Carrie Schwab Pomerantz

Dear Carrie: Last year, I loaned my brother $10,000 when he lost his job. We created a loan document with a payment schedule, but even though he's back at work, he hasn't started paying me. How can I get him to start making his monthly payments without hurting our relationship? -- A Reader

Dear Reader: To my way of thinking, no area of personal finance is trickier than transactions with family members -- especially siblings -- and your question is a perfect example.

But before I give you some guidance about how to broach this delicate subject with your brother, I want to point out that there are significant practical and tax implications when you lend money to your friends or family. The IRS is particularly interested in loans of more than $10,000, so you're off the hook there -- but, of course, a loan of any size can also trigger other family issues. To minimize problems down the road, I highly recommend that anyone considering making a family loan think about the following:

-- Don't risk your own financial security or loan money that you can't afford to lose. We've all heard about the road to ruin being paved by good intentions -- and that certainly can apply to a family loan. Think carefully before you write that check.

-- Document the loan (as you've done). This demonstrates that you expect to be repaid and are not making a gift; otherwise, the IRS could count the loan against your annual $13,000 annual gift tax exclusion as well as your $1 million lifetime exclusion. Documentation also gives you the ability to deduct an unpaid loan on your income tax return if your borrower cannot pay you back.

-- You don't have to charge market rates, but set an interest rate at least equal to what the IRS refers to as the "applicable federal rate" (AFR). This is especially important if the loan is over $10,000. Otherwise, you could get hit with having to pay taxes on the "imputed interest" you never received. AFR rates are set monthly and vary depending on the type and term of the loan; you can find them by going to IRS.gov and searching for "applicable federal rates." The tax implications of imputed interest can be tricky (involving the borrower's investment income). Check with a tax adviser if you're unsure about how to proceed.

I realize these are technical issues, but when the amount is substantial (and at $10,000 you're right on the cusp of having the IRS care), they are important.

Now back to your original question of how best to get your brother to start paying you back.


Carrie Schwab Pomerantz

Carrie Schwab Pomerantz is a Motley Fool contributor.

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