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TCP CPA Practice Questions: Imputed Interest
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May 14, 2024
In this video, we walk through 5 TCP CPA exam practice questions teaching about imputed interest on below-market-rate loans. Important Links Link to the free study training webinar mentioned in the video: https://www.superfastcpa.com/strategic-study See the full post for this video: https://www.superfastcpa.com/tcp-cpa-practice-questions-explained-calculating-imputed-interest/ See the other TCP walkthrough videos here: https://www.superfastcpa.com/free-tcp-cpa-practice-question-walkthroughs/ 00:00 Intro 00:44 Question 1: Calculating Partial Year Imputed Interest 02:29 Question 2: Calculating Partial Year Imputed Interest Again 03:56 Question 3: Below Market Rate Loans that Don't Incur Imputed Interest 05:15 Question 4: Below Market Rate Loans with 0% Interest 06:52 Question 5: Do Borrowers Pay Taxes on Imputed Interest? 08:06 Pillar Topics
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0:00
Welcome to another TCP walk-through video. I'm Logan, and in today's video, we're going to be going over imputed interest on below-market rate loans
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And we're going to be doing that, the Super Fast CPA way, which is diving straight into questions to learn the material
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If you don't know much about our strategies, make sure you go to our free training webinar on superfast CPA.com, where we go over the key ingredients to passing the CPA exam
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Again, it's only one hour, it's free, and it will save you a ton of time struggling with your process
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One thing you ought to know about this video, we will only be going over five questions in this video
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but Super Fast CPA members will have access to the full 10 question video when we post it on the forum
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So if you like this, you can access more of it when you're a Super Fast CPA member
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With all that said, let's dive straight into the questions. All right, here's question one
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Maria borrowed $100,000 from her Uncle Tom in January this year to help her start her own business
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Tom offered the loan at a 1% annual interest rate as he wanted to support Maria's endeavor
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the applicable federal rate, or AFR, at the time, was 3%. Assuming the loan is for one year, how much imputed interest must Tom include in his taxable income for this year
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Okay, so if you don't really know what is going on here, that's okay
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If you don't really understand what a below market rate loan is, we're going to go ahead and go straight into the answer to start learning how this works
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Okay, and the answer is $2,000. So let's learn about this. When a loan is provided below the AFR, the IRS requires the lender to calculate and report
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imputed interest, treating the loan as if it were issued at the AFR. The imputed interest is calculated
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as the difference between the interest calculated at the AFR and the interest actually paid. Here, the
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interest on $100,000 at 3% AFR would be $3,000 for one year. Maria pays 1% interest, which amounts to $1,000
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Therefore, the imputed interest is 3,000, less 1,000 equaling $2,000, which must be reported
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as income for Tom, regardless of whether he actually received that income
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So basically, that's what imputed interest on below market rate loans is right there
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We'll learn more things as we go on, but that's the general idea right there. Somebody gives a loan to somebody else at a really low interest rate
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but the government has an AFR, which is kind of like a minimum interest rate they should be charging
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So whatever the difference is between the AFR and the interest actually charged is imputed interest
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and that is taxed as ordinary income to the lender whether they actually got that money or not And with that we done the first question so let go ahead and go to the next question to learn more Here question two In March Kevin borrowed from his friend Lucy who offered him a loan at a 2 annual
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interest rate due to financial hardships he was facing. At that time, the applicable federal rate was 4%
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The loan duration is one year. How much imputed interest must Lucy include in her taxable income for the year
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All right, so this is very similar to what we just did. See if you can take a second, pause the video, figure it out, and when you're ready to come
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back and we'll look at the answer together. Okay, and the answer was $667. Did you get that right
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You might not have because you might not have thought of the different months because it started in
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March. So let's read through this. First, calculate the full year's interest at the AFR and the actual
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interest rate. Full year interest at the AFR would be 4% of $40,000, which is $1,600. The actual interest
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paid by Kevin at 2% would have been $800. Therefore, the annual imputed interest difference would have
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in $800. However, since the loan began in March, we have to find the monthly imputed interest
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and we do that by dividing the annual difference by 12 months. So 800 divided by 12 equals $66.67 per
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month, and then you multiply that by the 10 months that the loan was active in that year, so March to
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December, and you get $666.70, which rounded up is $667. So Lucy must include $667 in her taxable
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income. All right. Again, you're getting pretty much the idea of imputed interest already. So let's go
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ahead and go to the next question. Okay, here's question three. In July, Samantha borrowed $8,000 from her
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colleague David to cover unexpected medical expenses. David offered her a loan at an annual interest rate
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of 1.5% when the applicable federal rate was 3%. The loan is for a full year starting from July
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How much imputed interest must David include in his taxable income for the year? Okay, you've done this
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before, you've seen how we do this. So go ahead and pause the video. When you're ready
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come back, we'll look at the answer and see if you got it right. Oh, wait. There's a, there's a
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hidden rule. Sorry, I wasn't trying to trick you there, but it's actually zero dollars, and let's read why
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The IRS provides an exception from imputed interest rules for certain small loans. Specifically
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no imputed interest is calculated if the loan amount is less than $10,000, and the loan is
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used for personal purposes, not investment or income producing activities. Samantha's loan from David is only $8,000 and is for personal use
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He does not need to calculate or report any imputed interest So kind of a trick question there That that might change with time so don get stuck on that number But you know just know that there is a threshold where if it below that
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threshold and it's a personal loan, you know, it's not necessarily for making money or whatever
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then they don't have to calculate imputed interest. All right, let's go to the next question
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And here's question four. Max borrowed $25,000 from his friend Sarah in July to help fund his startup
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business. Sarah offered the loan at a 0% interest rate to support Max's venture. The applicable
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federal rate at the time of the loan was 3.5%. Assuming Max will pay back the loan in one year
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and the loan is not exempt from imputed interest rules, how much imputed interest must Sarah report
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as income for the tax purposes? Okay, so the only question here is if it's 0% like they didn't
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charge any interest to them, does that count as should there still be imputed interest or would
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that be a gift? That was kind of something that I've thought about when I saw this the first time
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So go ahead, pause the video, see if you can get the right answer and come back when you're ready. Okay, $438. So you probably got that right if you didn't get too hung up on the fact
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that it was 0% interest. So it doesn't, and that just kind of shows that it doesn't matter if it was
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0%. If it should have been 3.5%, then you calculate that imputed interest based on that difference
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So 3.5% of $25,000 was $875. And since it was for only half the year, so July through December, six months, you just
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divide it by two. You could do divided by 12 and then multiply it by six, and it would give you this same number
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But that's how you can do that there. So you get $438 rounded up
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And that's how much she would need to include on her tax return as ordinary income or as
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imputed interest. So whether it's 1% or 0%, as long as it's below the AFR, you have to calculate imputed
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interest as long as it's not one of those small loans that we looked at in the previous question
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Okay, let's go to the next question. Okay, here is question five. Paul borrowed $50,000 from his uncle to
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purchase a new car. The loan was issued with a 0% interest rate while the applicable federal rate at the
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time was 4%. The loan is set to be repaid over five years. Given the terms of the loan and the
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AFR, how much imputed interest must Paul include in his taxable income for the first year. All right
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this is the last question of the video. You probably know how to do this, so go ahead and pause the
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video and when you're ready, come back, we'll look at the answer. All right, did you pay attention? The answer is $0. Because Paul doesn't need to include imputed interest in his taxable income
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it would be his uncle So again just something that you want to pay attention to It is not the borrower who has to pay imputed interest or be taxed on it It is the lender So pay attention
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to the names because it was asking, does Paul include any of it in his taxable income? And actually
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no, he doesn't. It would have been his uncle that would have had to include it in his taxable
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income. Now, there are situations where the borrower wants to pay attention to imputed interest
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They might even be able to take a deduction for it or things like that. But in the end, that's not
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what we're focused on in this video. I just wanted to teach you how imputed interest works and how it
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affects the gross income of the lender. All right, we've done five questions in this video
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Before we go any further, let's go ahead and do one more part of the process, which is called
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pillar topics. Now, if you don't know much about our strategies, again, pillar topics
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the idea is as you're going through the questions to learn the material, you will notice things
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that keep popping up. These are the topics that are spread across three or five questions
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You keep seeing them. They keep popping up. They're obviously important according to your review
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course. So you take a second and write those pillar topics down. And so let's go ahead and look at the
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pillar topics for this video. Okay, and here are the pillar topics. Imputed interest on a below
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market rate loan is essentially the government requiring a lender to realize a minimum amount of
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interest income. The government has different AFRs for different loan lengths. And we didn't dive
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super deep into that, but you know, the AFR for a one year loan might be different than a two or
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three year loan. It just kind of depends. So to calculate the imputed interest, you take the interest
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that would have been charged if the loan had the AFR interest rate. Then you subtract the interest that was actually paid
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and the difference between the two is the imputed interest. The lender has to recognize this imputed interest as ordinary income
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even if they didn't actually receive the money. So, you know, this $2,000 extra dollars of imputed interest that just showed up
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you have to pay taxes on it, even though you didn't actually get $2,000 of interest
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The borrower does not have to recognize the interest as income. However, for personal or family loans under a certain threshold
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a lot of times $10,000, but that might change as time goes on. These rules may not apply
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They might not have to calculate imputed interest. All right, that is the end of this video
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Again, we only went over five questions in this video, but Superfast CPA members will have access to the full 10 question video
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when we post it on the member's forum. So if you liked this, you can get more of it
9:39
by becoming a super fast CPA member. One more reminder to go watch our free one-hour webinar training
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We go over the key ingredients to passing the CPA exam. We teach you how to study effectively
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make sure you go watch that, you won't regret it. Also, if you like this video, make sure to like it and leave a comment. I hope this was helpful and I will see you in the next video
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