Question

In: Accounting

Joshua loans his son, Seth, $100,000 interest free for five years. Seth is the money for...

Joshua loans his son, Seth, $100,000 interest free for five years. Seth is the money for a down payment on his home.   assume that the applicable federal interest rates is 4 percent.

a. What are the tax consequences of this loan to Joshua and to Seth?

b. How would your answer change if Seth uses the money to invest in corporate bonds paying 8 percent annual interest?

Solutions

Expert Solution

a) There are no tax consequences to Joshua ans Seth because the loan is not in excess of $100,000 and the proceeds are used for personal expense ( rather than investment); the transaction is not subjected to the imputed interest rules.

b)The imputed interest rules treat the transaction as if seth paid $4000 in interest ($100,000 × 4%) to Joshua each year with Joshua recognising $4000 of interest income; Joshua would then be assumed to make a gift of $4000 annually to seth.
                      Thus, Joshua must recognise $4000 in interest income ( from the interest imputed at the federal rate) annually and seth recognizes $8000 of interest income (from his investment in corporate bonds). If seth net Investments income is less than $4000, the imputed interest will be limited to the lower net Investments income.


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