what is imputed interest 
imputed interest is a term used in tax law to describe a situation where a lender charges no interest on a loan but the internal revenue service irs considers the loan to have been made at an interest rate that is imputed or implied by market conditions this can happen when a lender charges a lower interest rate than the market rate or when a borrower receives a loan from a family member or friend at a below market interest rate in such cases the irs may require the lender to pay taxes on the difference between the actual interest rate and the imputed interest rate the irs thus uses imputed interest to collect tax revenues on loans or securities that pay little or no interest imputed interest is important for discount bonds such as zero coupon bonds and other securities sold below face value and mature at par the irs uses an accretive method when calculating the imputed interest on treasury bonds and has applicable federal rates that set a minimum interest rate in relation to imputed interest and original issue discount rules understanding imputed interestimputed interest occurs when a taxpayer has borrowed money but the lender charges no interest or an interest rate that is much lower than the market rate the tax treatment of such loans depends on whether the loan was an actual loan a demand loan or a gift from friends or family this distinction is important because the tax authorities treat each type of loan differently with respect to imputed interest the irs considers an actual loan to occur when there is a written agreement between the lender and borrower in this case the lender may be required to pay taxes on interest income whether or not they actually charged a market interest rate submission of written records helps the irs determine whether the loan is a conventional loan as opposed to a gift loan imputed interest may therefore apply to loans among family and friends for example a mother loans her son 50 000 with no interest charges if the applicable short term federal rate is 2 percent the son should pay his mother 1 000 annually in interest the irs assumes the mother collects this amount from her son and lists it on her tax return as interest income even though she did not collect the funds gift loans of less than 10 000 are exempt from imputed interest as long as the money isn t used to buy income producing assets 1applicable federal ratesbecause there were many low interest or interest free loans that went untaxed the irs established applicable federal rates through the tax act of 1984 the applicable federal rate afr determines the lowest interest that one may charge on loans below a specific interest rate threshold and considers the amount of potential income generated from the interest rate as imputed income because of the creation of afr the irs may collect tax revenue from loans that are otherwise untaxed because imputed tax rates are tied to the actual interest rate environment at a given time each month the irs provides various prescribed rates for federal income tax purposes afr rates are regularly published as revenue rulings and can be looked up on the irs website 2calculating imputed interest on a zero coupon bond