Question

21. Margaret made a $90,000 interest-free loan to her son, Adam, who used the money to retire a mortgage on his personal residence and to buy a certificate of deposit. Adam’s only income for the year is his salary of $35,000 and $1,400 interest income on the certificate of deposit. Assume the relevant Federal interest rate is 8% compounded semiannually. The loan is outstanding for the entire year.

a. Based on this information, what is the effect of the loan on Margaret’s gross income for the year? The facts are the same as above except that you discovered that Margaret had made an additional loan of $15,000 to Adam in the previous year. Adam used the funds to pay his child’s private school tuition. What are the effects of the loans on Margaret’s gross income?

Answer 1

a. Loan amount = $ 90000 , r = 8 % compounded semiannually

Interest attributable to loan given by Margaret to her son = 90000*(1+ 0.08/2)^2 - 90000 = $ 7344

Adam's net interest income = $ 1400

Margaret's gross income will be increased by $ 1400 (lower of the two amounts calculated above) since the amount of loan is less than $ 100,000 and therefore net interest income restrictions apply here.

ii) Loan amount = $ 90000 + $ 15000 = $ 105,000

Since the amount of loan is more than $ 100,000 net interest income restrictions does not apply here.

Interest attributable to loan given by Margaret to her son = 105,000*(1+ 0.08/2)^2 - 105,000 = $ 8568

Margaret's gross income will be increased by $ 8568.