Sarah, a majority shareholder in Teal, Inc., made a $200,000 interest-free loan to the corporation.Sarah is not an employee of the corporation.
A)Sarah must recognize imputed interest expense and the corporation must recognize imputed interest income.
B)Sarah must recognize imputed interest income and the corporation must recognize imputed interest expense.
C)Sarah must recognize imputed dividend income and the corporation may recognize imputed interest expense.
D)Neither Sarah's nor the corporation's gross income is affected by the loans because no interest was charged.
E)None of these.

Question

Quizplus · Accepted Answer

Since Sarah made an interest-free loan to the corporation, the IRS treats this as though the corporation borrowed the funds at a below-market interest rate. Therefore, Sarah must recognize imputed interest income and the corporation must recognize imputed interest expense. The imputed interest income for Sarah is calculated as the interest she would have earned if the loan had been made at the applicable federal rate (AFR) for the duration of the loan. The imputed interest expense for the corporation is also calculated as the interest it would have paid if the loan had been made at the AFR for the duration of the loan.

Sarah, a Majority Shareholder in Teal, Inc