For many individuals, ensuring that the family business remains solvent is of utmost importance. Depending on the family enterprise, loans may be required between family members during turbulent financial times to keep the company afloat. In a decision issued on April 1, 2024, the U.S. Court of Appeals for the Ninth Circuit affirmed a Tax Court ruling that scrutinized a series of intrafamily “loans” and held that while some of the transfers in question could be characterized as borrowed amounts, subsequent transfers should be treated as gifts based on the intent and actions of the “lender” and “borrower” (Estate of Bolles v. CommissionerNo. 22-70192, 2024 WL 1364177 (9th Cir. Apr. 1, 2024)).

The history of the “loan”

Peter Bolles was the eldest of Mary and John Bolles' five children. He graduated in architecture in 1965, and based on his academic achievements and his father's reputation as an architect in San Francisco, he showed great promise. After working for a while in Boston, he would later move home to San Francisco, where he took over his father's practice. Despite such promise, he began to experience financial difficulties in the mid-1980s.

From 1985 to 2007, Mary transferred a total of $1,063,333 through a series of payments to or for the benefit of Peter to help him with the family business. While he initially made several payments on the “loan” (none of which was evidenced by a promissory note), Peter stopped making them after 1988.

Accordingly, in her revocable trust dated October 27, 1989, Mary excluded Peter from any distribution of her estate upon her death. In a later amendment to the trust agreement, instead of excluding Peter entirely, Mary provided a formula for the distribution of her estate after her death to essentially equalize the other beneficiaries of the trust for the unpaid “loans” owed to were given to Peter during her lifetime. In May 1995, Peter signed an acknowledgment, noting that he had, as of that date, received $771,628 and, although he had neither the assets nor the earning capacity to repay all or any part of the amount “borrowed” , such amount, together with interest, would be used in calculating the distribution of Mary's trust assets after her death. Beyond this acknowledgment, Peter never delivered a promissory note or other evidence of debt to his mother.

After Mary's death, her executor filed an estate tax return, which described Peter's signed acknowledgment as a “(p)render dated May 3, 1995, in the first sum of $771,628” that “is wholly uncollectible and void” because “Peter P. Bolles is insolvent.” The estate tax return also failed to report additional amounts transferred to or for Peter's benefit as gifts made to him during Mary's lifetime.After reviewing the estate tax return and payment history, the Internal Revenue Service disputed how transfers from Mary to Peter were reported on the return and sent Mary's executor a notice of deficiency, alleging: (1) if any amount was a loan, the return necessary to account for any unpaid amounts by adding them to the gross estate and (2) if any amount was a gift, the return would have to reflect such amounts as “prior gifts.” Since the parties could not agree which payments were loans and which were gifts, the executor applied to the Tax Court for resolve the matter.

Distinction of advances as loans or gifts

There are traditional factors, known as “Miller” Factors used to determine whether an advance of funds from one individual to another should be considered a loan or gift, including whether: (1) there was a promissory note or other evidence of indebtedness; (2) interest was charged; (3) had security or collateral; (4) had a fixed maturity date; (5) a request for redemption was made; (6) actual repayment has been made; (7) the recipient had the ability to repay; (8) the transferor kept records; and (9) the manner in which the transaction is reported for federal tax purposes is consistent with a loan. (Miller v. Commissioner, TC Memo 1996-3, af'd. 113 F.3d 1241 (9th Cir. 1997)).

In the context of intra-family loans, a transaction applies even more to determine whether the amount thus transferred is a loan in good faith or is, in fact, a gift. It is a longstanding principle that an actual expectation of repayment and an intention to enforce the debt are critical to support the tax characterization of the transaction as a loan. (Estate of Van Anda v. Commissioner12 TC 1158,1162 (1949), approved by the court192 P.2d 391 (2d Cir.1951)).

In that case, the Tax Court held, and the Ninth Circuit affirmed, that the payments by Maria to Peter from 1985 to 1989, despite the absence of promissory notes, were loans because the circumstances indicated that a bona fide creditor-debtor relationship existed between them . It took almost a decade for Peter to experience financial problems after entering the workforce, and Mary, who was previously married to an architect, knew that there were fluctuations in the practice's financial fortunes. It was reasonable then that, during this time, Mary expected Peter to use the payments to make the business successful and to pay it off once the practice became payable again.

The payments after 1989, however, were made under different circumstances: no reimbursement to Mary was made by Peter during this subsequent period, Peter was specifically excluded from Mary's estate plan at the end of 1989, and Peter had signed the acknowledgment saying he had neither the assets nor the earning capacity to make any repayments. The Ninth Circuit affirmed the Tax Court's finding that no bona fide creditor-debtor relationship existed after 1989 based on these facts and, accordingly, any payment during that subsequent period was actually a gift.

The facts made it clear that Maria had high hopes for her son when she began transferring money to him to support his professional work. However, it was also clear that, at least by October 27, 1989, Mary realized that Peter would not be able to repay her, causing her to revise her estate plan to remove him as a beneficiary. Therefore, as of that date, subsequent transfers could no longer be treated as loans and would be required to be treated as gifts for federal tax purposes.

Prepare for review

Practitioners who become aware of an intra-family loan, or because they are asked to directly assist or learn about the loan in their dealings with a client, should advise their clients to ensure that all parties to the transaction behave as if it were a loan. . If the facts do not support lending in good faith, an unintended gift may be committed and, depending on the amount of the “loan,” serious financial consequences may result from the transaction. The IRS position in this case is one that has been advanced frequently in recent years – intra-family transactions will be scrutinized more closely in determining gift/estate tax issues and deficiencies. As a result, practitioners must scratch beneath the surface of the transaction to ensure that the elements of a bona fide loan are present if the parties wish to avoid gift treatment.