Question

On October? 1,Bill lends Aaron $8 million.Aaron signs an? interest-free demand note. The loan is still...

On October? 1,Bill lends Aaron $8 million.Aaron signs an? interest-free demand note. The loan is still outstanding on December 31.

Requirement

Explain the income tax and gift tax consequences of the loan to both Bill and Aaron.Assume that the federal? short-term rate is 4%.

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Answer #1

1. Bill (donor) lends Aaron (donee) interest free demand note. Therefore the donor makes gift to the donee of the foregone interest equal to $80,000 [ $8,000,000 x 4% interest rate x 3 / 12 since there are 3months from october to december ]

2. The donor (Bill) gets $14,000 annual exclusion on the deemed gift ( the same is increased to $15,000 from 2018). Bill reports interest income in the amount of foregone interest.

3. Donee (Aaron) is deemed to receive an exclusible gift of the foregone interest of $80,000 for income tax purposes and has $80,000 of imputed interest expense. But depending on the classification of the interest , all or a portion of this interest may be personal interest , and thus non deductible Or it may be investment interest which is deductible only to the extent of donee's net investment income.

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