Question

Help! I need help arriving at the correct solution in the provided scenarios and need explanations. I would appreciate it.

Apply the imputed interest rules in the following situations

a. Mike loaned his sister Shonda $90,000 to buy a new home. Mike did not charge interest on the loan. The Federal rate was 4%. Shonda earned $900 of investment income for the year.

b. Nico’s employer maintains an emergency loan fund for its employees. During the year, Nico’s wife was very ill, and they incurred unusually large medical expenses. He borrowed $8,500 from his employer’s emergency loan fund for six months. The Federal rate was 4%. Nico and his wife earned no investment income for the year.

c. Jody borrowed $25,000 from her controlled corporation for six months. She used the funds to pay her daughter’s college tuition. The corporation charged Jody 3% interest. The Federal rate was 4%. Jody earned $3,500 of investment income for the year. d. Kait loaned her son, Jake, $60,000 for six months. Jake used the $60,000 to pay off college loans. The Federal rate was 4%, and Kait did not charge Jake any interest. Jake earned dividend and interest income of $2,100 for the tax year.

Answer 1

1. Shonda has $900 of investment income, so interest is not imputed under the exception that if the borrower’s net investment income is not greater than $1,000. So, the imputed amount is $0. However this loan between individuals is eligible for the $100,000 exception
2. Nico used the funds to medical expenses of his wife but not for buying investments, so there is no tax avoidance motive. Thus, no interest is imputed.
3. The $100,000 exception is not available on corporation- shareholder loans. Therefore Imputed Interest is $25,000 × (4% − 3%) × 1/2 = $125
4. The loan from Kait to Jake is classified as a gift loan between individuals that is eligible for the $100,000 exception. Imputed Interest for six months: $60,000 × 4% × 1/2 = $1,200. Under the $100,000 exception, the imputed interest is limited to Jake’s net investment income of $2,100. So, in this case, the limit has no effect on the amount of imputed interest.