Sam borrowed $50,000 from her employer at an annual rate of 1% interest last year to cover her gambling debts. Assume that at the time the loan was made, the prescribed rate of interest was 3% and this rate has not changed. Sam is subject to a combined tax rate of 30 percent. What is the after tax cost of the loan to Sam for the current year?

Question

Quizplus · Accepted Answer

First, we need to calculate the interest on the loan, which is $50,000 x 1% = $500.

Next, we need to calculate the prescribed rate of interest, which is 3%. Since Sam only paid 1% interest, she is deemed to have received a taxable benefit equal to the difference of 2% interest (3% prescribed rate - 1% actual rate) on the outstanding loan balance of $50,000.

Taxable benefit = 2% x $50,000 = $1,000

The taxable benefit of $1,000 is subject to Sam's marginal tax rate of 30%, resulting in an additional tax liability of $300.

Therefore, the after-tax cost of the loan for Sam is $500 (interest) + $300 (tax on taxable benefit) = $800.

Therefore, the best choice is C.

Sam Borrowed $50,000 from Her Employer at an Annual Rate