Wally is employed as an executive with Pay More Incorporated. To entice Wally to work for Pay More, the corporation loaned him $20,000 at the beginning of the year at a simple interest rate of 1 percent. Wally would have paid interest of $2,400 this year if the interest rate on the loan had been set at the prevailing federal interest rate.
a. Wally used the funds as a down payment on a speedboat and repaid the $20,000 loan (including $200 of interest) at year-end. Does this loan result in any income to either party, and if so, how much?
b. Assume instead that Pay More forgave the loan and interest on December 31. What amount of gross income does Wally recognize this year?
Ans:a) Corporation will have an Income of $ 200 as interest Income and $ 2200 as imputed income(i.e. difference between actual income and market amount of interest on loan). However they will also be entitled for compensation deduction of $2200 under federal tax law.
Whereas in case of wally, he will have compensation income of $2200(i.e. amount of imputed interest)and will also not be eligible for deduction as the amount is used towards personnel purpose.
Ans b) Amount of gross income does Wally recognize if Pay More forgave the loan and interest on December 31:
Loan Amount $ 20000
Interest Foregone $ 200
Imputed Interest $ 2200
Total Amount $22400