Interest that the tax authorities assign to certain transactions is called imputed interest, even if there was no payment or receipt of it. This concept is commonly utilized when a loan is made at a lower interest rate than the market rate or when it is interest-free. The IRS ensures that the lender pays taxes on the interest they could have earned if the loan had been made at a market rate.
To illustrate how imputed interest is calculated for tax purposes, here is an example:
Ashley, Lillie's good friend, provided her with a loan in November of last year. Ashley charged Lillie with an annual interest rate of 2.7%, a generous act that falls well below the AFR of 4%. Lillie took out a loan of $60,000 for one year at an interest rate of 2.7% a year. Determine the amount of imputed interest that Lillie is obligated to include in her taxable income for the current year.
Step by Step Solution:
Answer $650
- AFR = 4%
- Actual Interest Rate 2.7%
- Imputeted Interest is 1.3% (4% - 2.7%)
- 60,0000 x 1.3% = $780 for 12 months whereas for 10 months it is $650. Because the loan was given in November.
