Situation: Cash-poor father owns a home. One of his three sons gives him $10,000. Father puts a clause in his will saying that when he dies, the first $10,000 plus 4% interest goes to the one son. Then the rest of the estate is split equally between the 3 sons.
Assuming the value of the estate is well under the estate tax ememption, is this arrangement legal, and would there be any taxes due?
Thanks, Sal
Legally there's nothing wrong with this. The lending son will need to pay income tax on the interest received at the time. The interest rate of 4% may be too low, so it might be a good idea to have a contract now saying the same thing, using the interest rate allowed by the IRS for this purpose (it can change every month, but you can look in a rate if you put it in writing).
Stu
Thanks. As a follow-up, is there any way to do this so the son doesn't owe income tax on the interest? If one of the 3 sons is more generous to the father in life, can't the father give that son a bigger piece of the estate without there being any income tax? Where is the legal line between a father repaying generously in a will, and a loan requiring income tax? Note - to be clear, I'm asking where the legal line is, not how to break the law.
Thanks again for the first answer, Sal
Why do you say it's a loan? I see it as a gift; if the father later had a fight with that son, or got suckered by some pseudo-religious organization (etc.), there wouldn't be any enforceable obligation to repay. Hence, no loan.
The arrangement is certainly legal.
Seth
if the clause is put into the will as a condition to the son's giving the dad $10k, then it is a loan and enforceable, even if the father changes the will. Of course, proof will be an issue, and there will be a fight.
Not if the son wants to be legally entitled to be paid back. If the father can change his mind, that would make it better. Better still would be for father to leave a specific bequest (e.g. $15,000) rather than saying $10,000 plus interest. If that's done, it should be treated as a gift by the son to the father, and a gift by the father to the son, for which no income tax would be due.
The line is whether there is a legal obligation to pay. If part of a payment looks like interest, tax will be imposed on the interest. If it looks like interest it will be treated as evidence of an obligation to pay.
Stu
In article , Gil Faver > had a fight with that son, or got suckered by some pseudo-religious
I'd say that if a contract prevents the clause from being removed from the will, then it's an enforceable loan. If the father has the right to change his well and remove the clause, then it's not an enforceable loan, but a gift.
Seth
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