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What is a promissory note?

This simple tool can help you straighten out potentially confusing repayments from loved ones near and far.

Promissory notes, which may also be called notes payable or formal IOUs, are signed documents that contain a written promise to pay a specific sum. This stated sum will be paid to a specific person or the bearer of the promissory note on a specific date, depending on the details of the note itself.

It’s a tricky situation when you’re asked to lend money to friends or family outside the US. There’s the logistics of getting the funds there in a way that’s most convenient for your recipient. But you’ll also want to prevent potential problems by hammering out repayment details — this is where a promissory note comes in handy.

How to write a promissory note

Here’s how to put one together to safeguard your lending — and your relationships:

  1. Find a promissory note template online or contact a lawyer.
  2. Enter key details, including the name of the borrower, the lender and a witness, the amount, the date, the payoff date and any additional clauses.
  3. Have both parties sign and date the document.
  4. Have the witness sign and date the document.
  5. Make multiple copies of the signed and dated document, providing one for each person in the agreement for safe record keeping.

Additional clauses you may want to include in the promissory note include:

  • Interest rate
  • Whether the note is secured or not
  • What happens if payment isn’t completed by the specific date
  • Conditions outlining procedures in the event the note must be passed to the next of kin

Why should I use a promissory note?

A promissory note is a document that records agreed-on terms involved in providing a loan to someone. Think of it as a more formal IOU, as a way to remove the stress of lending money from weighing on your relationship with your family.

Because of the loosely legal binding of promissory notes, these documents can be an easy way to put everything to do with the loan in writing. That way there will be no question in the future about the amount lent or when repayment is expected.

Key tips on putting together a promissory note

When creating a promissory note, your intent to clarify the terms and conditions of the money you’re lending to avoid any future frustrations. Promissory notes work best when both parties completely agree on the terms stated.

Keeping that in mind:

  • Be specific and detailed. Don’t be vague about amounts, terms or repayment dates. And if you expect a lump-sum payment, include how much and when. The more details you put in the promissory note, the more you can make sure both parties are on the same page.
  • Have all parties sign it. A promissory note without signatures isn’t helpful — or legal. Witness signatures add credibility, but aren’t entirely necessary. Depending on the relationship of the borrower and lender, having a witness that is unbiased may be best.
  • Consider a notary. A notarized promissory note is legally enforceable. And a notary can serve as a both a witness and endorser, should the need arise.
  • Include recourse for nonpayment. Not an easy conversation, but discuss what happens if your borrowers doesn’t pay you — additional costs, extended terms or even legal action. Remember, discussing these potentially awkward topics now may save you stress later on.

Are there any tax implications with a promissory note?

A promissory note not only reiterates to each party that the loan is just that — a loan, and not a gift. But it also provides clear proof to the IRS that you aren’t gifting money.

To decide not to charge interest to your loved ones is noble. But if you’re lending more than $14,000, the IRS might consider your loan a gift anyway, subjecting the full amount to the gift tax.

If you are charging interest, you’ll likely need to report the interest you earn to the IRS. This is because all loans — whether between among loved ones or lenders, domestic or international — are subject to the same interest-related rules.

These rules can be complicated to untangle. If you’re unsure about the tax implications on your specific loan, discuss it with your accountant ahead of time.

How should I receive repayments?

Even under existing US rules and regulations, you have a lot of freedom in establishing how you’d like to be paid back.

No matter whether you are lending money to someone domestically or internationally, you have many options when it comes to receiving payments on the promissory note. Although cash may be the first thing that comes to mind, it may be best to avoid it as it leaves no paper trail. Instead, explore all of your options to send money to loved ones, and pick the method that best fits your situation.

Bottom line

Promissory notes are a responsible way to lend money to loved ones to help remove some of the potential stress in the future. Although they are similar to IOUs, they can be legally binding if witnessed and signed by a registered notary. It may seem rude to propose using a promissory note when lending money to loved ones, but it is important to protect your relationships as much as your investment.

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