Last week, the Tennessee Court of Appeals addressed a case that included an issue that we often see in estate planning – whether the transfer from one person to another, usually within a family and usually of money, is a loan or a gift. This issue typically arises in either of these situations:
- Parent transfers money to one of the children, but not to others. Later, after the parent dies, the other children claim the transfer to their sibling was a loan and the child needs to pay it back to the estate. The recipient child claims that it was a gift and asserts that they do not owe the estate anything.
- Child transfers money to a parent. After the parent dies, the child claims that the transfer was a loan and is looking for the parent’s estate to pay them back. The estate and the other children claim the transfer to the parent was a gift and nothing is owed to their sibling.
These situations can also come up if a parent becomes incapacitated before their death. Essentially, unlike other areas of the law, because the issue arises after one of the parties to the transfer is no longer able to give their understanding of the transfer, it can be difficult to clearly determine what the two of them understood and intended.
The Appeals Court case addressed a situation similar to example #2 above, but from the other side. In this case, a child made a transfer to the parent and the child then passed away. The child’s estate asserted the transfer to the parent was a loan and the parent needed to pay back the estate, while the parent asserted the transfer was a gift.
One of the primary questions is how these types of transactions are initially characterized, and who has the burden to prove otherwise. Either (a) it is initially considered a gift and the other side needs to show it was truly a loan, or (b) it is initially considered a loan and the other side needs to show it was truly a gift.
The Appeals Court, citing a case from 1995, reiterated the rule that a transfer such as this is initially considered a loan unless the other side can show that it was truly a gift.
This brings us to best practices in estate planning. When a parent wants to make a transfer of money to one or more family members, we recommend they (i) decide if the transfer is a loan or a gift, then (ii) document their intention.
If the transfer is a loan, we recommend the recipient child sign a promissory note so that there is no misunderstanding that this transfer was a loan from the parent to the child. That being said, often the parent includes a provision in their estate documents (either a Last Will and Testament or a Trust) that allocates any child’s unrepaid loans to that child’s share of the inheritance. This way, the children still receive the same amount of inheritance, but the child with the loan receives less of the estate assets after the parent’s death because they got part of their inheritance early through the unrepaid loan.
If the transfer is a gift, we recommend the parent writes and signs a simple memo stating that the transfer is a gift, not a loan, and the parent is not looking for any repayment.
Regardless of whether the transfer is a loan or a gift, there should be clear documentation as to its’ characterization to help prevent family arguments after one of the parties’ deaths.