IRS Tax Rules For Imputed Interest

If you ever lend people money, you’re going to want to know about this one IRS rule that may make you liable to paying more taxes than you realize. 

The IRS expects there to be a certain amount of interest for a loan. Even if you don’t charge this you may be subjected to taxes as if you did. The IRS calls this “imputed interest.”

How Imputed Interest Works

Imputed interest on a loan is the difference between the actual interest rate charged by the lender and the market interest rate for a similar loan. This difference is then multiplied by the loan principal to determine the amount of imputed interest.

What Is Imputed Interest?

When someone makes a “below-market-rate” loan, imputed interest come into play. This is a loan with an interest rate below the Applicable Federal Rate or AFR.

On a monthly basis the IRS publishes a list of current AFRs based on the market and economic conditions. For the current rates, talk with your tax professional.

What Kind of Loans Have Imputed Interest?

The following loans have imputed interest:

  • Gift loans 
  • Compensation-related loans
  • Loans to a shareholder from a corporation 
  • Loans made to reduce tax responsibility 
  • Loans made under contract to continuing care facilities 

Exceptions To The Rules

There are a few exceptions to this rule:

  • Gift loans of less than $10,000 (Is this right? Should it be $17,000?), if the money isn’t used for income-producing assets. See our gift tax blog post for more about how gifts work and when they’re taxed.
  • Compensation-related and corporation-shareholder loans less than $10,000, but only if the lender can prove that tax avoidance wasn’t the purpose of the loan.
  • Loans without “significant tax effect” 

When to speak with a tax professional

We always suggest that business owners meet with your tax strategist at least once a quarter to make sure you’re in compliance with all tax laws and taking advantage of ways to lower you tax liability. If you plan on making a loan, you’ll definitely want to call us at Paragon Accountants so we can help you make sure you’re doing it in a way that is most tax advantageous.

Contact Paragon today if you have questions!