In: Accounting
On July 1, 2020, Katerina made a $90,000 interest-free loan to her son, Dominic, who used the money to retire a mortgage on his personal residence and to buy a certificate of deposit. Dominic’s only income for the year is his salary of $35,000 and $1,400 interest income on the certificate of deposit. Assume the relevant Federal interest rate is 8% compounded semiannually.
Required: Determine the effect of the loan on Katerina’s gross income for 2020. Provide explanations and supporting computations to support your answer to receive full credit.
Ans :
As a parent, there’s a chance we may lend our kids money throughout life. Maybe it’s to buy a bike, to get their first car or even to purchase their very own home. Internal Revenue Service (IRS) doesn’t care about small loans. The IRS isn’t concerned with most personal loans to your son or daughter. They also don’t care how often loans are handed out, whether interest is charged or if you get paid back. In 2019 and 2020, you can give up to $15,000 to someone in a year and generally not have to deal with the IRS about it.
But if the amount is significant Like to buy a house or so , which is in this case applicable , it is important to charge Interest .
If you don’t, the IRS can say the interest you should have charged was a gift. In that case, the interest money goes toward your annual gift giving limit of $14,000 per individual. If you give more than $14,000 to one individual, you are required to file a gift tax form.
The rate of interest on the loan must be at least as high as the minimum interest rates set by the IRS.
There is an exception when interest-free loans between individuals do not constitute a taxable gift. When the amount of the loan does not exceed $10,000 no taxable gift or deemed interest income and expense is created. This exception does not apply, however, when the interest-free loan is for the purchase or carrying of income-producing assets.
Further, for one or more interest-free loans directly between individuals of $100,000 or less, the amount of interest income and expense treated as retransferred by the borrower to the lender at the close of any year may not be exceed the borrower’s net investment income for that year. However, this limitation does not apply where one of the principal purposes of the loan arrangement is the avoidance of federal tax.
Hence the effect of loan given to her son is that the loan is treated as gift and income of Katerina will include = 90000 * 8% = $ 7200