Question

Sarah, a majority shareholder in Teal, Inc., made a $200,000 interest-free loan to the corporation. Sarah is not an employee of the corporation.

a. Sarah must recognize imputed interest expense and the corporation must recognize imputed interest income.
b. Sarah must recognize imputed interest income and the corporation must recognize imputed interest expense.
c. Sarah must recognize imputed dividend income and the corporation may recognize imputed interest expense.
d. Neither Sarah’s nor the corporation’s gross income is affected by the loans because no interest was charged. e. None of these.

Answer 1

The answer is: B) Sarah must recognize imputed interest income and the corporation must recognize imputed interest expense.

Step-by-step explanation:

Even if Sarah doesn't charge interest on her loan to Teal Inc., she must recognize income from imputed interest. Something similar happens to Teal Inc., even though they don't pay any interest, they must recognize expenses from imputed interest.

Imputed Interest is the interest considered by the IRS to have been paid for tax purposes, It doesn't matter if the interest payment was made or not. The IRS uses imputed interest to collect taxes on interest free loans or loans that charge very low interest rates. They set a minimum interest that should have been charged.