508. What are the income tax consequences of below-market loans?Nuco Employeercline202014-07-24T15:04:00Z2014-07-24T15:04:00Z26773859UMKC329452714Site Map/General Income Taxation/Individuals/Gross IncomeTaxFactsDefaultArticle123781407-00-tf2.xml1407.00;#1727;#0x010100C568DB52D9D0A14D9B2FDCC96666E9F2007948130EC3DB064584E219954237AF3900242457EFB8B24247815D688C526CD44D009C4E67E972694125ABDA91AC61F5E51FTax Facts 2What are the income tax consequences of below-market loans?43800.0000000000TaxFactsDefaultArticle2010-01-14T22:59:29ZSBMEDIA\moss-admin508. What is a below-market loan?Editor’s Note: The Sarbanes-Oxley Act of 2002 (P.L. 107-204) adopted new securities law provisions intended to deter and punish corporate and accounting fraud and corruption, ensure justice for wrongdoers, and protect the interests of workers and shareholders of publicly-traded corporations. However, it would appear that one provision of the Act indirectly impacts below-market loans made to executives of publicly-traded corporations. See Q 511.Generally, a below-market loan is any demand loan with an interest rate that is below the applicable federal rate (see below) or any term loan in which the amount received by the borrower exceeds the present value of all payments due under the loan. A demand loan is any loan that is payable in full at any time on the demand of the lender, or that has an indefinite maturity. All other loans are generally term loans.IRC Secs. 7872(e), 7872(f). The IRC essentially recharacterizes a below-market loan as two transactions: (1) an arm’s-length loan requiring payment of interest at the applicable federal rate, and (2) a transfer of funds by the lender to the borrower (“imputed transfer”).Prop. Treas. Reg. §1.7872-1(a).Below-market loans include gift loans (Q 509), and compensation-related loans and corporation-shareholder loans (Q 510). In addition to these types of loans, below-market loans in which one of the principal purposes is tax avoidance or, to the extent provided for in regulations, in which the interest arrangements have a significant effect on the federal tax liability of either party, will also be subject to the rules governing below-market loans. (See Q 509, Q 510 and Q 511)IRC Sec. 7872(c)(1). The Service has determined that the interest arrangements of certain loans will not be considered as having a significant effect on the federal tax liability of either party–tax-exempt obligations, obligations of the U.S. government, life insurance policy loans, etc.–and, unless one of the principal purposes is tax avoidance, such transactions will not be subject to the below-market loan rules.Temp. Treas. Reg. §1.7872-5T.Applicable Federal RateThe applicable federal rate (see Q 515) for demand loans is the short-term rate in effect during the period for which the forgone interest is being determined, compounded semiannually.IRC Sec. 7872(f)(2)(B). In the case of a below-market loan of a fixed principal amount that remains outstanding for the entire calendar year, forgone interest is equal to the excess of the “blended annual rate” for that calendar year multiplied by the outstanding principal over any interest payable on the loan properly allocable to the calendar year. The blended annual rate is published annually with the AFRs for the month of July.Rev. Rul. 86-17, 1986-1 CB 377. The blended annual rate for the calendar year 2011 was 0.40%, the blended annual rate for calendar year 2012 was 0.22%, and the blended annual rate for calendar year 2013 was 0.22%. Rev. Rul. 2010-18, Rev. Rul. 2012-20, 2012-27 IRB 1, Rev. Rul. 2013-15.For term loans, the applicable federal rate is the corresponding federal rate (i.e., short-, mid-, or long-term) in effect on the day the loan was made, compounded semiannually.IRC Sec. 7872(f)(2)(A).The applicable federal rates are determined by the Secretary on a monthly basis.IRC Sec. 1274(d). The Secretary may by regulation permit a rate that is lower than the applicable federal rate to be used under certain circumstances.See IRC Sec. 1274(d)(1)(D).Reporting RequirementsIn any taxable year in which the lender or the borrower either has imputed income or claims a deduction for an amount imputed under IRC Section 7872, he must: (1) attach a statement to his income tax return explaining that it relates to the amount includable in income or deductible by reason of the below-market loan rules; (2) provide the name, address and taxpayer identification number of the other party; and (3) specify the amount includable or deductible and the mathematical assumptions and method used in computing the amounts imputed.Prop. Treas. Reg. §1.7872-11(g).