GST TAx

  • Noelle Merwin
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Keeping Wealth in the Family: How Family Banks Work
Keeping Wealth in the Family: How Family Banks Work 266 266 Noelle Merwin

For families with significant wealth, lending money to children, grandchildren or other relatives can be an effective way to provide financial assistance while preserving family assets. But informal arrangements can create complications. Without clear expectations, loans between relatives may lead to misunderstandings, strained relationships and unintended tax consequences. One way to avoid these problems is to create a family bank, a formal arrangement designed to manage intrafamily lending in an organized manner.

Benefits of intrafamily loans

Intrafamily loans can serve various purposes, such as purchasing a home, pursuing higher education, starting a business or addressing temporary financial difficulties. And they offer several advantages. For borrowers, they may provide access to financing that’s difficult to obtain through traditional lenders, often with more flexible repayment terms or lower interest rates. For lenders, they provide an opportunity to help loved ones achieve financial goals without making outright gifts. Assuming the loans are repaid, the funds can eventually be used to assist other family members.

Intrafamily loans can also be valuable estate planning tools. For example, if a borrower invests loan proceeds and earns a return that exceeds the interest rate charged, the excess appreciation generally remains with the borrower rather than becoming part of the lender’s estate.

However, it’s essential to structure these transactions properly to avoid having loans characterized as taxable gifts. Generally, lenders should document loans with written promissory notes, establish realistic repayment schedules and maintain records of payments. In addition, they should charge interest at least equal to the applicable federal rate (AFR) for the loan’s term. Borrowers also must have a reasonable ability and genuine intention to repay their loans.

How a family bank works

Although individual intrafamily loans can be effective, managing multiple loans to different relatives can become complicated. Questions may arise about who qualifies for assistance, how much each person can borrow and whether some family members receive preferential treatment. A family bank addresses these concerns by creating a centralized system for making and administering loans. By evaluating requests according to predetermined standards, it can help preserve family wealth, encourage financial responsibility and reduce disputes.

Despite its name, a family bank typically isn’t a chartered financial institution. Rather, it’s a family-funded arrangement that operates under established lending policies. Depending on the circumstances, it may be organized as a limited liability company, partnership or another legal structure.

Set clear lending policies

A family bank’s success depends largely on its governance structure. Clear policies and consistent administration help ensure that lending decisions are made objectively and borrowers understand their obligations.

For example, a family bank should define eligibility requirements, maximum loan amounts, acceptable uses of borrowed funds and repayment expectations. It should also specify how loan requests are evaluated and what happens if borrowers encounter financial difficulties.

Families may appoint a committee to oversee lending activities and involve independent advisors to provide objectivity. Transparency is also important. Family members should understand the bank’s purpose and lending guidelines, even if individual borrowers’ financial information remains confidential.

A strategy worth considering

Beyond providing financial support, a family bank can teach younger generations about borrowing, budgeting and responsible money management. It can also help families promote fairness and shared financial values. However, this approach isn’t appropriate for every family. Creating and administering one involves legal, tax and practical considerations. Contact us to discuss whether intrafamily loans or a family bank might fit into your family’s wealth transfer strategy.
Contact your Smolin representative to start the conversation. 

  • Noelle Merwin
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Passing Down Wealth? Don’t Forget the GST Tax
Passing Down Wealth? Don’t Forget the GST Tax 266 266 Noelle Merwin

If your estate plan includes gifts, bequests or other transfers to grandchildren, great-grandchildren or other beneficiaries decades younger than you, the generation-skipping transfer (GST) tax deserves careful attention. Without proper planning, transfers that skip a generation can potentially trigger a significant federal tax in addition to gift or estate taxes.

GST tax rules at a glance

The GST tax is designed to prevent families from avoiding transfer tax at one or more generational levels. Generally, this tax applies to certain transfers to a “skip person.” A skip person may be a grandchild or another family member who’s two or more generations below the person making the transfer. An unrelated individual generally is considered a skip person if he or she is more than 37½ years younger than the transferor.

GSTs generally fall into three categories: direct skips, taxable distributions and taxable terminations. Depending on the circumstances, the GST tax may apply to an outright gift or bequest to a skip person, a distribution from a trust, or a termination of a beneficiary’s interest that leaves only skip persons with interests in the trust.

The GST tax rate is 40%. Fortunately, a $15 million GST tax exemption is available. It’s separate from the $15 million gift and estate tax exemption.

But under the annual gift tax exclusion, you can exclude from gift tax certain gifts of up to the annual exclusion amount — $19,000 per recipient for 2026 (twice that if your spouse elects to split the gift with you or you’re giving community property) — without using up any of your gift and estate tax exemption. And annual exclusion gifts are generally also exempt from the GST tax.

Beware of a few pitfalls

Automatic allocation rules for the GST tax exemption can reduce the risk that you’ll inadvertently fail to allocate it to GSTs. For example, the GST tax exemption generally will be automatically allocated to certain direct skips and to transfers to trusts that meet the definition of a “GST trust.”

Automatic allocation can be useful, but it doesn’t always produce the desired result. For example, depending on the trust’s beneficiaries and your estate planning objectives, the exemption may be allocated to a trust that has little chance of generating a GST tax, wasting your exemption.

To avoid this result — and preserve your exemption for transfers that are more likely to trigger GST taxes — elect to opt out of automatic allocation on a timely filed gift tax return. If you neglect to opt out, you may still be able to obtain relief from the IRS. Doing so allows you to make a late election so long as you can demonstrate that you acted reasonably and in good faith.

Another potential issue can arise when a trust has both skip-person and non-skip-person beneficiaries and the GST exemption has been allocated to only part of the trust. The trust then will have an “inclusion ratio” between zero and one.

A trust’s inclusion ratio refers to the portion of a trust’s assets that will be subject to the GST tax if a taxable event occurs. If you haven’t allocated any of your exemption to a trust, its inclusion ratio is 1.0. If the exemption protects a trust’s assets, its inclusion ratio is 0.0. So, if the inclusion ratio is, for example, 0.5, then only 50% of the distributions to skip persons will be exempt from the GST tax.

In some situations, it may be possible to divide, or sever, a trust into separate trusts so that one has an inclusion ratio of zero and the other has an inclusion ratio of one. This approach may make it easier to administer the trusts and direct GST-exempt assets toward skip persons.

Review your GST tax strategy regularly

If your estate plan includes multigenerational trusts or significant transfers to grandchildren or other younger beneficiaries, review your GST exemption allocation, trust provisions and previous gift tax returns periodically. We can help determine whether your current strategy is using the available exemption effectively and identify opportunities to minimize unnecessary GST tax exposure. Contact your Smolin representative to start the conversation. 

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