Question

1.Why were the interest imputation rules created?
2. Explain why Antonio is required to report income even though he did not receive an asset ( either cash or property)

Answer 1

Why were the interest imputation rules created?

When someone lends money to another person, either free of any interest or at a rate of interest which is quite low as compared to the prevailing rate of interest in the market for the same type of loan, it is treated by IRS as a below-market loan. Any difference between the rate that the borrower would have paid at prevailing rate of interest in the market is imputed as having been received by the lender which he must report as income in his filing. For the purpose of calculating the imputed interest, the IRS publishes the applicable federal rates” (AFRs)—a minimum interest rate that must be charged on all loans, even personal loans.

The interest imputation rules were created in the tax code because some people and organizations have tried to dodge taxes by showing large gifts, additional compensation, dividends and other taxable payments as loans.The interest imputation rules are aimed at ensuring that no evasion of taxes takes place due to people or organizations granting either interest free loans or charging interest at a rate lower than the AFR. If any interest free or low interest loans are given, there is a presumption of some benefit as being passed on to the receiver of such loans on which the tax is imputed as falling due and as such must be paid by the receiver of such benefit regardless of whether he received it or not. The government expects a lender to structure the loans given by him in "a business-like manner," charging interest rates that reflect market conditions. The whole idea is that if you do not charge or collect a certain level of interest, the government isn't going to take your word for it would impute market related interest rate on such loan.

Why Antonio is required to report income even though he did not receive an asset ( either cash or property):

Antonio is required to report income even though he did not receive either cash or property due to his using the accrual method of reporting income. Taxpayers who use the accrual method include any money that they have the right to receive as payment for services in their taxable income once the same has been earned, regardless of whether it is actually received or not. Similarly, any proprty over which an accrual method taxpayer gets the right is included by him in his filing, regardless of whether he actually received the property or not.