Auto Dealerships - Audit Technique Guide - Uncle Fed's Tax*Board

2) The corporation is treated as having received a like amount of interest income.
3) After the 1990 year, the shareholder will be allowed a deduction for the interest
deemed paid to the corporation only if the shareholder can demonstrate the expense is
other than a personal expense.
If the corporate loan is made to an employee, who is unrelated to the shareholder as
discussed in IRC section 267(c), the scenario is similar except:
1) The foregone interest is characterized as additional compensation to the employee.
2) The corporation has deemed interest income in a like amount.
3) The corporation can deduct the amount as compensation, subject to reasonable
compensation limits. IRC section 7872(f)(9) specifically states that the amount of
additional compensation flowing to an employee from a compensation-related
below-market loan is not subject to income tax withholding. Such compensation is
subject to FICA and FUTA employment taxes (Conference Committee Report on P.L.
98-369). Even though income tax withholding is not required, payments must be
reported under the appropriate information provision.
4) After the 1990 year, the employee will only be allowed a deduction for the interest
deemed paid to the corporation if the employee can demonstrate the expense is not a
personal expense.
When a below-market interest rate loan is made between otherwise related entities, or a
shareholder makes a loan to his or her corporation, the adjustments resulting after
imputing the interest are:
1) The shareholder receives interest income in the amount of the foregone interest.
2) The corporation has deemed interest expense in a like amount.
3) The foregone interest will treated as a capital contribution by the shareholder. See
Treas. Reg. section 1.7872-4(d) (Proposed).
Although the transfer of taxable income between parties may appear to be offsetting, there
can be significant tax impact in the reallocation, depending on the relative tax brackets of
the borrower and lender and the deductibility of the interest deemed paid.
The regulations contain detailed instructions for computing the interest imputed on
interest free and below-market rate loans using published federal rates. A simplified
method is available for use in imputing interest on loans of $250,000 or less. Rev. Rul.
86-17 provides for the use of a "blended annual rate" to simplify the computation of the
amount of foregone interest. There is no threshold dollar amount.
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