Your Wealth, Health, And Lifestyle Newsletter

How To Avoid Tax On Debts

By Jason Markum

Estate planning is tricky under the best of circumstances, and even under normal circumstances it can be downright difficult to do correctly. One thing that often slips through our fingers and we fail to spend an adequate amount of attention on is the effect of debt on estate planning.

Most people think, “I’ll be dead, why would I care about the debt that remains!” Well that’s a valid point I guess, but if the people that come after you will have to deal with this then so should you have to deal with it too, in fact what’s the point of planning for anything in that case!

Consider this hypothetical situation; imagine that you have loaned your son $50,000 to start a business. Now imagine that you die. Not a lot of fun – sure – but roll with it here! What happens to that $50,000?

You’re going to be tempted to simply forget about it and let it go way, unfortunately you can’t and here’s why. If you forget about that $50,000 then what you have effectively done is forgive the debt. Just because you will never collect that $50,000, doesn’t mean that it’s not an asset to your estate. In fact the IRS considers exactly that it is an asset even if you never collect it; therefore your estate will be taxed on that asset.

What’s a better way to do it? Well here’s one suggestion… be sure to consult with a licensed tax advisor and maybe possibly even an estate attorney or somebody else who specializes in this exact area.

Basically what you want to do is spell out the fact that your sons payment obligation will cease in the case of your death. Put that right into the loan documents when you first issue the loan to your son. That means of course that you will have to create loan documents but that is not a problem as you can draw anything up on your computer and call it “loan documents”. Make sure to do this right away when you first issue the loan. If you do it afterwards it will not work.

What’s the result of all this? Well when you do die then your estate doesn’t have an inherent repayment right therefore the asset no longer exists to the estate and is therefore no longer taxed.

Of course now your son may have tax issues of his own because he has been giving something for free which may trigger gift taxes or any number of other taxes. So be sure to check with a tax lawyer or certified public accountant before hand.

Nobody likes the idea of dying and planning for your death is not especially pleasant… but taking the time to set your house in order is an important part of living and an important part of having a family and therefore an important part of your life.

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