when calculating imputed interest on a zero coupon bond an investor first determines the bond s yield to maturity ytm assuming the accrual period is one year the investor divides the face value of the bond by the price paid when it was purchased the investor then increases the value by a power equal to one divided by the number of accrual periods before the bond matures the investor reduces the number by one and multiplies by the number of accrual periods in one year to determine the zero coupon bond s ytm 
because the adjusted purchase price of a zero coupon bond is initially equal to its purchase price when issued the accrued interest gained over each accrual period adds to the adjusted purchase price the accrued interest is the initial adjusted purchase price multiplied by the ytm this value is the imputed interest for the period while the concept of interest and the charging of interest on loans is a common practice in the financial world the idea of imputed interest is a legal construct that is used to determine whether a lender is required to pay taxes on a loan that has been made at a below market interest rate imputed interest is therefore not an actual interest rate or a real cost to the borrower but rather a theoretical interest rate that is used for tax purposes imputed interest exemptionsthere are several exemptions to the rules on imputed interest which may allow a lender to avoid paying taxes on the difference between the actual and imputed interest rates for example a loan between family members may be exempt from imputed interest if the loan is for a reasonable amount typically less than 10 000 and is charged at a rate that is not significantly below the market rate and if the loan is not used to purchase income generating assets additionally loans made by a qualified charitable organization a political organization or a nonprofit organization may also be exempt from imputed interest 1loans made for the purpose of buying a primary residence may be exempt from imputed interest as may loans made for the purpose of buying a car or other certain other personal property additionally loans made for the purpose of funding a business or investment may also be exempt from imputed interest in some cases 1it s important to note that the rules and exemptions for imputed interest can vary depending on the specific circumstances of the loan and the applicable tax laws it s always best to consult with a tax professional if you have questions about imputed interest and how it may apply to you imputed interest on a zero coupon bonda zero coupon bond is a type of bond that does not pay periodic interest payments to the bondholder instead the bond is sold at a discount from its face value and the difference between the purchase price and the face value is considered to be the return on the investment in the case of a zero coupon bond the imputed interest is the difference between the purchase price of the bond and the face value for example if a zero coupon bond has a face value of 1 000 and is purchased for 700 the imputed interest would be 300 the bondholder would be required to pay taxes on this imputed interest each year even though they did not receive any actual interest payments example of imputed interestimputed interest is important for determining pension payouts for example when an employee retires from a company where they were a member of a pension plan the company may offer the retiree a lump sum of the 500 000 set aside for them under the plan or they may receive 5 000 a year in benefits assuming the applicable short term federal rate is 2 percent the retiree needs to determine whether they could find better imputed interest in another market by taking the lump sum and purchasing a higher yield annuity can you deduct imputed interest on your taxes in most cases imputed interest is not tax deductible this means that if you are required to pay taxes on the imputed interest on a loan you cannot claim a deduction for that interest on your tax return however there are some exceptions to this rule for example if you use the loan proceeds to buy a primary residence or to fund a business or investment you may be able to claim a deduction for the imputed interest on your taxes additionally if you are a qualified charitable organization a political organization or a nonprofit organization you may be exempt from the rules on imputed interest and may be able to claim a deduction for the interest you pay on your loans it s always best to consult with a tax professional if you have questions about whether you can claim a deduction for imputed interest on your taxes who pays imputed interest in most cases the lender is responsible for paying taxes on the imputed interest on a loan this means that if the irs determines that a loan should have been made at a higher interest rate than the actual rate charged by the lender the lender may be required to pay taxes on the difference between the two rates and is responsible for reporting the imputed interest on their tax return in some cases the borrower may also be required to report the imputed interest and pay taxes on it depending on the specific circumstances of the loan 3