Gifting money to your children is a common way to provide financial support and plan for the future. The small gift exemption is a valuable tool in this process. But what happens if you find yourself needing to borrow that money back? Could this arrangement complicate things with Revenue and undermine your tax planning?
Many parents use the small gift exemption to build a savings nest egg for their children, but an unexpected need for a lump sum can create a dilemma. Borrowing from your children might seem like a simple solution, but it is a financial transaction that requires careful handling. Without the proper steps, you risk blurring the lines between a genuine loan and a gift, potentially leading to unwelcome tax consequences.
This article explains how to navigate borrowing from your children without jeopardizing the tax benefits you’ve worked to secure. We will cover the importance of transparency, formal loan agreements, and what you need to know about Capital Acquisitions Tax (CAT) to ensure everything is handled correctly.
Understanding the Small Gift Exemption
The small gift exemption is a key part of Irish tax law that allows you to give a gift of up to €3,000 to any individual in a calendar year without that person having to pay Capital Acquisitions Tax (CAT).
Key points about the exemption include:
- Per Person, Per Year: Any individual can give €3,000 to any other individual. This means a child can receive €3,000 from each parent, totalling €6,000 per year, completely tax-free.
- No Relationship Needed: The exemption applies regardless of the relationship between the giver and the receiver.
- Separate from Lifetime Thresholds: Crucially, gifts covered by this annual exemption do not reduce the recipient’s lifetime tax-free threshold for larger gifts and inheritances.
Over several years, consistent use of this exemption can result in a significant, tax-free sum being passed to your children. This is a popular and effective way for parents to build up savings for their children’s future.
The Scenario: Borrowing from Your Children’s Savings
Imagine this: over the last few years, you and your partner have each gifted your children €3,000 annually. They now have a comfortable amount saved up, which they don’t currently need. Unexpectedly, you find yourselves needing a lump sum. While a bank loan is an option, you consider borrowing from your children’s savings, with the intention of paying it back.
This is where things can get complicated. If the transaction is not structured correctly, Revenue could question whether the initial gifts were genuine. They might argue that the arrangement was simply a way to temporarily park your money, thus nullifying the tax exemption.
To avoid this, you must treat the loan as a formal, arm’s-length transaction.
Transparency is Key
The most important principle when borrowing money from a family member is transparency. To ensure the loan is seen as legitimate by Revenue, it must be clearly documented and conducted in a business-like manner. If the transaction is ever queried, you will need to prove it was a genuine loan, not a clawback of a gift.
Charging a Reasonable Interest Rate
One of the best ways to formalise the loan is to pay interest on the money you borrow. An interest-free loan from a family member can be considered a gift in itself under Revenue rules. The value of this “gift” is the interest that your child forgoes by not investing the money elsewhere.
By charging a reasonable, market-rate interest, you demonstrate that this is a commercial arrangement. The interest paid to your child is their income and may be subject to DIRT (Deposit Interest Retention Tax), but it solidifies the transaction’s legitimacy.
Put the Loan Agreement in Writing
A verbal agreement is not enough. A formal, written loan agreement is essential. This document should clearly state:
- The names of the lender (your child) and the borrower (you).
- The total amount of the loan.
- The agreed-upon interest rate.
- The repayment schedule, including start and end dates.
- Signatures of all parties involved.
This written record serves as clear evidence of the loan’s terms and protects everyone involved. It removes any ambiguity and is your primary defence if Revenue ever questions the arrangement.
Understanding the CAT Threshold
It’s also helpful to understand the context of the Capital Acquisitions Tax (CAT) lifetime thresholds. Currently, under the Category A threshold, a child can receive gifts and inheritances from their parents up to a lifetime limit of €335,000 (note: this figure can change, so always check the current threshold) before any tax is due.
While the small gift exemption operates outside this threshold, any gifts above the annual €3,000 limit will eat into this lifetime allowance. If a loan from a child is disallowed and deemed a gift back to the parent, it could have implications for their own tax situation, although this is a less common scenario. The main risk remains the initial gifts to the child being invalidated.
Filing Requirements with Revenue
If a child receives gifts or inheritances that exceed 80% of their lifetime tax-free threshold, they must file a Form IT38 (Inland Revenue Affidavit). While the small gift exemption amounts do not count towards this, it’s important to be aware of filing obligations for any larger gifts. Proper documentation of loans ensures these distinct transactions are not confused with gifts.
Navigating Family Finances with Confidence
Borrowing from your children can be a practical solution, but it requires careful handling to avoid undoing the benefits of the small gift exemption. By ensuring full transparency, documenting the loan in writing, and charging a fair interest rate, you can maintain a clear and formal arrangement that should satisfy any scrutiny from Revenue.
Financial arrangements within a family can be complex. Seeking professional advice ensures that you are compliant with all legal and tax regulations, protecting both your own and your children’s financial futures.
If you are considering a similar arrangement or need guidance on estate planning and family financial matters, the team at HOMS Assist is here to help. Our experienced solicitors can provide clear, practical advice to help you navigate these issues with confidence. Contact us today for a consultation.
