Alarm
Extension filers: Only left to file your taxes by October 17
Open
Hide Arrow

TurboTax / Tax Calculators & Tips / All Tax Guides / General Tax Tips / IRS Tax Rules for Imputed Interest

IRS Tax Rules for Imputed Interest

Updated for Tax Year 2015


OVERVIEW

Lend someone money at zero interest, and you don't make any profit from the deal. Therefore, you might assume that the loan doesn't have any tax implications for you. In many cases, though, you'd be wrong. The tax code expects you to charge a certain amount of interest for a loan — and even if you don't, you can be taxed as if you did. The IRS refers to this as "imputed interest."


Below-market loans

Holding money in hand

Imputed interest comes into play when someone makes a "below-market" loan. That's a loan with an interest rate below a certain minimum level set by the government, known as the Applicable Federal Rate, or AFR.

Every month, the IRS publishes a list of current Applicable Federal Rates, which reflect market conditions. For example, in June 2015, the AFR for loans of less than 3 years was 0.43%. If you loan someone money at no interest, or at 0.25%, or at any rate below 0.43%, you have to deal with imputed interest.

How imputed interest works

Imputed interest is interest that the tax code assumes you collected but you didn't actually collect. For example, say you loan a friend $20,000 for one year at 0.1% interest. That friend will pay you $20 in interest ($20,000 x .001 = $20).

But if the AFR for that type of loan is 0.43%, then you should have collected $86 ($20,000 x .0043 = $86). The difference — $86 - $20 = $66 — is imputed interest, and you must report it as taxable income and pay taxes on it.

Rationale for imputed interest

The tax code calls for imputed interest because some people and organizations have tried to dodge taxes by portraying large gifts, additional compensation, dividends and other taxable payments as loans.

As explained by Seattle accountant and tax specialist Scott Usher, the government expects loans to be "structured in a business-like manner," including interest rates that reflect market conditions. The idea is that if you're not charging and collecting a certain level of interest, the government isn't going to take your word for it that this is a loan.

What kinds of loans have imputed interest

The rules for below-market loans apply to several kinds of loans:

  • Gift loans — loans between friends and family members other than spouses.
  • Compensation-related loans — loans from an employer to an employee or independent contractor.
  • Loans from a corporation to one or more of its shareholders.
  • Any loan made specifically to reduce someone's tax responsibility.
  • Certain loans made to continuing care facilities under a contract.

Key exceptions to the rules

The tax code provides a couple notable exceptions to the imputed interest rules:

  • Gift loans of less than $10,000 are exempt, as long as the money isn't used to buy income-producing assets.
  • Compensation-related and corporation-shareholder loans under $10,000 are also exempt if the lender can demonstrate that tax avoidance wasn't the purpose of the loan.

Loans "without significant tax effect" are also exempt. The IRS provides several examples in Publication 550, which describes sources of taxable income. Such loans include, among others:

  • Government-subsidized loans, like student loans.
  • Loans provided by a lender to the general public that are consistent with the lender's normal business practices (such as no-interest financing on an auto loan or a zero-interest period on a credit card).
  • Loans to help an employee relocate.
  • Loans from a non-U.S. citizen that wouldn't otherwise be subject to U.S. tax law.

Get every deduction you deserve

TurboTax Deluxe searches more than 350 tax deductions and credits so you get your maximum refund, guaranteed.

For only $54.99*
Start for Free

Looking for more information?

The above article is intended to provide generalized financial information designed to educate a broad segment of the public; it does not give personalized tax, investment, legal, or other business and professional advice. Before taking any action, you should always seek the assistance of a professional who knows your particular situation for advice on taxes, your investments, the law, or any other business and professional matters that affect you and/or your business.


Security is built into everything we do
Here's how
* Important Offer Details and Disclosures
  • Filing Deadline: IRS filing deadline for tax year 2015 is April 18, 2016 (except for residents of Massachusetts or Maine, where the IRS filing deadline for tax year 2015 is April 19, 2016).
  • Try for Free/Pay When You File: TurboTax online and mobile pricing is based on your tax situation and varies by product. Free 1040EZ/A + Free State offer only available with TurboTax Federal Free Edition; Offer may change or end at any time without notice. Actual prices are determined at the time of print or e-file and are subject to change without notice. Savings and price comparisons based on anticipated price increase expected 3/18/16. Special discount offers may not be valid for mobile in-app purchases.
  • TurboTax CD/Download products: Price includes tax preparation and printing of federal tax returns and free federal e-file of up to 5 federal tax returns. Additional fees apply for efiling state returns. E-file fees do not apply to New York state returns. Savings and price comparison based on anticipated price increase expected 3/18/16. Prices subject to change without notice.
  • Anytime, anywhere: Internet access required; standard message and data rates apply to download and use mobile app.
  • Fastest refund possible: Fastest tax refund with efile and direct deposit; tax refund timeframes will vary.
  • Pay for TurboTax out of your federal refund: A $X.XX Refund Processing Service fee applies to this payment method. Prices are subject to change without notice. This benefit is available with TurboTax Federal products except the TurboTax Home & Business/QuickBooks Self-Employed bundle offers.
  • About our TurboTax Product Experts: Customer service and product support vary by time of year.
  • About our credentialed tax experts: Live tax advice service is available via phone for your toughest tax questions; fees may apply. Service, experience levels, hours of operation and availability vary, and are subject to restriction and change without notice. Not available for TurboTax Business customers.
  • #1 best-selling tax software: Based on aggregated sales data for all tax year 2014 TurboTax products.
  • Most Popular: TurboTax Deluxe is our most popular product among TurboTax Online users with more complex tax situations.