Mike is a college student who has big ideas but often fails to follow through on
ID: 2444999 • Letter: M
Question
Mike is a college student who has big ideas but often fails to follow through on those ideas. Mike’s parents agreed to loan him $30,000 to pay for his tuition, books, and room and board. Mike is required to pay the money back to his parents, along with 6% interest, within 6 months of graduating. 2014 was Mike’s 6th year as a full-time student at TSU and his parents are concerned about Mike’s lack of motivation to graduate and find a job. After his parents confronted him about the issue, Mike admitted that he had delayed graduating because he was afraid he would not be able to pay back the money his parents loaned him. Because Mike’s parents love him and as an act of kindness to him, they told Mike that if he graduated they would forgive his debt and that he should not put off graduation any longer. Mike was so grateful for his parents’ generosity and will finally complete his general studies degree in in December, 2015. Assume Mike parents forgive the debt to Mike in December 2015 after he graduates. In addition, Mike’s parents will give him a gift of $20,000 cash to help him get started on his own.
Please discuss whether Mike’s parents will have made a gift to Mike in December if all of the transactions discussed above occur at that time. If there is a gift, how much is the gift and how much is a taxable gift?
Please be sure to fully explain your answer and the relevant rules.
Explanation / Answer
Generally, the recipient of a loan from a family member is not exposed to additional taxes if the loan is under a certain amount OR the loan is structured in a way that meets certain standards. A family member who voluntarily forgives a loan over $14,000 is considered to be gifting the value of the loan to the recipient. There are no tax consequences to the borrower of the money if the lender (family member) forgives the loan. However, if the lender was charging interest and the borrower defaulted on the loan then the borrower will experience tax consequences. A loan that is written off unwillingly, because it cannot be collected, is considered to be a non-business bad debt. This means that the lender has written off the loan to the borrower, which is referred to as cancellation of debt. In a situation where a taxpayer’s debt is cancelled the unpaid interest that would have been collected by the lender is considered income to the borrower by the IRS. While the cancellation of debt triggers an inclusion in income for the borrower, the lender can deduct the amount of the loan made and it will be classified as a non-business bad debt.
In the present case it is not gift. the amount of $30,000 will be treated as a non-business bad debt.