In: Accounting
An employer loans 100,000 interest-free to an officer for two years at a time when the AFR =
11.8%. What are the tax consequences?
In case of employer-employee loans of more than $10,000, the minimum interest rate to be charged under the loan must be at least equal to the Applicable Federal Rate (the "AFR") for the month in which the loan takes place.
If the applicable interest rate on loan is below the AFR, the Difference between the interest calculated as per AFR and actual charged interest rate will consitute a taxable compensation income to the employee. If the loan is a term loan, the amount of the foregone interest is considered to be transferred to the employee as of the date of the loan, with the result that the employee's taxable compensation would increase as of the date on which the loan is made.
In the given case, since the loan amount is greater than $10,000 (100,000) and the charged interest rate (Nil) is less than the AFR of 11.80%. Interest Difference 11.80% - Nil = 11.80% for 2 Years on $100,000 = $23,600 will be treated as the employee compensation as on the date of loan.