Question

Wally is employed as an executive with Pay More Incorporated. To entice Wally to work for Pay More, the corporation loaned him $20,000 at the beginning of the year at a simple interest rate of 1 percent. Wally would have paid interest of $2,400 this year if the interest rate on the loan had been set at the prevailing federal interest rate.

a. Wally used the funds as a down payment on a speedboat and repaid the $20,000 loan (including $200 of interest) at year-end. Does this loan result in any income to either party, and if so, how much?

b. Assume instead that Pay More forgave the loan and interest on December 31. What amount of gross income does Wally recognize this year?

Answer 1

Explanation:

a) The Company shall have an income of $200 as interest Revenues and $2200 as imputed revenues(i.e. difference between actual income and market value of interest on loans.

Nevertheless the corporation shall also have the right to compensation incurred by the federal tax law at $2200 for wally and shall not be eligible for deduction under Federal Taxation Law.

b) Amount of gross income does Wally recognize if Pay More forgave the loan and interest on December 31:

Loan Amount            $ 20000

Interest Foregone      $   200

Imputed Interest         $ 2200

Total Amount            $22400