Understanding Your Legal Responsibilities When Family Loans Become Estate Issues
If you’ve been named as an executor or personal representative in a will, you may face unexpected challenges when dealing with intrafamily loans. A recent Tax Court case, Estate of Galli v. Commissioner, provides critical guidance on how to avoid personal liability and tax disputes when administering estates that include loans between family members.
Who This Guide Is For
This article is specifically designed for:
- Executors and personal representatives who are managing estates with intrafamily loan arrangements
- Family members who have made or received loans from relatives and want to protect their estate planning
- Anyone concerned about whether family financial transfers will be treated as loans or gifts by the IRS
The Problem: When Are Family Loans Actually Gifts?
As an executor, one of your most challenging responsibilities is determining whether money transferred between family members constitutes a legitimate loan or a gift. This distinction matters because:
- Gifts may trigger gift tax obligations and reporting requirements
- Mischaracterized loans can lead to estate valuation disputes with the IRS
- Executors can face personal liability for incorrect tax treatment
The IRS presumes all intrafamily transfers are gifts unless you can prove otherwise. This presumption puts the burden of proof squarely on executors and families to demonstrate that a bona fide loan existed.
Real-World Example: The Estate of Galli Case
In the Estate of Galli case, Barbara Galli lent $2.3 million to her son Stephen. When Barbara died, the IRS challenged whether this was truly a loan or a disguised gift. The Tax Court ultimately ruled in favor of the estate, but only because the family had meticulously documented the transaction.
What the Galli family did right:
- Created a formal written promissory note with clear terms
- Charged interest at the applicable federal rate (1.01%)
- Established a fixed 9-year repayment term
- Stephen made annual interest payments in 2014, 2015, and 2016
- Barbara reported the interest as taxable income on her tax returns
Even with this documentation, the IRS still challenged the loan’s legitimacy, arguing it was unsecured and lacked commercial comparability. However, the court found that charging interest at the AFR and maintaining consistent payment and reporting practices were sufficient to establish a bona fide debtor-creditor relationship.
Contrasting Case: When Family Loans Fail IRS Scrutiny
The Estate of Bolles case demonstrates what happens when intrafamily loans lack proper documentation. Mary made numerous advances to her son Peter, who was experiencing financial distress. The court ruled these were gifts, not loans, because:
- No formal promissory notes existed
- No collateral secured the advances
- Interest and principal payments were inconsistent
- Peter lacked the financial capacity to repay
- No meaningful enforcement of repayment occurred
The absence of these formalities, combined with Peter’s insolvency, led the court to conclude the transfers were gifts.
How Can Executors Determine If a Family Transfer Is a Loan?
Courts examine multiple factors when determining whether intrafamily transfers are loans or gifts. As an executor, you should evaluate whether:
- A written promissory note or evidence of indebtedness exists
- Interest was charged on the loan
- Security or collateral was provided
- A fixed maturity date was established
- Demands for repayment were made
- The borrower had the ability to repay
- Actual repayments were made
- Records reflect the transaction as a loan (not a gift)
- Federal tax reporting treated the arrangement as a loan
No single factor is determinative—courts look at the totality of circumstances. However, documentation and consistent conduct aligned with loan treatment are critical.
What Are the Key Lessons for Executors and Families?
Both the Galli and Bolles cases provide essential guidance for protecting estates from IRS challenges:
1. Documentation is absolutely critical
Written loan agreements with clear terms strongly support loan treatment. Maintain accurate records showing the loan as an asset of the lender and a liability of the borrower to demonstrate intent.
2. Actions must reflect intent
Regular payments and enforcement of repayment obligations help convey the parties’ intent to create a legally enforceable debt. Sporadic or missed payments undermine loan characterization.
3. Borrower insolvency is a significant red flag
A loan is difficult to sustain if repayment was unrealistic from the beginning. If the borrower clearly cannot repay, the IRS will likely treat the transfer as a gift.
4. Consistent tax reporting strengthens your position
Regular interest payments and reporting such payments as income both support the transaction as a loan. Inconsistent reporting raises red flags.
How to Protect Your Estate from IRS Challenges
Intrafamily loans must be structured and administered to resemble arm’s-length commercial transactions. As an executor or someone creating an estate plan, you should:
- Work with experienced estate planning attorneys to draft proper loan documentation
- Ensure interest rates meet or exceed the applicable federal rate
- Establish realistic repayment terms based on the borrower’s financial capacity
- Maintain detailed records of all payments and communications
- Report interest income consistently on tax returns
- Consider securing loans with collateral when possible
The importance of careful planning, proper documentation, and compliance with loan terms cannot be overstated when seeking favorable tax treatment.
Get Expert Guidance for Probate and Trust Administration
If you’ve been named as an executor or personal representative and are facing questions about intrafamily loans, estate valuation, or potential tax disputes, you don’t have to navigate these complex issues alone.
California Probate and Trust, PC specializes in helping executors fulfill their legal duties while avoiding personal liability. Our experienced probate attorneys understand the nuances of cases like Estate of Galli and can help you:
- Evaluate whether family financial transfers qualify as loans or gifts
- Prepare proper documentation to support estate valuations
- Navigate IRS challenges and estate tax disputes
- Protect yourself from personal liability as an executor
- Ensure compliance with California probate law requirements
Schedule your free consultation today by calling (866) 674-1130 or visiting cpt.law/contact-us. Our compassionate team will walk you through your responsibilities and develop a strategy to protect both the estate and your interests as executor.
Source: Original content based on “Holiday Generosity or Enforceable Loan? Intrafamily Transfers in Light of Estate of Galli” published January 5, 2026. Legal analysis derived from Estate of Galli v. Commissioner (T.C. No. 7003-20 and 7005-20) and Estate of Bolles (T.C. Memo 2020-71, affirmed, (9th Cir. 2024) No. 22-70192).