Family Loans Explained: Taxes, Equity, and How to Do It Right

A family loan—a formal loan from a relative—could be the answer if you’re equity-rich, cash-poor, and trying to figure out how to exercise your ISOs, pay off credit cards, or maybe buy your first home. 

Need a traditional bank loan? Good luck explaining your private company stock. As for your savings? It probably isn’t going to cover a $500K exercise.

But your parents have been saving for decades. Or your aunt is sitting on some idle cash. What if you could turn that family support into a low-interest loan that doesn’t spark IRS alarms?

Welcome to the intrafamily loan.

What is a family loan?

A family loan—sometimes referred to as an intrafamily loan—is exactly what it sounds like: a loan made between family members. 

But unlike casually covering your cousin’s concert ticket, a true intrafamily loan is formal, documented, and structured with interest. That last part is important: interest. Why? Because without it, the IRS could classify the loan as a gift, triggering potential tax consequences.

Here’s the key distinction: a properly structured family loan includes an interest rate that meets or exceeds the IRS's Applicable Federal Rate (AFR). That’s what separates it from a gift in the eyes of the IRS. If done right, you can borrow a large sum, sometimes much more than a bank would offer you, at a friendlier rate, without anyone paying gift tax.

What is a family loan vs. gift?

The key difference between a family loan and a gift comes down to repayment and tax treatment. Here’s how to tell them apart:
‍

In 2025, the annual gift exclusion is $18,000 per person. If your parents gift you more than that without repayment, it counts against their $13.61M lifetime estate/gift exemption. Go above that limit? The excess is taxable, potentially up to 40%, depending on the amount.

Why startup employees care about family loans

For startup employees with illiquid equity and major tax exposure, family loans can offer flexible, low-risk funding when traditional lenders won’t.

Say you joined Ramp in 2020 and hold ISOs worth $2M on paper. The company is now valued at $13B and tender offers are in play. Exercising could save you hundreds of thousands in taxes, but you don’t have the cash. And banks won’t lend against your illiquid shares.

Enter: your parents, who are willing to help.

Instead of gifting you the money (which could create tax exposure), they issue a formal intrafamily loan. You get the liquidity to exercise. They get a modest return. Everyone avoids the IRS’s gift trap.

When family loans make sense

A family loan might be the right move if you:

• Want to exercise options ahead of a liquidity event
• Need cash to cover ordinary income or AMT taxes from exercising options
• Want to buy a home but don’t yet qualify for a large mortgage
• Have high-interest personal debt you want to refinance

These loans are especially powerful in low-interest rate environments, where AFRs may undercut bank rates. But they also work well when:

• The lender has capital they won’t need for day-to-day expenses for years
• They’re comfortable with the risks of lending against private company equity
• They’re aligned with your repayment plan and return expectations

IRS rules you should follow

Let’s talk compliance. To avoid IRS scrutiny or unintentional gift tax, a family loan needs to meet three key rules.

1. Charge interest at least equal to the AFR (Applicable Federal Rate).
2. Be documented in writing—ideally with a formal promissory note.
3. Specify repayment terms (loan amount, interest rate, payment schedule).

AFRs are published monthly and vary based on loan length:

• Short-term: 3 years or less
• Mid-term: 3–9 years
• Long-term: 9+ years

These requirements ensure the IRS treats it as a real loan—not a disguised gift.

Are you taxed on family loans?

Taxes on family loans depend on how the loan is structured and whether you're the borrower or lender.

Let’s break down the tax implications that each party should know:

• Borrower: Not taxed for receiving the loan. But you may owe capital gains or income tax on how you use the money (e.g., exercising ISOs).
• Lender: Must report the interest as income. They can offset this using the annual gift exclusion if they choose to forgive the interest each year.

Heads up: If the loan is interest-free or below AFR, the IRS may impute interest, essentially pretending interest was paid, and treat it as a gift. That can trigger filing requirements.

How to set up a family loan

Setting up a proper family loan means treating it like a real financial agreement—with documents, interest, and repayment terms the IRS will recognize.

Here’s your family loan checklist:

• Loan Agreement: Document the parties, amount, term, interest rate, and repayment schedule.

• Promissory Note: A legal document acknowledging the debt.

• AFR Compliance: Make sure the interest meets or exceeds the federal rate.

• Payment Schedule: Monthly, quarterly, annual, or lump sum. Define this clearly.

• Optional Collateral: Some families secure the loan with equity, property, or other assets.

What happens if you can’t repay? It depends on the family dynamics—and the legal terms. If your agreement says the loan is secured by your equity, your lender could claim those shares. In practice, many families absorb non-repayment as a gift later. But be careful: if you stop repaying, the IRS may reclassify the loan as a gift retroactively.

Tips for managing a family loan successfully

Even when you're borrowing from family, transparency and structure are essential to keep relationships (and your tax situation) healthy.

Here are some tips to help preserve trust, ensure compliance, and keep things running smoothly on both sides of the deal.

• Be transparent about repayment expectations.
• Keep payments on schedule to avoid disputes.
• Record all payments (even informal ones) for your records.
• Don’t forget: interest is taxable income to the lender!

Watch out for:

• Family tension if repayment stalls
• IRS scrutiny if terms aren’t documented
• Potential estate tax impacts if reclassified as a gift

Should you just ask for a gift instead?

In some cases, a direct gift might be simpler than a formal family loan—but it comes with tradeoffs.. 

If your parents are comfortable parting with the money, a gift might be cleaner. But:

• It could reduce their lifetime estate exemption.
• You lose the optionality of repayment if things go well.

Start with a conversation. Align on expectations. If there’s any chance of ambiguity, a documented intrafamily loan gives you clarity, structure, and optional tax advantages.

Bottom line: How to use family loans without triggering taxes

Intrafamily loans are a powerful tool for startup employees and founders navigating major equity decisions. They can help you:

• Exercise ISOs or NSOs without selling shares
• Cover equity-related taxes like AMT
• Buy a home before liquidity
• Refinance expensive personal debt

Done right, it’s one of the most powerful financial moves available to employees without the liquid cash to move fast.

Just make sure you:

• Follow the AFR guidelines
• Document everything
• Talk to your CPA or legal advisor

You’ve worked hard to earn your equity. Don’t let lack of liquidity cost you a life-changing gain.

Want help modeling your exit? Prospect lets you upload your equity, simulate outcomes, and plan for tax moves like intrafamily loans. It’s like having your own CFO—just smarter, faster, and built for employees.