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Navigating the Tax Implications of Below-Market Family Loans: A Breakdown from the IRS (2023 Update)

Can anyone provide links to __IRS__ explanations of the rules that govern required interest rates for family loans?

Also, for calculating and reporting taxable interest income for "below-market" family loans?

I can find some webpages written by "tax experts". And I find some discussions in this forum. They are all good.

But I also like to get the information "from the horse's mouth": IRS pubs; IRS rev ruls; IRS forms and instructions; etc.

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Also, the AFR documents are unclear to me.

Are the subannual rates stated as annual rates or as periodic rates?

If they are annual rates (as I assume), is the periodic rate calculated by annual/freq or (1+annual)^(1/freq)-1, treating the AFR as a compounded rate?

For example, for a monthly loan initiated in Feb 2022, is the __monthly__ rate 0.59%, 0.59%/12 (0.049167%) or (1+0.59%)^(1/12)-1 (0.049034%)?

And are there any particular rounding rules?

For example, for Section 7520 interest rates (*), IRS regulations are very specific: ``That rate is then rounded to the nearest two-tenths of one percent or 2.6 percent.``.

Unfortunately, that example is for annual rate. Would I also round to 0.2% for calculated subannual rates?

In any case, I don't know if similar rounding rules applies to family loans.

(*)

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Finally, it is unclear to me how and where to calculate and report taxable interest income for below-AFR family loans.

"Expert" webpages that I find (so far) only discuss interest-free family loans. So the imputed interest is based on the entire AFR.

But I assume the calculation is actually something like:

(interest at AFR) minus (interest at below-market rate)

The "expert" webpages indicate that such taxable interest income should be reported on "line 8a".

But persumably, that is not for the 2021 Form 1040. There is no line "8a" per se; and Schedule 1 line 8a is for "net operating loss", which is entered as a negative amount.

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Sorry for all the questions. Thanks for any pointers to IRS answers.

Reply to
Joe User
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The IRS has several publications and resources that provide information on the rules that govern required interest rates for family loans. The following links can provide more information on the topic:

  1. Publication 936:
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    This publication provides information on the interest rate that must be charged on a family loan in order for it to be considered a bona fide loan.

  1. Revenue Ruling 87-24:
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    This revenue ruling provides information on how to determine the interest rate that must be charged on a family loan in order for it to be considered a bona fide loan.

  2. Form 709:
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    This form is used to report taxable gifts and must be filed if the loan is interest-free or if the interest rate charged is less than the applicable federal rate (AFR).

  1. Instructions for Form 709:
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    These instructions provide information on how to complete Form 709 and report taxable gifts.

  2. Applicable Federal Rates:
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    This page provides the current applicable federal rates (AFR) and other interest rates that are used to calculate imputed interest on family loans. Regarding the AFR, the annual rate is stated on the IRS website. To calculate a periodic rate (e.g. monthly), you would divide the annual rate by the number of periods in a year (12 for monthly). The formula you mentioned (1+annual)^(1/freq)-1) is used to calculate a continuously compounded rate. The rounding rules for the AFR are not specified on the IRS website, but it's best to follow the general rules of rounding.

Regarding the taxable interest income, it should be calculated as the difference between the interest charged at the AFR and the interest charged at the below-market rate on the loan. The taxable interest should be reported on Form 1040, Schedule B, Interest and Ordinary Dividends.

Reply to
Smart Bean

But getting back to your formula:

For a monthly loan initiated in February 2022, the monthly rate would be 0.59%/12, which is equal to 0.049167%.

The formula (1+0.59%)^(1/12)-1 (0.049034%) is used to calculate a continuously compounded rate, which is different from the nominal interest rate for the loan, which is the interest rate stated on the loan contract.

It's important to note that when calculating the interest on a loan, the method used should be consistent with the terms of the loan. If the loan agreement states that the interest rate is a nominal rate, then the interest should be calculated using the nominal rate. If the loan agreement states that the interest rate is a continuously compounded rate, then the interest should be calculated using the continuously compounded rate formula

Reply to
Smart Bean

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