Willy, who has no income and no investments, borrows $51,000 from his mother at no interest. The...

Question:

Willy, who has no income and no investments, borrows $51,000 from his mother at no interest.

The applicable federal rate is 4 percent.

a. Explain the tax consequences of this loan, if Willy uses the money for an exotic vacation.

Imputed interest income $_

b. Compute Willy's deductible income, if he uses the money to invest in bonds paying 4 percent interest

Deductible interest expense $

Interest income:

Interest income refers to the income earned by lending money and letting other persons use the funds. It is simply calculated by multiplying the amount lend with the applied interest rate. Interest income is generally taxable.

Answer and Explanation:

a) If willy uses the money for an exotic vacations then interest income will be:

{eq}\begin{align*} \rm\text{Interest income}&= \rm\text{Borrowed amount}\times\rm\text{Interest rate}\\ &= \$ 51,000 \times 4\% \\ &= \$ 2,040 \end{align*} {/eq}

  • Tax consequences: Loan taken from family or friend is not taxable.

b) The deductible income of Willy would be $0 because the interest income from a bond is a taxable event.


Learn more about this topic:

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How to Calculate Interest Expense: Formula & Example

from Financial Accounting: Help and Review

Chapter 5 / Lesson 18
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