For the first time since the financial crisis, the Federal Reserve has taken the first step in raising interest rates.  Changing interest rates can seriously affect estate plans of affluent families and certain strategies should be kept in mind as the rates climb.

An intrafamily loan can be an effective strategy for transferring wealth to younger generations.  By lending money to adult children to invest, the parent can take back a promissory note on which the children pay interest and retain any net investment return above the loan rate.  The Internal Revenue Code imposes a minimum interest rate that parents must charge their children on intrafamily loans to avoid the below-market-rate loans being treated as gifts.  This month the interest rate ranges from 0.56% – 2.61% depending on the term of the loan.  As interest rates rise, borrowers will need a higher rate of return to make a profit, thereby making this strategy less attractive if rates continue to increase.

Further consideration should be made for those seeking to loan or borrow money intrafamily between a U.S. person and a nonresident alien.  Under IRC § 871, there is a 30% withholding tax on any U.S. source income received by a nonresident alien individual. There are however some exceptions to this rule.  Some countries have tax treaties with the United States providing for no tax on interest paid to someone in that other country.  The other exception is provided in IRC § 871(h), which states that no tax shall be imposed on portfolio interest received by a nonresident individual from U.S. sources.  By structuring the loan as a portfolio debt obligation, a nonresident alien individual can avoid the tax on interest payments received.