If the interest rate charged for a loan is below the applicable federal rate, imputed interest is calculated. The applicable federal rate (AFR) is published monthly by the internal revenue service (IRS) in an internal revenue service bulletin and can be found at irs.gov. Search for “applicable federal rate” for the month in which the loan begins. For loans between individuals, the foregone interest is considered a gift subject to gift tax provisions. For a loan to a stockholder from a corporation, the foregone interest is taxable dividend. For a loan to an employee from a corporation, or an entity, the foregone interest is taxable as compensation along with all payroll implications.
There are exceptions to below-market rules as follows. There is a $10,000 gift loan exception if the principal purpose of the loan is not tax avoidance. Employee relocation loans are exempt. Arm’s length commercial transactions, such as 0% financing auto loans by an auto manufacturer, are exempt. Loans between individuals are exempt if the amount borrowed does not exceed $100,000 or the borrower’s investment income does not exceed $1,000. Please call us at 719.388.8606 with any questions.