Reduced Interest Loans

An employer may loan money to employees. When this happens, if the amount of the loan is greater than $10,000 and is at an interest rate less than the Applicable Federal Rate (AFR), the difference is taxable income to the employee. This income is subject to Social Security and Medicare taxes, but not income tax withholding. The current AFR is available on the IRS web site at www.irs.gov or by calling 800-829-1040.

Example. An employer loans $1,000,000 to one of its officers so the individual can purchase a new home. The stated interest rate on the loan is 3 percent, while the AFR is 7 percent. The amount of income reportable by the employee is the 4 percent difference between the two rates, or $40,000.