What is 'Unstated Interest Paid'

Unstated interest paid is the amount of money the Internal Revenue Service assumes has been paid to the seller of an item that has been sold on an installment basis. Unstated interest must be calculated in some cases when you have sold an item on installment basis, but have charged the customer little or no interest. Because interest income must sometimes be treated differently than other types of income, it may be necessary to estimate which portion of an installment payment is actually interest income.

BREAKING DOWN 'Unstated Interest Paid'

Unstated interest paid is only calculated for contracts in which interest payments are not included, or when the interest charged falls below the test rate of interest. If a contract or invoice describes both an interest payment and a principal payment, the interest payment is referred to as stated interest. Stated interest in an installment contract must be greater than the test rate of interest, which in most cases is the based on the applicable federal rates (AFRs)

The applicable federal rate is calculated by the IRS and published monthly online and by various financial news sources. The IRS publishes three different applicable rates: short-term, mid-term and long-term rates. The short-term rate is calculated by averaging the rates the government pays on bond issues with maturities of three years or less. The mid-term rate is derived from averaging the rate paid on Treasury securities between three and nine years in maturity, while the long-term rate is based on issues of ten years or longer in maturity. To calculate unstated interest paid, sellers of goods paid for on installment should choose the applicable federal rate based on the length of the installment contract.

Example of Unstated Interest Paid

Let’s say that Ernie’s Tractor Supply company sells a tractor to a customer for $10,000, and allows the customer to pay for the tractor in installments: $5,000 in six months from now, and another $5,000 one year from now. On the customer contract for this installment plan, there is no amount that is stipulated for interest paid. For tax purposes, you may need to recognize that this arrangement involves the implicit lending of the customer two $5,000 loans: one with a maturity of six months, and the other for one year. 

If the applicable federal rate for this loan is 2 percent per year, then the interest you would pay on the two $5,000 loans would end up being roughly $150 dollars. The IRS would assume that you have sold the Tractor for $9,850 and issued two loans that paid interest income of $150.
 

RELATED TERMS
  1. Form 6252: Installment Sale Income

    Form 6252: Installment Sale Income is a tax form distributed ...
  2. Gross Interest

    Gross interest is the annual rate of interest to be paid on an ...
  3. Interest Rate Call Option

    An interest rate derivative in which the holder has the right ...
  4. IRS Publication 544

    A document published by the Internal Revenue Service (IRS) that ...
  5. Interest Deduction

    Interest deduction causes a reduction in taxable income or revenues ...
  6. Interest Cost

    Interest cost refers to the cumulative amount of interest a borrower ...
Related Articles
  1. Investing

    Avoiding A Big Tax Bill On Real Estate Gains

    Installment sales allow sellers to defer taxes on real estate profits. This is a comprehensive guide on how to avoid a big tax bill on real estate gains.
  2. Taxes

    Form 9465: Don't Pay Your Back Taxes Without It

    This form can lighten your tax load if you owe Uncle Sam. And you can often apply online.
  3. Personal Finance

    Simple Interest Loans: Do They Exist?

    Yes, they do. Here is what they are – and how to use them to your advantage.
  4. Investing

    4 Ways Simple Interest Is Used In Real Life

    Simple interest works in your favor when you're a borrower, but against you when you're an investor.
  5. Trading

    Why Interest Rates Affect Everyone

    Learn why interest rates are one of the most important economic variables and how every individual and business is affected by rate changes.
  6. Financial Advisor

    How Federal Reserve Activity Impacts Investment Portfolios

    The Federal Reserve's monetary policies impact investments in a number of ways.
  7. IPF - Mortgage

    How Interest Rates Work on a Mortgage

    A step-by-step explanation of the interest calculations, mortgage types and how the loan is eventually “retired” – which means paid off.
  8. Insurance

    Hiring a Contractor vs. DIY: Cost – Benefits

    When you want to change something about your home, the first question to ask yourself is whether it’s more cost-effective to DIY or hire a professional.
  9. Personal Finance

    Will Installment Loans Be the New Payday Loans?

    Payday lenders are leaning toward installment loans as a result of proposed federal regulations. But is this what's best for consumers?
RELATED FAQS
  1. What are the differences between installment sales and credit sales?

    Determine the differences between credit sales and installment sales, which businesses often offer their customers for deferred ... Read Answer >>
  2. Revolving Credit vs Installment Credit: What is the Difference?

    Understand how to distinguish the difference between installment credit loans and revolving credit loans. Learn about the ... Read Answer >>
  3. What Home-Buying Costs Can I Deduct from Taxes?

    Except for interest, points, real estate taxes and PMI, costs to acquire a home increase the asset’s tax basis and are not ... Read Answer >>
Trading Center