Estate Problems with Gifts and Loans to Children
Gifts of money or property from parents to children often become sources of confusion, resentment and litigation upon the parents’ death. These problems could be limited if the parents and the children properly documented their intentions at the time of making the gifts and during the preparation of Wills. In the absence of such specific agreements and direct instructions the estate executors will have to rely on various legal principals and assumptions in trying to determine how the parents’ estate should be divided between the children.
Firstly, money given to a child can be either a gift or a loan. If the money is intended to be a loan (even if the parents may intend to forgive the loan at the time of their death) it should be properly documented. The simplest way to document a loan is for the child receiving the money to sign a promissory note agreeing to repay the debt at some future time.
Secondly, if the money is intended to be a gift, then there needs to be consideration as to whether or not the amount of the gift is intended to be treated as an advance on the child’s share of the parents’ estate and therefore deducted for the child’s share of the parents’ estate.
Consider the following scenario:
Parents have four children. During their lifetimes they periodically helped their children financially. They gave $50,000.00 to one child to help him buy a house with his wife. They lent to the second child (without making any loan documents) $100,000.00 to help her open a business but the business faltered and the child never paid the money back. They transferred to the third child the ownership of a vacant lot in cottage country worth $130,000.00 where the child and her family go camping in the summers. The fourth child has always been very independent and except for paying for the child’s university and post graduate studies, the parents never made any loans or gifts of money or property to the fourth child. When the survivor of the parents’ died, she left an estate worth $500,000.00 and a Will in which she directed the executors to divide the estate equally between her four children.
There are many good reason to properly document loans (and secure them against various property) which are not related to division of estates. For example, in the above scenario having proper loan documents and appropriate security would go a long way to protecting the parents in the event that the first child separated from this spouse or the second child got into financial difficulty.
Estate-Related Issues to Consider
For the purpose of this article we consider only estate related issues such as:
- Should the Estate Executor deduct the $50,000.00 given to the first child from the first child’s share of the estate?
- Should the Estate Executor demand that the second child repay the $100,000.00 loan to the estate – does the Executor have enough proof that the loan exists – has the time for demanding repayment of any loan expired?
- Should the Estate Executor deduct the value of the cottage lot from the third child’s share of the estate?
- Does the money the parents spent on the fourth child’s education count in the distribution of the estate?
- If the Executor just divides the existing $500,000.00 estate into four shares and each child receives $125,000.00, is that fair to the children, especially the fourth child? Is this what the parents meant when they instructed in their Will for the Executor to divide the estate equally between the four children?
Here are our suggestions to minimize the above issues:
Loans to children
- If you are making a loan to a child, document the loan by arranging for a document to be prepared and signed by your child which confirms the loan and its repayment terms.
- Consider if you want to receive security (i.e. mortgage) for your loan and become a secured creditor which will give you priority over spouses or other unsecured creditors in the event of the child’s divorce or financial difficulty.
- Decide if you want the loan forgiven or not on your death and make sure your Will has the appropriate provisions.
- If you do want the loan forgiven then consider if it should be treated as an advancement on the child’s share of your estate and, therefore, deducted from the child’s share of the estate.
Gifts to children
- If you want some money or property to be a gift, then prepare a document which says it is a gift (i.e. gift letter) or transfer the ownership.
- In your Will stipulate if you want this gift to be considered an advancement on the child’s share of your estate (deducted from the child’s share of the estate).
Use of the Hotchpot Clause in a Will
One key methods of readjusting the share of an estate that the beneficiaries are entitled to in order to provide for various gifts is the use of a clause called the “hotchpot clause.” In short, a Will can include a hotchpot clause which will direct the Executors to take into account various advances made during the testator’s life when dividing the estate. As such if a hotchpot clause was used in the above examples and it provided that the gifts made the first three children, the estate would be divided as follows:
Value of the estate: $780,000.00 ($500,000.00 +$50,000.00 + $100,000.00 + $130,000.00).
Each child’s notional share: $780,000.00/4= $195,000.00
First child share would be $195,000.00 – $50,000.00 = $145,000.00
Second child share would be $195,000.00 – $100,000.00 = $95,000.00
Third child share would be $195,000.00 – $130,000.00 = $65,000.00
Fourth child share would be $195,000.00
This material is provided for general information purposes only and is not intended to constitute legal advice. If you have a specific legal question about Estates or Wills, please contact Adam Altmid at firstname.lastname@example.org.