Consider the following hypothetical: A married couple has grown children. The mother writes checks in the amount of $100,000 to each of her two sons, describing each as a “loan” in her check register. Each son signs a note for $100,000; the notes provide that they are payable on demand or on a fixed date if no demand is made. There is no security for the loans. The repayment date passes, but the parents do not make demand for payment. Each year for several years after the notes are executed, the mother sends a letter to each son stating that she had forgiven a part of the balance of the loan. One year, the amount of the principal reduction exceeds $10,000, but the parents do not file a gift tax return.
The tax court ruled that under these circumstances, the “loans” were, in fact, gifts. At the time the loans were made, the sons did not have the ability to repay their parents; no security was given for the loans; the parents’ records did not adequately reflect the payments to the children were loans; and there was no evidence that the parents intended to enforce the loans. Thus, the tax court ruled in favor of the IRS, holding that the entire amount of loans was a gift at the time it was made and thus reduced the parents’ available unified estate tax credit. Please do not hesitate to telephone us if you have any questions regarding the use of gifts as part of your estate plan.