![]() The IRS doesn’t want us making substantial, interest free loans to our family members. In addition to holding the Lender responsible for the taxable imputed interest, the IRS also assumes that since the Borrower did not make the required interest payments, the Lender is considered to have gifted the Borrower the money to pay the interest that was due. In other words, you lend a loved one over $10,000, and never charge or collect a penny of interest income on the family loan, the IRS requires you to pay income taxes on the earned interest income the IRS believes you should have received, based on the AFR at the time the loan was made. If a Lender chooses to simply not charge a family member a rate of interest at least equal to or above the appropriate Applicable Federal Rate in effect at the time a family loan is made, the IRS may impute the interest by taxing the Lender on the difference between the Applicable Federal Rate and the interest rate the Lender actually charged. Generally speaking, these rates are significantly lower than market rates offered by a bank. When structuring a term loan, so long as the parties meet or exceed the appropriate AFR in effect at the time the loan is made*, the rate is essentially “locked in” for the life of the loan. Typically, the IRS will announce the minimum required rates for transactions occurring in an upcoming month, around the twentieth day of the preceding month. The IRS Applicable Federal Rates change monthly. (2) The IRS Applicable Federal Rate for that repayment term during the month in which the loan is made. (1) The length of the agreed upon repayment term of the loan. (3) Long-term rates, for loans with a repayment term greater than nine years.Ī Lender should assess two main factors when selecting the appropriate IRS Applicable Federal Rate for a family loan: (2) Mid-term rates, for loans with a repayment term between three and nine years. (1) Short-term rates, for loans with a repayment term up to three years. ![]() There are three AFR tiers based on the repayment term of a family loan: When it comes to family loans - especially loans above $10,000 - the IRS Applicable Federal Rates represent the absolute minimum market rate of interest a Lender should consider charging a Borrower in order to prevent unnecessary tax complications. (We’ll explain what “imputed interest on below market loans” means in a moment.) The Applicable Federal Rates are used for various purposes under the Internal Revenue Code - including the calculation of imputed interest on below market loans between family members. These interest rates are determined by a variety of economic factors, including the prior thirty day average market yields of corresponding US treasury obligations, such as T-bills. Each month, the IRS publishes an interest rate index called the Applicable Federal Rates (AFRs).
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