Parent’s Payment of Child’s Debt

A child gets easily in debt because many creditors such as credit card companies market to youth when they see their clean records. When a child is in debt, the parent may think twice about paying off the debt because it could be considered a gift, not income. The parent can help a child stay on track in finances, and not get into bankruptcy, by paying off a child’s debt.

If the payoff was considered income, then the parent could put the child in debt with the Internal Revenue Service (IRS) for taxes. But, if the payoff was a gift, the parent could get exemptions based on gift tax laws, and neither the parent nor child would end up with tax to pay.

In a recent ruling against the IRS, a court found that a parent’s payment of a child’s debts were a gift not taxable income. In the case, a mother worried her daughter was financially irresponsible. The daughter had liabilities the mother wanted to be paid, but the mother did not want to give money to her daughter. The mother paid the claimants directly on the liabilities.

The IRS decided the daughter had income from her mother’s payments of the liabilities. The court held the mother’s payments were gifts to the daughter, not taxable income.

A parent can also help a child out in finances by co-signing a debt such as a car loan. If the child later defaults and ends up in bankruptcy, depending on whether the debt a person co-signed for is dischargeable in bankruptcy, the debt will be discharged for the person filing bankruptcy. The non-filing person will still be liable for the debt, but if the person who files bankruptcy files under Chapter 13, the co-debtor not filing bankruptcy is protected.

In a Chapter 13 bankruptcy, the person filing bankruptcy can make the co-signed debt part of the debts to payoff in the Chapter 13 plan, and pay the debt over time. The payment plans for Chapter 13 are usually 3-5 years. The plan requires confirmation by the court, and the filing person pays a monthly amount to the trustee who distributes the money to each of the creditors. While the bankruptcy is going on, the creditor cannot go after the non-filing person or the filing person for paying the debt because of the automatic stay.