How to Avoid IRS Imputed Interest
How to Avoid IRS Imputed Interest
What is IRS Imputed Interest?
The interest that is created on a loan by the IRS, as well as the taxes they level on the lender is known as IRS Imputed Interest (explained in detail in the post IRS Imputed Interest Rules). Even if the lender is not charging and collecting interest on that loan, the IRS will add it to your tax liability anyway. In most instances, IRS imputed interest gets levied when you loan money to a family member or friend and specify the terms of the loan (length of time to repay), but you don’t charge any interest.
A Brief History of IRS Imputed Interest
The rules about imputed interest were originated because the IRS wanted to stop the wealthy from loaning money to their heirs in order to drop them into a lower tax bracket. Evidently, the IRS felt that the rich were trying to beat (or cheat) the system. Additionally, the recipients of the loans would invest the money so that the income would fall into a lower tax bracket. In so many words, the money is still in the family. However, instead of being taxed at the proper rate, the money is now being taxed at the lower child’s rate.
Understanding how IRS Imputed Interest works
In a standard transaction involving a loan from a bank, credit union, or other lender, the financial institution will charge you interest on that loan. Obviously the bank needs to make money and stay in business, so the interest on your loan becomes another one of their many revenue streams.
Be aware of the fact that if you do not charge your family member or friend interest on that personal loan, the IRS is going to impute interest on that loan (usually at the current average percentage) and charge taxes on that imputed interest as if it were actual income. In other words, even if you are not charging and collecting interest on that personal loan, you are going be taxed by the IRS as if you were.
What are the best ways to avoid being charged imputed interest tax?
Whether you are making a personal loan to a family member or friend, you should still charge some kind of interest on that loan. However, we do recommend that you charge whatever the average rate currently is as this will alleviate any doubts or stress about the issue. The percentage rate that the IRS establishes will depend on the size and the terms of that personal loan.
© How to Avoid IRS Imputed Interest
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