Issues With Gifts Or Loans To Future Beneficiaries

This article discusses how to handle gifts or loans to children already listed in a will or trust. We will answer the following questions:

• How to clarify a loan versus a gift?
• What happens if my beneficiaries think a loan is a gift?
• What evidence is admissible to clear up any confusion?
• How do I avoid my children fighting about loans or gifts after I die?

Supporting your children rarely ends after they become adults. Many parents continue to help their children financially, whether "gifting" them a lump sum of money for a specific purchase or providing a car, home, or business loan. In some families, loans and monetary gifts may lead to dispute if not kept equal. However, if it's not clear whether the money is a loan or a gift, conflicts can arise if the parent dies and their estate enters probate. Parents are often reacting to their children's needs at the moment and fail to consider the long-term consequences. If it's not in writing, the beneficiaries are left to figure it out on their own, or the court must step in and decide. 

How To Clarify A Loan Versus A Gift?

Most parents don't think through clarifying if something is a loan or a gift when they give their children money. Maybe they have a short discussion that includes, "I expect you to pay this back when you can," but nothing is written down. Many families find these discussions awkward and assume everything will work itself out in the end. As most of us know but choose to ignore, mixing family, money, and business rarely works out well. 

The best time to clarify your intentions is when you transfer the funds for the loan or gift. It's not enough to have a digital bank record that shows money going from your account to your child's account. Even if there is a note under the transfer that reads "loan for car" or "money for Bobby's business," it's not enough information to clarify if the funds were indeed a loan that must be repaid or a gift.

Most families shy away from "businesslike" transactions. It feels awkward, and we'd rather place our faith in trust versus having a conversation that might question our children's accountability. But all the court needs to settle a dispute is a one-page document that indicates whether the money given was a loan or a gift. Funds meant to be a loan should contain a description of the terms, such as length of the loan, payment schedule, and APR. Both parties should sign the document.

What Happens If My Beneficiaries Think My Loan Is A Gift?

Ambiguity is the proverbial "thrown wrench" in estate administration. Suppose John thinks that the money you gave to Sally was not a loan because there is no evidence of loan terms or repayment. John demands that the money be deducted from Sally's inheritance and evened out amongst the rest of the children. Sally claps back, saying that was never the agreement. Suddenly, your children end up going to court over the dispute. Litigation costs money; everyone loses in this scenario. 

Estate planning is your chance to clarify your intentions. Even if your child does not sign it, having a document that lays out the reason for the gift or loan will give your family and the court something to hang their collective hats on.

Can Evidence Be Used To Clear Up Any Confusion?

Let's consider the example above with John and Sally. Neither has physical or digital evidence to support their argument. What happens now? Each state has a base set of rules that govern how transactions between family members, friends, and businesses are classified when there is a lack of clear evidence. For example, in Illinois, when money is given from a parent to a child it is presumed to be a gift. The same goes for money transferred from spouse to spouse, but not from child to parent, or when transferred to relatives and non-relatives.

So, the court sees that you transferred $50,000 to Sally. There is no note under the transfer, nor a document that explains the reason for the transfer. The court only has Sally's testimony that the money was meant to be a loan and should not reflect on her inheritance. However, since Illinois views all monetary transfers from parent to child as a gift, barring any evidence to the contrary, the court decides it was a gift and rules in favor of John.

But what if one of the other children (let's call her Dina) recalls you mentioning something about a loan to Sally. Dina agrees to speak on Sally's behalf, but Dina is considered an "interested person" by the court. You and your spouse are gone, and the rules of evidence do not allow testimony from someone with a stake in the estate. This type of evidence is referred to as hearsay, and it is inherently unreliable. Now, suppose you spoke about this loan to a friend of yours on multiple occasions. If your friend provides testimony that you told her the money you gave to Sally was meant to be a loan paid back over ten years, the court can consider that when making its decision.

How Do I Avoid Children Fighting About Loans Or Gifts After I Die?

Put everything in writing. If you transfer money to a beneficiary —especially if you feel your death is imminent— record the reason and any applicable terms, and place the document in your estate planning files. You can also include a section describing any loans or gifts in your estate plan. The more evidence you provide your family and the court, the clearer your intentions will be, leaving little room for interpretation and litigation.