A Loan, Not a Gift
On February 25, 2013, Barbara lent $2.3 million to her son, Stephen. The loan was secured by a note that required payment of interest only for nine years, and repayment in full at the end of the term. The interest rate was set at 1.01%, which may seem like a bargain, but that was the applicable federal rate at that time. Barbara was 79 years old when the loan was made. Because the transfer was a loan, not a gift, no gift tax return was filed for the transaction.
Barbara died in 2016. Her estate reported the note as an asset on the estate tax return. The IRS objected that when the loan was made the fair market value of the note was less than the amount lent to Stephen, and that the difference was an unreported gift to him at that time.
Before the Tax Court, Stephen provided the bank records showing the transfer to him, his annual interest payments as required by the note, and the fact that Barbara had paid income tax on the interest payments that he made to her. Under IRC §7872, because the note charged the applicable federal rate of interest, it is not a “below-market” loan. The Tax Court held that it was a valid loan, and as such, no gift tax return was required from Barbara.
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