In: Accounting
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?
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.