Parents want to pay off loans - but we'll pay them back - how to do it

My husband and I are currently saddled with a mountain of debt from his law school degree. Each set of our parents has offered to loan us the money (100K from each of them ) to pay off the loans most of which carry with them a whopping 8.5% interest rate. His parents would charge us a much lower interest rate (3%) and give us a longer term. My parents, however, would prefer not to charge us interest and have us pay them back over a shorter term, which now of course I understand has gift, and thus tax, implications. But . . . is there any way to to do it?

Unless both your parents have $5 million plus estates you won't have to worry too much about the tax implications for either side.

If someone gives you a 0% loan then that can be considered a gift. Otherwise everyone would call their gifts 0% loans with infinite payback time and avoid gift tax obligations. So they either have to call it a gift officially or charge you some certin minimum interest rate (defined by IRS) to qualify as a valid loan.

If its a gift then they are supposed to fill out the gift tax form. Gift taxes aren't due immediately and basically just reduce the credit you get towards your estate taxes. So like harruin said, unless your parents are mult-millionaires gift taxes don't really cost anyone anything. But if you're a millionaire and you give away a couple million when you're alive as gifts then that eats up your exemption when it comes time to figure estate taxes and you may have to start paying the estate tax rate on the gifts up front.

Or both of your parents can each gift each of you $13k a year and it can all fall under the gift tax exemption. $13k from each parent to each of you. 4 parents x $13k gifts x man + wife = $52k a year
Spread it over 4 years and you'd have $200k free of gift tax.

Or they could charge you interest then annually gift you back the interest. (I think that works, not 100% sure).

I'm not a CPA or lawyer.

jerosen said:   <snip> Or both of your parents can each gift each of you $13k a year and it can all fall under the gift tax exemption. $13k from each parent to each of you. 4 parents x $13k gifts x man + wife = $52k a year

Just to clarify, I believe it's $13k from each parent to each child and $13k from each parent to each child's spouse amounting to $52k per parental set per year. Since there are two parental sets, $104k in total could be gifted each year, $52k from each family.



Gift Splitting

If you or your spouse makes a gift to a third party, the gift can be considered as made one-half by you and one-half by your spouse. This is known as gift splitting. Both of you must agree to split the gift. If you do, you each can take the annual exclusion for your part of the gift.

Currently, gift splitting allows married couples to give up to $26,000 to a person without making a taxable gift.

If you split a gift you made, you must file a gift tax return to show that you and your spouse agree to use gift splitting. You must file a Form 709 even if half of the split gift is less than the annual exclusion.

Example. Harold and his wife, Helen, agree to split the gifts that they made during 2011. Harold gives his nephew, George, $21,000, and Helen gives her niece, Gina, $18,000. Although each gift is more than the annual exclusion ($13,000), by gift splitting they can make these gifts without making a taxable gift.

Harold's gift to George is treated as one-half ($10,500) from Harold and one-half ($10,500) from Helen. Helen's gift to Gina is also treated as one-half ($9,000) from Helen and one-half ($9,000) from Harold. In each case, because one-half of the split gift is not more than the annual exclusion, it is not a taxable gift. However, each of them must file a gift tax return.
Source: IRS Pulication 950

NotSoHard said:   jerosen said:   <snip> Or both of your parents can each gift each of you $13k a year and it can all fall under the gift tax exemption. $13k from each parent to each of you. 4 parents x $13k gifts x man + wife = $52k a year

Just to clarify, I believe it's $13k from each parent to each child and $13k from each parent to each child's spouse amounting to $52k per parental set per year. Since there are two parental sets, $104k in total could be gifted each year, $52k from each family.

Yeah thats right.

Mom to me
Mom to spouse
Dad to me
Dad to spouse
Mother in law to me
MIL to spouse
Father in law to me
FIL to spouse

8 combos x 13 = $104k max a year.

So make it the IRS minimum interest rate, instead of 6%

I think the min rate is 1% or so

Not your question, but what happens to the loan from your parents if you and hubby get a divorce? Is he responsible to repay your parents from his half of the marital assets? I would suggest you have papers written up by a lawyer if these funds are a material portion of your parents' retirement monies.

Kat009 said:   Not your question, but what happens to the loan from your parents if you and hubby get a divorce? Is he responsible to repay your parents from his half of the marital assets? I would suggest you have papers written up by a lawyer if these funds are a material portion of your parents' retirement monies.

Yes, this is an important point, especially if they are going to gift back the interest, at least until they are repaid, since its for hubby's degree, should you divorce he should solely be responsible for the debt as you won't be getting 1/2 the degree.

At first I read the OP as saying they had $400k in student loans...

Question: Is your hubby using his degree? Working at all?

ksa822 said:   ...So my parents could loan us $100,000 and charge us 0.92% interest, with a repayment schedule of 6-9 years, and they’d avoid taxes altogether.
Not altogether. Read earlier replies.

ksa822 said:   Hi all, Thanks for the replies. A lot to think about.

Yes, my husband is working at a law firm. We can "afford" our current monthly loan payments but our parents do want to help us save the mountains of interest.

The 3% loan is easy to structure - we are drawing up a promissory note with his parents. In the event that anything happens to his parents, the loan would become an asset of the estate and then the remainder would be split between my husband and his sister.

I've done a little more research and it looks like the IRS applicable federal rate for loans with maturities between 3 and 9 years is currently 0.92%. So my parents could loan us $100,000 and charge us 0.92% interest, with a repayment schedule of 6-9 years, and they’d avoid taxes altogether.

Everyone plans on paying their law school loans off in 10 years, but it doesn't always happen. Collectively, you should come up with a plan that ensures the loan is wiped out after 9 years both to avoid taxes on the 0.92% interest and to avoid a situation where you have to refinance the loan to a higher interest rate (if they ever climb) to avoid the gift tax coming due, or a 1099 for debt forgiveness or some other tax consequence that a commoner such as myself wouldn't know about.

I think this is a situation where you need to see a financial planner / tax professional who can explain all the pitfalls if something goes wrong or is not executed to the plan.