I am the trustee of an irrevocable trust for my sister. I recently made a $22k loan to her from the trust's funds to help her get out of credit card debt. The terms of the loan (which are memorialized in a signed note) are 15 years at 5 percent interest with payments due monthly. I did this in the form of a loan rather than just making a straight distribution because I did not want her to have a huge tax bill and I wanted the monthly payments to be a constant reminder of the perils of unsecured debt. Will these admittedly favorable loan terms pass muster with the IRS or will the $22k be considered a distribution to her which she must claim as income? If this will be considered income to her, what can I do to fix it? I don't see that you have any tax problem on the $22K here. If you distribute all the Trust income to her every year anything more would be a distribution from capital, untaxed. If you don't distribute all income to her each year you run into the throw-back rules and have to do a Schedule J, which WOULD be straight income to be taxed, but this (the threat of a Schedule J) should have been enough incentive to have actually distributed all the income to her in the past (or at least "credited" it to her to pay tax on whether actually physically distributed or not). I personally think you did the right thing, practically, trustee-wize, and to get the point across to her. The interest RATE is somewhat immaterial because it probably just circulates through the trust and is returned to her as taxable income, and isn't deductible by her personally. If the Trust had loaned it interest free it probably would be contested with an imputed interest rate just to get the tax for the IRS on the income versus the non-deductible interest. At no interest, she is avoiding taxable income the $22K would have generated for her, whereas charging her interest replaces some of that but doesn't give her an offsetting deduction. If the Trust was only getting 4.5% interest (or less) on the funds, that is a good argument for your interest rate being reasonable IN THIS CIRCUMSTANCE. These comments are not professionally inspired, just some common sense. Ed
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