Example of Below Interest Loan by kpw16392

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									Example of Below Interest Loan
 Example: Parent (35% tax bracket)
  makes $100,000 interest-free gift loan
  to child (10% tax bracket). Child
  deposits funds, earns 5% interest
  ($100,000 X 5% = $5,000).

Tax parent would have paid        $1,750
  Tax child pays                    500
  Savings to family               $1,250
Congressional Response -
Imputed interest rules § 7872
 § 7872 applies to:
   Gift loans

   Compensation-related loans

   Corporation loans to shareholders

   Tax avoidance loans
Imputed Interest on Gift Loans
 Imputed interest rules on gift loans –
  4 deemed (imaginary) transactions
   Lender recognizes interest income

   Borrower has interest expense

   Lender is deemed to have made a gift

   Borrower is deemed to have received a gift
Imputed Interest on Gift Loans-
Deemed Transactions
Parent                Child




Interest Income ==   Interest Expense

Gift Made   =====    Gift Received
Example of Gift Loan
Parent loans Child $200,000 at no interest; government
    rate is 4% for the entire year.
Interest for first 6 months         $ 4,000
    ($200,000 X .04 X 1/2)
Interest for last 6 months            4,080
    ($204,000 X .04 X 1/2)

Total imputed interest           $ 8,080

Parent - $8,080 interest income and $8,080 gift made

Child $8,080 interest expense and $8,080 gift received
Effect of Below
Market Loans
Type          Step   Lender       Borrower
Gift           1     Int. inc.    Int. exp.
               2     Gift made    Gift rec’d
Compensation 1       Int. inc.    Int. exp.
               2     Comp. exp.   Comp. inc.
Corp./s’holder 1     Int. inc.    Int. exp.
               2     Div. paid    Div. inc.
Exceptions and Limitations to
Imputed Interest Rules
 Loans of $10,000 or less
   Gift loans – unless proceeds are used to
    purchase income-producing assets
   Employer/employee loans–unless the
    principal purpose is tax avoidance
   Corporation/shareholder loans–same
    as employer/employee loans
Exceptions and Limitations to
Imputed Interest Rules
Loans of $100,000 or less between
  individuals–imputed interest is
  limited to the borrower’s net
  investment income (NII)
   If NII<$1,000, no interest is imputed
   Exception is not available if principal
    purpose is tax avoidance
Computation of
Imputed Interest
Example: Parent loans Child $100,000 at no interest;
   Child invests money and earns $5,000; government
   rate is 3% for first 6 months and 4% for last six
   months.
Interest for first 6 months           $ 1,500
Interest for last 6 months               2,030
Total imputed interest                $ 3,530

Apply limitation:
Parent - $3,530 interest income and $3,530 gift made
Child $3,530 interest expense and $3,530 gift received

What if child earned $2,000? $800?
Tax Benefit Rule
 Recovery of amount
  that was previously
  deducted is income in
  the year of recovery
  (to the extent of tax
  benefit in the prior
  year).

 Example – Bad debt
  for accrual taxpayer
Exclusion for Interest on State
and Local Government Bonds
 Only for interest on
  state and local
  government bonds



 Proceeds used to
  finance private business



 N/A for gains on sale of
  municipal bonds
Improvements on Leased
Property
 No income for
  improvements unless
  in lieu of rent




 The landlord’s basis for
  the improvements is
  zero
Life Insurance Proceeds
 Generally excluded from
  beneficiary’s income

 Exceptions
    Owner cancels policy
    Transfers for valuable
     consideration


 Exceptions to the exception
    Buy-sell agreements
Income from Discharge of
Indebtedness
 A taxpayer must
  report income
  when
   Appreciated
    property is used
    to satisfy the
    taxpayer’s debt
   A creditor cancels
    the taxpayer’s
    debt
Income from Discharge of
Indebtedness
 Common Exceptions
  Creditors’ gifts
  Federal Bankruptcy law
  Debtor is insolvent
  Seller’s cancellation of a buyer’s
   indebtedness
  Forgiveness of certain loans to students
Property Transactions
Formula for gain or loss

Amount realized (cash + FMV property)
-Adjusted basis (basis + additions - reductions)
=Realized gain (loss)

 Some realized gains are postponed (not
  recognized)
 Some realized losses are not deductible
Capital Gains & Losses
 Sales of capital assets generate capital gains (losses)
 Netted to arrive at net capital gains or net capital
  losses
 Individual taxpayers
   Net long-term capital gains are taxed at lower rates
   Net capital losses may offset up to $3,000 in ordinary
     income
 Corporate taxpayers
   Net long-term capital gains receive no special
     treatment
   Net capital losses are carried back 3 years or forward
     up to 5 years
Exam Thursday
 You may bring a 3” X 5” index card
  with notes, formulas, etc.
 All writing must be in your original
  handwriting.
 All cards will be collected with the
  exam.

								
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