Tax Insights: Taxable benefit rate declining to 1%: Don’t act until January 1, 2014

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Issue 2013-23

The federal prescribed interest rate for taxable benefits will decrease to 1% on January 1, 2014. The rate – which is subject to change every quarter – is currently 2%. To lock in the 1% rate and save tax, you must not act until January 1, 2014.

A low prescribed interest rate for taxable benefits can provide tax saving opportunities for you or your family, if you will be:

  • participating in or refinancing a family income-splitting loan arrangement, or
  • taking out or replacing an employee home purchase loan

The drop in the prescribed rate means that you should wait until 2014 to make a loan to a low-income spouse and/or other adult family member who will invest the funds.

If you make the loan in 2013, it must bear at least 2% interest to avoid the attribution of income rules described below. The rate is reduced to 1% if the loan is made from January 1, 2014, to March 31, 2014 (or later, if the prescribed rate remains 1% after the first quarter of 2014).

The loan splits income, because income earned on the investment of the loaned funds, in excess of the 1% interest charge, can be taxable to the low-income family member at his or her lower tax rate.

For example, if $300,000 is borrowed and invested at 2.5% for the year, $4,500 of income (i.e. $300,000 x [2.5% - 1%]) will be taxable to the borrower, at his or her low marginal tax rate, rather than to the family lender.

Normally, this income (including interest, dividends and certain other types of investment income, and capital gains in the case of a spousal loan) would be ‘attributed’ to the lender and included in his or her income, rather than the borrower’s income, for tax purposes.

An exemption from the attribution rules can apply, though, if:

  • the borrowed money bears interest at a rate at least equal to the prescribed rate in effect when the loan is made, and
  • the interest is paid each year within 30 days of the end of the year