DEFINITION of Minimum-Interest Rules
Minimum-interest rules refers to a law that requires that a minimum rate of interest be charged on any loan transaction between two parties. The minimum-interest rules mandate that even if no rate is charged by the lender, an arbitrary rate will be automatically imposed upon the loan. The minimum-interest rules are at least partly intended to prevent excess gifting between taxpayers via intra-family loans with no or below-market interest rates.
BREAKING DOWN Minimum-Interest Rules
Minimum-interest rules are fairly complex and have been subject to numerous changes and modifications. There are separate rules for personal and commercial loans and sales of property that are financed by the seller.
Lenders could be required to report with their taxes any interest they received in excess of the principal loan amount.
Potential Exceptions to Minimum-Interest Rules
According to section 7872 or the Internal Revenue Code, there are some exceptions to the rules for direct gift loans between individuals if the amount is below $10,000. However, this exception does not apply to gift loans made for the acquisition of income-producing assets.
Gift loans up to $100,000 might also qualify as an exception to the rules under particular circumstances. The loan must be granted to a relative or child for the purpose of buying a home or launching a business. Furthermore, the borrower’s net investment income must be $1,000 or less for the year.
If the total outstanding balance in gift loans exceeds the limits during the year, then the loan will be subject to interest rules. If the net investment income of the borrower exceeds the $1,000 threshold, imputed interest rules would apply but only on their net investment income.
There are other instances where the providing of funds could be classified as a loan that may fall within interest rules. Funds granted to senior continuing care facilities as part of the fees paid for ongoing care may qualify as a loan if it exceeds certain limits and is considered refundable.
Imputed interest can be avoided on other loans as long as the current federal interest rate is applied to them. The rates are set monthly by the Internal Revenue Service. For term loans, the rate that should be applied is the federal rate that was set on the day the loan was made. For loans that have a term that is less than three years, the short term rate would apply. Mid-term rates would apply on loans with terms of three to nine years. Loans with greater than a nine-year term, the long-term rate would apply.