Loans to C corporation

[Pacun]

Let's say that an unrelated party (good friend of the owner of corporation) wants to lend $10K to the corporation for one year. The loan document will state the loan will be made on August 15 2011 and the corporation will pay back the loan plus interest on August 14, 2012. What should be the minimum interest rate that the individual should charge to the corporation? Can I use something like 10% yearly and that will be legal and will not have any imputed interest?

[TAXBILLY]

http://www.irs.gov/app/picklist/list/federalRates.html

taxbilly

[OldJack]

When would a note call for interest and not state the interest rate? You should not be imputing interest, the note should state the interest. If no note document, ask the parties what the interest rate was agreed.

[Pacun]

I have noticed that the minumum was 3.6. Can I just charge 5% annually and forget about the fluctiations in interest that the government publishes?

[OldJack]

>> Can I just charge 5% annually and forget about<<

In my opinion a tax preparer does not have authority to determine interest rates on a client loan. Suggest you ask the clients to provide you with their terms on the loan. If the loan goes bad guess who they might sue? As far as the IRS is concerned the interest rate is not a question if it is more than the AFR rate.

[Pacun]

>> Can I just charge 5% annually and forget about<<

As far as the IRS is concerned the interest rate is not a question if it is more than the AFR rate.

Are we on agreement that 5% per year is more than the AFR rate? I rather tell my client to make the loan with AT LEAST 5% insterest than telling to check every month what the AFR is.

[Bees Knees]

The imputed interest rules apply when the interest rate is less than the applicable federal rate (AFR). Thus, if interest is greater than AFR, there is no imputed interest.

The purpose of the rule is to prevent taxpayers from using loans to shift income to taxpayers in lower brackets or to shift income from ordinary income to capital gains by raising a purchase price and charging less interest.

For example, Kyle sells Ken property with a FMV of $50 million and an adjusted basis of $20 million. Assume Ken pays $5 million down and makes monthly payments of $500,000 to Kyle. If the sales price is $50 million and the interest rate is 8%, Kyle will realize a $30 million capital gain and earn approximately $24 million in taxable interest income. If the sales price is $60 million and the interest rate is 4%, Kyle will realize a $40 million capital gain and earn approximately $14 million in taxable interest income. Under both methods, Ken pays approximately $74 million in total principal and interest to purchase the property. However, by raising the purchase price and charging less interest, Kyle has shifted $10 million from ordinary income to capital gain income.

Obviously, then, the IRS does not care if the interest is higher than the AFR because in that case, income subject to ordinary income tax rates increases and income subject to capital gain rates decreases.

As to whether or not we should advise clients about the current AFR and the imputed interest rules, I believe that is a legitimate function of a tax professional.

As to fluctuations in the AFR, the AFR that applies is the rate that applied at the time the loan was made. Future AFR that go up or down after the loan is made are irrelevant.

[Pacun]

As to fluctuations in the AFR, the AFR that applies is the rate that applied at the time the loan was made. Future AFR that go up or down after the loan is made are irrelevant.

That's what I wanted to hear. Thank you so much for your answers.