The applicable federal rate is simple the obtainable interest rate that is set out by the Internal Revenue Service over private loans. The interest rate of Applicable Federal Rate is regulated every month by the IRS which they considered as the minimum market rate for loans. You attract tax implications by offering any interest rate that is less than the AFR. The AFR is published in accordance with Section 1274(d) of the Internal Revenue Code by the IRS.
WHAT YOU SHOULD KNOW
- Never allow your interest rate on a low to below the AFR because it will attract taxable event for both parties involved.
- AFR is used to regulate original issue discount, unstated interest, gift tax, and income tax consequences of going below-market loans.
- The AFR at the time the lender makes a loan is what the parties should use.
There are basically three published AFR from the IRS and they include; short-term, mid-term, and long-term. A short-term AFR rate is used to determine the average market yield. For the month (one month) from marketable obligations with three years of maturities or less. Mid-term AFR rates still leverage on one one-month. Average market yield to determine interest but the AFR is from. Obligations with maturities of more than three and up to nine years. The Long-term AFR rates are form bonds with. Maturities of more than nine years.
Furthermore, apart from the three basic rates under which AFRs are published. There are several other compounding periods.
In respect to factors considered to select the accurate. AFR when preparing to make a loan between related parties. Taxpayers should consider the length of the loan in respect to the AFRs; the short-term lasting for three years or less. Mid-term lasting up to nine years. And long-term lasting more than nine years.
Anytime the lender charges interest at a lower rate instead of the AFR, this will warrant that the IRS will reassess the lender and add imputed interest to income to show the AFR rather than the actual amount paid by the borrower. If the lender charges interest at a rate that is lower than the proper AFR, the IRS may reassess the lender and add imputed interest to the income to reflect the AFR rather than the actual amount paid by the borrower. In some cases, the IRS may place some penalties.
Note: Any interest rate charged below the stated AFR for the particular term of the loan is placed as foregone interest and such is taxable.