If you're a business owner, your company may be a valuable source of cash. Borrowing from your firm may be more appealing than applying for a bank loan or using credit cards for money you need personally. There's a catch, though. If you borrow from your company at a below market rate, you might have to pick up taxable income equal to an imputed interest rate. In a truly worst-case scenario, the IRS might call the transaction a dividend rather than a loan. You'd have taxable income equal to the amount received, and your company would not get a deduction. Fortunately, there are some exceptions for loans between employees and employers that you might be able to use when borrowing from your company.
Loans that total no more than $10,000 will not trigger imputed interest. Be sure to make the loan formal, with repayment terms, in order to avoid its re-characterization as a dividend. (In fact, you should make any loan between you and your company formal.)
A loan made in connection with a business-related relocation also may avoid such adverse tax consequences. Example: Your company moves from one area of the U.S. to another. You move to be near the company. In this scenario, your company could loan money to you, interest free. No interest will be imputed if certain conditions are met. Your new residence must secure such a loan, which must be at least 50 miles from the old one. The loan must not be transferable. You, the borrower, not only must promise to perform future services, you also must pledge to itemize deductions each year the loan is outstanding.
In today's housing market, you may find it difficult to sell your home quickly. At the same time, you may want to buy a house right away if your company moves to a new location. The tax code allows you to take a low-interest bridge loan from your company. In order to avoid tax problems, you must meet all of the above conditions for relocation loans. Other conditions also apply:
If you hope to qualify for a relocation or bridge loan, a savvy strategy is to open a separate bank account in which the borrowed funds may be deposited. That will make it obvious the loan proceeds have been used to purchase a new residence, helping you to justify your reliance on one of those exceptions.
Amid political uncertainty, you cannot know whether the federal estate tax will be eased or even repealed altogether. In this situation, it makes sense to reduce your taxable estate. You can do so by giving away assets. A gift tax applies, but you can find shelter by using the annual gift tax exclusion and the lifetime gift tax exemption. These tax breaks enable you to shed assets from your estate without paying tax.
Married couples have double exclusions and exemptions. If the assets given away come from only one spouse, the couple can elect to "split" gifts. Despite the term, splitting gifts doubles the giver's tax shelter, rather than halving the tax benefits. The annual gift tax exclusion, now set at $12,000 per year per recipient, effectively increases to $24,000 with gift splitting.
Example #1: Jane Smith has three children. She can give them a total of $36,000 worth of assets in 2008 ($12,000 to each) in addition to any payments she makes for medical bills and tuition. Jane can make that $36,000 worth of gifts without owing gift tax. She will not even have to file a gift tax return. Jane's husband Bob can also give a total of $36,000 to their three children this year. With such gifts, twice as many assets can be removed from their estates in 2008 tax-free. This is true even if Bob has minimal assets in his own name and scant concerns about estate tax. By gift splitting, this couple can make the most of their combined gift tax exclusions.
To split their gifts, Jane could give each of their children up to $24,000 this year, not $12,000. Then Bob would elect to join in the gift. This election is made on a gift tax return. The split must be 50-50 and both spouses must consent to this election. By consenting, Bob effectively gives $12,000 to each child this year. He uses up his exclusion and cannot make any other tax-free gifts to the children in 2008. To qualify for gift splitting, spouses must meet certain conditions:
Suppose you would like to give more then $24,000 per recipient this year. Gift splitting can still be used as you eat into your lifetime $1 million gift tax exemption. Example #2: Jane and Bob's oldest child, Lynn, wants to buy a house. Jane decides to help by giving Lynn $300,000. One approach is for Jane to use her $12,000 exclusion and go over the 2008 limit by $288,000. If Jane has made no other taxable gifts, she will owe no gift tax.
That doesn't mean this large gift will be tax free, however. Jane's $1 million lifetime gift tax exemption will be reduced by $288,000, diminishing her remaining gift tax exemption from $1 million to $712,000. Additionally, that $288,000 taxable gift will shrink Jane's estate tax shelter. Suppose Jane dies next year, when the federal estate tax exemption is $3.5 million. Assuming Jane has made no other taxable gifts, her estate tax exemption would be reduced by $288,000, from $3,500,000 to $3,212,000. Instead, Jane and Bob could choose to split the $300,000 gift. Then $24,000 will be covered by the annual exclusion. The excess $276,000 will reduce their lifetime gift tax exemptions and their estate tax exemptions by $138,000 apiece.
Gift splitting enables a married couple to give away up to $2 million worth of assets, over and above the amounts sheltered by the annual exclusion, free of gift tax. Subsequent to the gifts, that $2 million worth of assets might grow to $4 million, $8 million, or more. All of that potential appreciation will escape estate tax. Of course, you should not give away assets that you or your spouse might need for your own well-being.
Gift splitting also may be used for gifts to trusts. Even if the annual $12,000 exclusion cannot be used, in some cases the $1 million lifetime exemption may be employed. However, you should not split gifts to certain types of trusts, including qualified personal residence trusts (QPRTs), grantor retained annuity trusts (GRATs), and grantor retained unitrusts (GRUTs). If you spilt gifts and the grantor dies during the trust term, the other spouse will lose valuable tax benefits. Example #3: Paul Jones creates a GRAT and transfers assets into it. Based on current interest rates and the duration of the term, the value of the transfer is placed at $400,000. Paul and his wife Ann split the gift, effectively using up $200,000 apiece of their gift tax exemptions. If Paul dies before the trust term, the trust assets would go back into his estate and the $200,000 worth of gift tax exemption that he used would be restored. However, Ann would not get any refund or tax relief. Thus, she would have used up $200,000 worth of gift and estate tax exemption and received no benefit. For these types of trusts, one donor should bear all the gift tax consequences.
| Gift and Estate Taxes | ||
| Exemption Amounts | ||
| Year | For Gift Tax Purposes | For Estate Tax Purposes |
| 2008 | $1 million | $2 million |
| 2009 | $1 million | $3.5 million |
| 2010 | $1 million | Unlimited |
| Source: IRS, American Bar Association | ||