Question:

I made a family mortgage loan to my son under my revocable trust. Recently, I amended the mortgage interest rate as market rates fell. I am told that I need to file Form 709 if the difference in total interests over the lifetime of the mortgage exceeds the annual gift tax allowance. Is this gift subject only to gift tax (Part 1 of Schedule A in Form 709) or is this considered a direct skip (Part 2) or an indirect skip (Part 3)?

Response:

It’s not a skip since it’s a gift to your son, not to a grandchild. But there’s a lot to explain here to the uninitiated.

First, when you extend a loan to a third party, even a family member, the IRS deems it a gift if you don’t charge interest on the loan or you charge interest that is under the market rate for such a loan. (The gift could, in fact, go the other way if you charged more than the market rate.) So that taxpayers don’t have to wonder what the market rate is, the IRS sets it and updates it every month to reflect changing market conditions. It’s called the “Applicable Federal Rate” or “AFR” and can be found here.

Second, as you know, you can give anyone up to $16,000 a year without filing a gift tax return. (A husband and wife together can give anyone up to $30,000 a year without filing a gift tax return.) In your case, it sounds like by renegotiating your contract with your son, you will be relieving him of more than $16,000 (or $32,000 if you’re married) of future interest payments, necessitating the filing of the gift tax return.

Third, in order to make sure the wealthy don’t avoid taxes at each generation by skipping a generation and passing some or all of their estates to their grandchildren, Congress in addition to the estate tax adopted a generation-skipping tax. Your question refers to filing a gift tax return for a gift to grandchildren or great-grandchildren, who would be members of a “skip” generation. That is not the case here since your gift is to your son, who is not in a skip generation, so the generation skipping tax is not implicated.

Fourth, all of this is irrelevant to 99% of Americans since the unified threshold for estate, gift and generation-skipping taxes currently (2022) is $12.06 million for individuals and $24.12 million for married couples. It will become relevant to another one or so percent of Americans in 2026 when the thresholds drop in half. But if you’re not near these categories in terms of wealth, although a gift tax return is technically required for gifts over $15,000 (or $30,000) per recipient, there’s no penalty for not filing them.

Finally, all that said, even as practitioners in the field, our office doesn’t prepare gift tax returns. We leave that to accountants.

Related Articles:

How Must I Document a Gift to My Daughter?

A Short History of the Federal Estate Tax