Understanding How Imputed Interest Affects A Business Loan

By: First Union

business-finance

Understanding How Imputed Interest Affects A Business Loan

Imputed interest comes into play as far as a business loan if that loan was issued with an interest rate that falls significantly below market value. It is used by the IRS to calculate the taxable amount of the total loan. So for instance, let's say there is a loan transacted between family members; the loan has no interest. The IRS would then, utilizing the short-term federal interest rate, figure out the amount of interest that should have been paid on said loan. The party that loaned the money would thus have to calculate the imputed interest rate and consequently pay taxes on it.

And this is also the case when it comes to loans with interest rates that are below market value. In many cases, a business owner will loan their company money, especially in the early stages. Depending on the loan amount, if you are not charging an interest rate in line with what the IRS has set as the benchmark then again, you would be responsible for paying taxes on the imputed rate.

Some might wonder why the imputed interest rate was developed in the first place…In the 80s several companies were skirting taxes that they were otherwise responsible for by offering loans with interest rates that fell far below market rates, or that had no interest at all. This is subsequently when the IRS stepped in and came up with the imputed interest rate. The Tax Act of 1984 essentially mandated that a certain interest rate apply to any applicable loans.

Those loans that fall under this tax act include gift loans, those made with no interest rate attached. Also, if a loan is made with the intent to reduce a person or organization's tax liability, this then will also be subject to imputed interest.

The rules and regulations surrounding certain business loans can be somewhat complex. If you are unsure of the status of a loan, consulting with an accountant or business attorney might be your best bet. At First Union Lending, we help small businesses navigate the commercial loan landscape all the time. Call today to see if we have a business loan product that can help you.

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