The Wealth & Wisdom Blog

Now that both my parents have died, what is the legal effect of that big check that my mother wrote to my brother a few years ago?  Was that big check meant as payment for my brother’s work on my mother’s house, or was it a gift to him when he was going through difficult financial times that my mother did not want considered part of my brother’s share of the inheritance?

Ambiguity surrounding lifetime transfers to children might result in significant legal and relationship issues following death.  In this month’s update, I summarize the three different ways in which disproportionate lifetime transfers can be characterized – that is, as compensation, as a loan, or as a gift— and briefly describe the legal and tax implications of each such characterization.

Legal and Estate Planning Implications of Lifetime Transfers to a Child

Compensation: First, the transfer may be compensation.  Whether working around the house, in the family business, or as a fiduciary, a child can be legally compensated for his or her work. I recommend a compensation agreement be written up between the parties.  The child’s share of the inheritance following death is not reduced by compensation.

Personal Loan: Second, the transfer may be a loan. A loan should be substantiated by an agreement signed by the child receiving the loan and include the terms of repayment.  Following the death of the parents, the child’s obligations then continue to the named beneficiaries of the trust or estate.¹

Gift: Third, the transfer may be a gift. Unless mom or dad specifically referenced the gift as an “advancement,” the child who received the lifetime gift will not have her share of remaining assets reduced by the value of the gift following the parent’s death.  In contrast, gifts referenced as an advancement would be incorporated into an equal division among children following death.

Tax Rules

The tax rules related to each of these types of transfers are as follows:

• The child must pay income taxes on the compensation. The compensation owed to the child is treated like any other debt, reducing the parents’ estate for estate tax purposes.
• It is not legally necessary to impose an interest rate on the outstanding principle of a debt owed by a child. However, if the loan is substantial,² the IRS will impose a minimum interest rate on an intra-family loan.³ Regardless of whether the parents receive the interest payments from the child, the parents must report on their personal tax returns the interest payments as if received.
• If the transfers are characterized as a gift, the child should not report the transfer as taxable income. If the value of the gift is above $19,000 in value (or, $38,000 if married), the parents must file a gift tax return.  The gift tax return would need to be filed to report the use of “unified credit” against federal gift and estate taxes. ⁴

Seek Clarity

Most of our clients are willing identify the purpose of a lifetime transfer to a child, and work with our firm to clarify that purpose through proper documentation.  However, some parents are unwilling to provide clarity for one of the following reasons:

• The parents simply decide not to decide, hoping that because they can’t decide how to treat the transfer, that somehow the kids can figure it out for themselves.
• Being “Minnesota nice,” parents evade communicating the plan to the adversely-affected child or children out of fear of disappointing those children.
• The parent are intentional in keeping the plan murky and vague to effectively “weaponize” their personal estate plan to elicit the desired behavior from their children, whether greater personal attention from their children, reformed personal behavior, or preferred political affiliations.

On this Valentine’s Day, perhaps your clients can write a love letter to their family of a different note; that is, to clarify any ambiguities that might exist with disproportionate lifetime transfers. As always, my colleagues and I at Veritage Law would be glad to speak with you or your clients about the implications of various family transfer strategies.

¹ In many cases, there are sufficient other assets to offset the value of the loan, such that other children or beneficiaries receive other assets equal to the outstanding balance of the loan.  In such a case, the loan is allocated to the share of the debtor-child, then forgiven.

²  If the loan amount is $10,000 or less, no interest needs to be reported.  If the loan amount is between $10,000 and $100,000, the interest rate is the lower of (i) the AFR rate and (ii) the child’s net investment income for the year.  IRC §7872(d).

³ The rate will depend on whether the loan is a short-term loan (up to 3 year loan), mid-term loan (3 to 9 years), or long-term loan (longer than 9 years).  In February of 2026, mid-term rate is 3.86%.

⁴ The federal unified credit is currently $15,000,000, such that in most cases of asset transfers, no gift tax would be due.  Rather, the gift of the property would reduce your remaining “unified credit” against federal gift and estate taxes.