On January 1 a corporation loans its sharholder Lynda Matsen

On January 1, a corporation loans its sharholder, Lynda Matsen, $120,000. The terms of the loan require that Lynda pay Interest anually based on a 2.5%annual rate of interst. In addition, Lynda is to rapay the $120,000 at the end of the six years. At the time of the loan was made, the current annual AFR short term, mid term, and long term rates were 4.5%, 5.5%, and 6.5% respectevley. Determin the tax consequences of this loan to both the corporation and to Lynda in the first year.  

Solution

solution: -the given loan is a mid term loan because it is for six years and fulfills the condition of mid term which is more than 3 years upto 9 years.

corporation should be taxed on $120000*5.5%=$6600, rather than 2.5% beacuse it is a income for the corporation concerned.

tax consequences in the hands of the Lynda :-

the loan amount which has been given to her at lower rate of interest shall be taxable in the hands of lynda assuming that the loan which has been distributed as dividends for the shareholders

taxability amount= $120000*3%(5.5%-2.5%)=$3600