If we could count up the recurring issues our clients face each year, then the question of making or receiving loans from friends and family would be high up the list.
As with most things US tax, there can be caveats and implications to consider with almost every financial decision, and loans are no exception.
Making or receiving a loan can seem a relatively inconsequential action, but in certain situations, tax implications may arise.
Below, we’ll discuss some of the key issues when making or receiving a loan involving a US person. Of course, its always important to obtain US tax specialist advice on your specific circumstances.
US Person
Firstly, to clarify the definition of a US person.
A US person is any:
- US Citizen
- Green Card holder
- Any other person who meets the substantial presence test in the US
Are there US tax implications of receiving a loan?
Fortunately, for those receiving a loan, the implications are usually not overly complicated.
In the case interest is being charged, then the loan is treated no differently to a commercial bank loan. Minimal reporting is needed on a US tax return, and no tax should result from the loan.
If however interest is not being charged, then the recipient of the loan may be in receipt of a gift.
The interest not being charged, can be considered a gift being made to the individual.
In most cases, gifts received don’t need to be reported to the IRS. However, this is subject to thresholds and depending on the amount of interest being waived, then US tax reporting can be needed on Form 3520 in some cases.
Are there US tax implications of making a loan?
As you’ve likely seen above, one of the key factors to consider when reviewing the US tax impact of a loan, is whether interest is being charged.
The US does impose tax on gifts being made, and this tax is imposed on the person making the gift, rather than the recipient.
This means, if a loan is made to a family or friend, and interest is not charged, then there may be a taxable gift taking place.
The amount of interest that should be charged under US tax regulation, can be considered a gift being made to the recipient.
But, in most cases, there is no gift tax liability, however, due to large gift tax exclusions available.
Specific US tax advice from a US tax specialist should be sought prior to making the gift.
But how much interest should be charged?
Each month, the IRS publishes the AFR, which stands for the Applicable Federal Rate.
These rates tell us the minimum amount of interest that should be charged for short term, medium term, and long term loans made in that particular month.
These are generally reasonable rates, and usually lower than commercial bank rates.
If I charge interest, will this result in taxable income for me?
Most likely yes, the interest being charged to the family or friend would result in taxable income which may need to be reported on your US and NZ tax return.
Again, specific NZ and US tax advice should be sought from a tax specialist here.
Are there US tax implications of receiving a loan from an NZ trust?
Yes, when a loan involves a New Zealand trust, in many cases the repayments can be considered a contribution to the trust. This can expose the trust to US tax implications, and can become very complex.
A foreign non-grantor trust is generally a trust which has no US beneficiaries, trustees, or owners. This status can change by a loan being made.
Certain conditions must be for a loan from a foreign trust to be considered a “qualified obligation”, which can avoid some of the trust issues.
Once again, US specialist tax advice should be sought here.
Do I need a loan agreement in writing?
Absolutely, a loan agreement should always be prepared, showing the interest rate to be charged, and ensuring that the loan is as arms length as possible.
Summary
As you can see above, making or receiving a loan as a US person can be with only minimal US tax implications in some cases, but also very complex in others.
It is important always to obtain advice before the transaction occurs, and to ensure that your US tax obligations in New Zealand remain as simple as possible. Getting advice first can prevent costly accountancy fees later.
If any of the issues above affect you, or you’re considering making a loan to a US person, reach out to us for specialist US tax advice today – info@usatax.nz