Question

Tariq, who has no income and no investments, borrows $50,000 from his mother at no interest. The applicable federal rate is 4 percent.

    A) Explain the tax consequences of this loan if Tariq uses the money for a vacation.

    B) How would your answer change if Tariq uses the money to invest in bonds

          paying 6 percent interest?

Answer 1

A. As per the Tax rules if the parents lend money to their children without charging any interest then the rules of imputed income will apply which means the interest that is not being charged is assumed to be income to the parent from the child on the basis of IRS determined minimum rate.

So, in the given case Tariq mother is required to show interest income ($2,000 i.e ($50,000*4% ) at the IRS- determined minimum rate which is 4% as gross income, and pay the tax for Federal Tax purpose.

B. As per rules if loan amount is less than $100,000 then the imputed income rules applies. However, the the patent who is lending can show imputed interest at the lower of the applicable federal rate or the borrower’s net investment income for the year. So in the given case the imputed interest will be 4% as this is less than 6%.