Parents Can Give Till It Hurts, and in Tax Terms, That Can Take a While

Q Recently at a gathering of friends, conversation turned to the subject of parents’ lending large sums of money to their adult children to buy furniture, a car, a home, whatever. One of the guests said this is not allowed unless interest is charged by the parents. Is this true?

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A Fortunately for those of us who occasionally tap the Bank of Mom and Dad, the answer is no. Your guest misunderstood the difference between what’s “allowed” and what’s taxable.

Parents can set up any financial arrangement they want with their offspring. They can give money or lend money, charge interest or not, and Uncle Sam won’t utter a peep.

But if Mom and Dad want to avoid gift and estate taxes on their generosity, they have to be a bit more careful how they structure the transaction.

To recap a little tax law: Anyone is allowed to give anyone up to $10,000 a year without having to file a gift tax return. (The money is tax-free to the recipient no matter what the amount.)

Filing a gift tax return doesn’t mean the giver has to pay taxes, however. The IRS keeps track of the returns but doesn’t expect a tax payment until the total value of the gifts given in a lifetime exceeds the individual’s estate tax exemption, which this year is $625,000. (The limit will gradually increase to $1 million by 2006.)

Most people never exceed those limits, and so never owe tax. Those who do owe usually don’t hit the limit until after death, and the tax then goes by the name “estate” rather than “gift.”

An interest-free or low-interest loan is considered a gift by tax authorities; the amount of the gift is the amount of interest the recipient should have paid but didn’t.

Obviously, there’s some gray area here, such as what interest rate “should” be charged. The average rate for a personal loan now is about 15%.

For most people, frankly, loan interest isn’t an issue, because the interest you “should” be paying will probably be less than the annual $10,000-per-person limit. Assuming a simple 15% as a reasonable rate, your folks could lend you and your spouse up to $266,000 interest-free and still not have to file a gift tax return, let alone pay tax. If you assume a 10% rate as reasonable, the parents could give the happy campers up to $400,000.

You would have to pay the lent money back, however, or your folks would also end up having to declare the loan amount as a gift.

Parents who have that kind of money to throw around, by the way, probably should consult an estate-planning attorney for help on structuring their finances. Their children might raise the issue--sometime when they’re not hitting up Mom and Dad for a loan.

Payment of Debts Is Relative

Q A family member died recently, leaving behind a home in foreclosure, a mound of credit card bills and no assets to speak of. We (the rest of the family) wanted to do the right thing and pay off the debts--until we found out that the deceased owed at least $15,000, probably more. None of us has that kind of money lying around. Should we do the ethical thing, dig into our retirement funds, and pay off the bills?

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A You are to be commended for wanting to do the right thing. But your sense of ethics may be a little overblown. If the deceased was not your spouse or a minor child, you have no obligation, legal, ethical or otherwise, to pay off the debts.

The answer would be different if the dearly departed had left any assets behind. Then you (or whoever is the executor of the estate) would be legally and morally bound to use the assets to pay off the creditors; if there wasn’t enough money, the executor would offer each creditor a pro-rata share of what there was.

You could also have a moral obligation if the deceased got into financial trouble because of you--if, for example, he or she took out a second mortgage to help you start a business that went bust and you never paid the money back.

The amount of debt, by the way, isn’t an issue. If you had a legal and moral obligation to pay it, you would need to pay whether it was $15 or $150,000.

In short, we get to be responsible for our own actions. That should be more than enough for most of us. Don’t borrow trouble by taking on responsibilities that aren’t yours.

Liz Pulliam is a personal finance writer for The Times and a graduate of the certified financial planner training program at UC Irvine. She will answer questions submitted--or inspired--by readers on a variety of financial issues in this column. She regrets that she cannot respond personally to queries. Questions can be sent to her at liz.pulliam@latimes.com or mailed to her in care of Money Talk, Business Section, Los Angeles Times, Times Mirror Square, Los Angeles, CA 90053.

Timely Tip

If you earn more than $72,000, your Social Security taxes will go up next year by about $260. That’s because the wage limit against which Social Security taxes are assessed will rise to $72,600 in 1999 from $68,400 in 1998. Workers pay 6.2% of their incomes up to these limits for Social Security. They also pay 1.45% of income to Medicare; this tax applies to every dollar earned, without limit.