Payoff of student loan by parents

Question

My son recently graduated from medical school with a student loan of ~ 200K. He will be a resident fellow for the next 7-8 years with 60-80k annual income. My wife and I have some cash and are willing to payoff his loan as a lump sum to stop interest accumulation with rates between 4% and 6%. He will then pay us the loan each month at a level that is possible for him.

I was wondering:

1) Is this a sound decision from a financial and tax point of view?

2) What are tax implications for us? Would his monthly payments to us be tax deductible for him?

3) Do we have to pay taxes from these monthly payments? Can he give this money to us a "gift" to make it tax exempt? What are tax consequences of this payoff?

Answer 1

Yes, if you gift him with a large amount you may be liable for gift tax. I believe the current limit is still $17k per person per person per year, so between you and your spouse you could give him up to $34k per year without triggering gift tax.

If you want to give a larger sum, the standard workaround is an intra-family loan. Websearch for that phrase to learn more about it, but basically you loan the money and then gift the payments on the loan. This gives him the money up front, spreading the gift over subsequent years --but it requires that you declare the interest that he is supposedly paying you as income. There is a lower limit on the interest rate for these loans, but it's a fraction of a percent so this generally isn't a significant cost.

(If you are able to structure the loan as a mortgage, he may be able to deduct the interest from his taxes. That usually requires a few hundred dollars if paperwork to set up.)

I've done it. It works. And one of the advantages is that it puts the exact terms of the lian on paper where everyone can agree to them, which could be useful should there be arguments later on.

When doing business with friends and relatives, keeping it on a clear business contract basis is the best way to avoid destroying the friendship.

Answer 2

I would advise against this, answering only the first part of question #1.

Borrowing and lending money among friends and family members can often ruin relationships. While it can sometimes be done successfully, this is most likely not the case. All parties involved have to approach this uniquely in order for it to work. This would include your son's future significant other.

Obviously you have done very well financially, congratulations. Your view for your son might be for him to pay you off ASAP: Even after becoming a doctor, continue to live like a student until the loan is paid off.

His view might be more conventional; get the car and house and pay off my loans before I am 50. He may start with your view, but two years in he marries a woman that pressures him to be more conventional.

My advice would be to give if you can afford to, but if not, do not lend. If you decide to lend then come up with a very clear agreement on the repayment schedule and consequences of non-payment. You may want to see a lawyer.

For the rest of it, interest payments received are taxable.