Son’s Loan Repayment Isn’t Income
Q: Over the last several years, I loaned my son about $100,000 for his education. Now he wants to repay me all at once. Will this pose a problem for me with the IRS? Do I have to report this as income? --D.C.
A: With one notable exception, being repaid for a loan you made--even if you are paid in one huge lump sum--shouldn’t raise any eyebrows. The only potential issue is whether you charged your son interest for the loan.
The IRS allows taxpayers to make an interest-free or low-interest loan of up to $100,000 without having to report the foregone interest as imputed, taxable income. However, that waiver is lost if the borrower’s net investment income exceeds $1,000. If the limit is exceeded, the lender must report the amount of the borrower’s income as imputed interest.
Perhaps all this will make more sense once you understand the reason for the rules.
The government does not want taxpayers in lower tax brackets to get low-interest or interest-free loans while they are earning investment income that Uncle Sam cannot get his full share of.
For example, let’s say a couple in the 31% tax bracket lend their college-age son money for school. Meanwhile, the son, a member of the 15% tax bracket, puts the money in his bank account and reports that interest on his tax return. Uncle Sam feels cheated.
If the example seems eerily familiar, you can make it up to Uncle Sam by filing amended tax returns. Our experts say that under the statute of limitations, amended returns would be necessary only for the last three years.
Earned Income Can’t Be Shifted to Others
Q: I am employed by a university and have a consulting business on the side that generates substantial fees. I am wondering if I can have some of my fees paid directly to my college-age son, who would report the income on his taxes. I figure this is a way I can give my son the money he needs for college while not having it taxed in my higher bracket.-- L.P.
A: Your plan won’t pass muster with Uncle Sam. You cannot legally shift earned income among taxpayers. You can transfer income-generating assets, such as stocks, bonds and real estate. You can give your son a gift of after-tax money. But you can’t transfer pretax earnings by using his name and Social Security number on a 1099 Form.
If you want to help you son earn money for college, you could hire him to do some of your consulting work. However, your son would then either be subject to payroll taxes as your employee or to self-employment taxes if he elected to consider himself an independent contractor.
Depending on the sums involved, you might discover that it is easier and cheaper to pay your son’s college expenses with your after-tax money than to treat him as an employee or independent contractor of your consulting business.
No Way to Gloss Over the Golden Handshake
Q: Employees all over the country are being let go with generous severance packages as corporate America downsizes its operations. For many of us, the golden handshakes are worth several hundred thousand dollars. However, if we get all this money at once, we face a huge tax bite. This doesn’t seem quite fair. Is there any way to use some sort of income averaging to reduce our tax bill?-- J.E.H .
A: When Congress lowered tax rates in 1986, it eliminated income averaging. But even though Congress raised rates earlier this year, income averaging was not revived.
Basically, the only way to avoid the big new tax bite--the highest bracket is now 39.6%--is to spread your payments out over several years.
However, this tactic may not make much sense if you don’t get any interest on the money you defer taking. After all, if you can get a substantial return on your investment, even after taking a huge tax hit, why would you want to defer your compensation? Only you can decide--assuming your company gives you that choice.
Rules for Getting IRA Withdrawal Waiver
Q: I am 56 years old and am taking early retirement from my job. May I put the lump-sum distribution from my pension plan into an individual retirement account and immediately begin drawing an annual disbursement without penalty, just as if I were age 59?-- C.W.C.
A: The Internal Revenue Service waives the 10% penalty for early IRA withdrawals if taxpayers take equal annual disbursements calculated according to life expectancy tables for their age group.
For example, the life expectancy of a 56-year-old is listed at about 28 years. To calculate your annual disbursement, divide the total balance in all of your IRA accounts by your life expectancy--or, if you want, your life expectancy and that of the beneficiary, or beneficiaries. Once you reach age 59, you may withdraw more funds from your IRA accounts without penalty--but never less than the life expectancy amount.
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Note: In the column of Sept. 19 I wrote that members of the military were the only taxpayers exempted from the IRS requirement that home sale profits must be reinvested in a new home within two years to defer taxation on them. In fact, the two-year replacement requirement is also suspended for taxpayers required by their jobs to move abroad. In these cases, the suspension applies only if the foreign transfer is completed before the two-year period expires. The suspension lasts until the taxpayer returns home or until four years after the home sale occurred, whichever happens first. Once the suspension expires, the two-year clock resumes ticking.
