September 23, 2010

Interest-Free Loan to Church Employee

Question:

A church gives its pastor a loan to be used to pay down his home mortgage. The condition will be that he will not pay anything back until or unless he leaves the church or sells the home. At that time he would pay the money back without any interest. How this would be treated by the IRS for tax purposes?

Answer:

IRS Publication 15-A answers this one pretty well:

"In general, if an employer lends an employee more than $10,000 at an interest rate less than the current applicable federal rate (AFR), the difference between the interest paid and the interest that would be paid under the AFR is considered additional compensation to the employee. This rule applies to a loan of $10,000 or less if one of its principal purposes is the avoidance of federal tax.

"This additional compensation to the employee is [reported as] compensation on Form W-2 (or Form 1099-MISC for an independent contractor). The AFR is established monthly and published by the IRS each month in the Internal Revenue Bulletin."

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