing the right thing.

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

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

Stephanie was smart.

She drew up a simple agreement.

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

Because again, were balancing finances and emotion.

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

Her brother made the first few payments on time.

He was a great borrower.

But then the payments started coming late.

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

And he would always have an excuse.

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

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

Now, Stephanie tried to be understanding.

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

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

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

She tried again.

She tried reaching out to her brother.

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

And what she noticed is he became really defensive.

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

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

You're not supporting my dream.

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

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

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

She said, I needed this money.

So she took her brother to court.

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

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

We've reached Defcon five.

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

But more than that, it tore her family apart.

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

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

And with that, these family gatherings became tense affairs.

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

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

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

I want the case.

I had the documents.

I could prove that he wasn't paying me.

So she won her case.

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.

And guess what?

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

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

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

There were really two camps because of this situation.

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

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

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

How can we navigate these tricky waters?

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

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

You're listening to this right now.

I bet you have to.

And I'm going to say this.

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

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

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

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

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

And you've also got to take this mindset.

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

That's just a fact.

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.

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

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

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

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.

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.

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

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

You don't want to take my advice.

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

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

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

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

What is the interest rate?

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

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.

Lay it out in writing in black and white.

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.

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

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

See, that's a thing.

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.

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

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

Number three, as Stephanie learned, keep good records.

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

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.

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

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.

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

Number four, consider collateral.

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.

So now you've decided to loan it.

You want to get paid.

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

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

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

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

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

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

You got to understand it.

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

It might bring out ugly in people.

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

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

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

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

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

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.

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

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

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

Formalize that agreement and be prepared for potential consequences.

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

I hate to say that, and that stinks.

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

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

Money.

That's what it comes down to.

Money goes away.

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

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

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

Can you help me?

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

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

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

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

But here's the truth.

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

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

I'll go fill up their tank of gas.

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.

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

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.

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

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

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.

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

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

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

And you don't want to miss that.

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

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

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

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

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

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

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

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

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

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

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

I will help you move from living paycheck to paycheck.

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

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

I want you to improve your personal finances.

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

I need somebody to help me.

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

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

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

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

Here's my top three things.

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

So here's my takeaway from this.

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

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

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

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

This is why I turn the microphone on.

I turn the camera on.

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

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

It's not just finances.

It's not just faith.

It's when those two things come together.

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

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