Gift of a loan guarantee.

• Author: Dunn, Lee
• Position: Taxation

To secure a bank business loan for a child, a parent may agree to guarantee the loan if the child fails to make the payments. Or, a parent may agree to guarantee his child's mortgage loan. The issue is whether these clients are making transfers subject to gift tax if they guarantee the loans for their children.

In each case, the child who needs the loan guarantee could go to a commercial surety and pay for a guarantee. When he turns to his parent for a free guarantee, is the parent conferring an interest in property subject to the gift tax? An argument against the imposition of gift tax on the initial guarantee centers on the consequences if the parent has to pay off the loan under the guarantee if the child fails to make payment. If the parent is considered to have made a gift on the initial guarantee, does he also make another gift when called on to pay off the loan?

Letter Ruling 9113009 addressed whether a loan guarantee is a transfer subject to the gift tax. The Service ruled that the parent was making a gift to the child when he guaranteed the child's loan. As later determined, however, the original letter ruling was issued on fictitious facts. An attorney who had wanted to publish a tax article on loan guarantees convinced a client that he needed a letter ruling on a marital deduction issue. In submitting the facts for the marital deduction, the attorney fabricated additional facts about the loan guarantee that he included in the ruling request (at no additional charge).

After the letter ruling was issued and the attorney's article was published, the IRS was inundated with protest letters from taxpayers who, for the most part, were guaranteeing mortgage loans for their children. It was...