Tax Insights

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What to Consider When Drafting Promissory Notes

I had a client who brought me in a blank promissory note that they had printed off the internet and wanted me to help them fill it out.  I wanted to make sure I informed them of all the items they needed to consider when drafting a promissory note.  I am used to getting complete promissory notes from clients, but never had to prepare one for the client.  So I set out to research what to consider when drafting a promissory note.

The promissory note simply states that there is an unconditional promise by the borrower to pay the lender on demand or at a specified date, a sum that is certain.  Something  to consider is selecting interest payment dates that are specific and you may want to meet the published federal rate for a similar loan with the same duration.  Furthermore, the borrower should not be an obligator or co-obligator on the loan.  This just means that there is not a pledge or guarantee to the lender of the maker’s assets and that the loan was obtained solely on the holder’s credit.

In my research, I also learned that promissory notes may also include an acceleration clause, which will make the entire amount of the note due if a payment is missed.  Be careful to look up your state’s usury laws that define the maximum interest rate you are allowed to charge.  The term usury refers to an unlawfully high interest rate.  So if you violate usury laws then there can be civil and even sometimes criminal charges.  A misconception in this area is just because a bank or credit card company charges a particular interest rate, then an individual can charge a similar rate.  However, most jurisdictions have different interest rate regulations for individuals than for banks or financial institutions.   Individuals are often restricted to charging a lower rate of interest.

Finally, when looking for state-specific promissory note forms you may want to go to an office supply store or purchase one online.  Sometimes these forms will include instructions, but make sure that the instructions are not out of date.  You should also consider seeking assistance from a lawyer or your CPA, especially for larger loan amounts that you want to make sure are in proper form and recorded correctly.

Ronda Priborsky, MBA