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Under section 7872 of the Internal Revenue Code, there is interest imputed to "below market loans" between family members, employers and employees, corporations and shareholders, and in other situations. For a loan payable on demand, the short-term applicable federal rate would apply for the purpose of calculating any foregone interest, and because that rate can change monthly, the calculation of interest would have to be month-by-month, with monthly compounding of accrued interest.
To simplify calculations of interest for demand loans, I.R.C. section 7872(e)(2) allows the use of a "blended annual rate" for demand loans with a fixed principal amount outstanding for an entire calendar year. According to Rev. Rul. 86-17, 1986-1 C.B. 377, the blended annual rate is the product of (a) one half of the January semiannual short-term applicable federal rate times (b) one half of the July semiannual short-term applicable federal rate. This blended annual rate is published by the Internal Revenue Service in a Revenue Ruling every June, based on the relevant rates for January and July of that year.For 2011 the rate would be .40%
I am asking about an installment note-isn't this different than a demand note which is covered by your answer? or are you suggesting that the minimum accepatable rate would have to be calculated monthly because the loan is payable in monthly installments?
When you make a term loan (one with a specific balloon repayment date or specific installment repayment dates), you are allowed to use the same fixed AFR for the entire loan term. Yes they are differnt, the demand note would be when you as the lender can demand full repayment at any time. So you are not going to need to recompute the % if the AFR goes up. You can charge the loan amount onthe total and then set the payments over the months. Each month would then have principle and the portion of interest.On $100000 the .40% would be $400. If the loan is to be paid back over 12 months that would be $100400 divided by the 12 month - per month $867 of which $33 is interest