How to record corporate loans to employees
With year end appearing on the horizon, you will soon have to make decisions on all those items that can comfortably be put off until year end—such as how to book corporate loans to employees. The following tip, originally published in The General Ledger, the monthly technical newsletter for AIPB members (www.aipb.org/general_ledger.html) spells it out. The important news and practical tips you will receive in your October issue of The General Ledger (if you decide to become a member) are outlined after the following tip.
Demand loans (loans payable in full when the lender demands payment): A corporation makes an interest-free or below-market demand loan to an employee or independent contractor (IC). That corporation is considered to “pay” the imputed interest as compensation to the employee or IC borrower each year on Dec. 31. Also on Dec. 31, the borrower is considered to “pay” that fair-market interest to the corporation in full.
Example: CorpCo makes a $50,000 interest-free demand loan to Employee Al that is outstanding for all of calendar 2005. The 2005 imputed interest is $2,490. CorpCo records the following journal entries on Dec. 31:
Compensation Expense 2,490
Interest Income 2,490
CorpCo treats the imputed interest as a deduction for compensation expense and as interest income.
The following adjusting entries illustrate how Employee Al treats the imputed interest on Dec. 31:
Compensation Income 2,490
Interest Expense 2,490
To summarize, in general, the corporation can claim a compensation expense deduction and must recognize interest income. The employee is taxed on the compensation income and takes a deduction for interest expense subject to the limits on personal and investment expenses. If the interest expense is nondeductible on the employee’s tax return, the employee will have taxable income without this offsetting deduction. If the borrower is an IC, the tax consequences are similar, except that the imputed interest is treated as nonemployee compensation rather than wages.
Calendar-year corporations on the accrual basis book the adjusting entries to accrue compensation expense and interest income as shown above. The phantom cash transfers are booked as if made on Dec. 31.
If the demand loan is paid in full during the calendar year, the imputed interest “payments” are recorded on date of repayment rather than on Dec. 31.
Term loans: Corporations may make interest-free or below-market term loans to an employee and impute interest accordingly. If, however, employment-related conditions are attached, such as accelerating the due date if the employee terminates, or requiring cash payment of the fair-market interest upon termination, the loan is treated as a demand loan to determine the timing and character of imputed transfers. In other words, the imputed interest “payments” (transfers) are considered made on Dec. 31 as in the example above.
What can you expect in your October 2005 issue of The General Ledger newsletter, yours free each month, when you join? Here's just a sampling:
- A new online tool that quickly helps you avoid W-2 penalties by spotting name/SSN mismatches before you produce your W-2s
- New tax deductions and tax credits for vehicle purchases under the new energy law—but why it takes careful timing to get them.
- How a company proved that it had mailed its taxes timely—and how your company can aovid lateness penalties.
- Tax planning for purchases of SUVs, light trucks and vans—tricky Sec. 179 and depreciation rules explained in simple detail.
- When you must—or need not—pay employees for each kind of commuting and travel time, such as: to and from job sites, in company vans, travel out of town during working hours, after working hours, on weekends, and more.
- Plus: Bookkeepers' quiz... bookkeepers' Q&A... and more.
Please accept our invitation to become a member of The American Institute of Professional Bookkeepers. To see your benefits of membership, click on www.aipb.org/ member_benefits.html. Join today.
BOOKKEEPING TIPS is a twice monthly newsletter published by The American Institute of Professional Bookkeepers (AIPB), Suite 500, 6001 Montrose Road, Rockville, MD 20852. Tel.: 800-622-0121, Fax: 800-541-0066,