Employment Expense Repayment Demand Letter - PDF

							                        Bookkeeping Tips
The American Institute of Professional Bookkeepers (www.aipb.org)              VOL. 2: Issue 51

                                Recording corporate loans
                                      to employees

If your employer lends money to employees, including owner-employees, recording the
interest at year-end can be tricky. The journal entry depends, in part, on the kind of loan
made.

Demand loans. A demand loan is one payable in full when the lender demands it. Here, the
trick is properly recording the unpaid interest. Say that a corporation makes an interest-free or
below-market demand loan to an employee or independent contractor (IC). After the loan is
made, the corporation must, at each Dec. 31, record as compensation to the employee or IC
the imputed interest—the interest the employee or IC would pay if the loan was from a bank or
other creditor.

Example: CorpCo makes a $50,000 interest-free demand loan to Employee Joan that is
outstanding for all of calendar 2006. The 2006 imputed interest is $2,490. CorpCo records the
following journal entries on Dec. 31:

Compensation Expense              2,490
  Cash                                       2,490

Cash                              2,490
   Interest Income                           2,490

     CorpCo treats the imputed interest as a deduction for compensation expense and as
interest income.

    The following adjusting entries illustrate how Employee Joan treats the imputed interest on
Dec. 31:

Cash                                2,490
   Compensation Income                          2,490

Interest Expense                  2,490
   Cash                                      2,490

To summarize: In general, the corporation can claim a compensation expense deduction and
must recognize interest income. The employee is taxed on the compensation income and takes
a deduction for interest expense subject to the limits on personal and investment expenses. If
the interest expense is nondeductible on the employee’s tax return, the employee will have
taxable income without this offsetting deduction. If the borrower is an IC, the tax
consequences are similar, except that the imputed interest is treated as nonemployee
compensation rather than wages.

    Calendar-year corporations on the accrual basis book the adjusting entries to accrue
compensation expense and interest income as shown above. The phantom cash transfers are
booked as if made on Dec. 31.

    If the demand loan is paid in full during the calendar year, the imputed interest
“payments” are recorded on the date of repayment rather than on Dec. 31.

                                                                                        (continued)
Term loans. Corporations may make interest-free or below-market term loans to an
employee and impute interest. If, however, employment-related conditions are attached, such
as accelerating the due date if the employee terminates, or requiring cash payment of the fair-
market interest upon termination, the loan is treated as a demand loan to determine the
timing and character of imputed transfers. In other words, the imputed interest “payments”
(transfers) are considered made on Dec. 31, as in the example above.




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