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What Are The Tax Implications of Employee Loans?


In the midst of a struggling economy, companies understand the need to recruit and preserve talent. Numerous firms have turned to offering employee loans as an incentive. Whether such loans are constructed for retention or to administer employee aid, their tax treatment should be closely considered. Taxand USA investigates the tax consequences of the three main types of employee loans.

Traditional employee loan
A traditional employee loan adheres to the strict definition of a loan and does not require the recognition of compensation by the employee. Therefore this loan is commonly used to administer financial assistance to an employee, whereby an employer lends money with the full intention that the employee will repay the loan plus interest. The guidelines for administering a traditional employee loan hinge on the legal obligation of the employee to make monetary repayment of the advance, as well as the employer's intention to impose repayment.

Below-market employee loan
Below-market loans are provided to employees at a lower interest rate then they could otherwise receive in the market. These loans can be offered at either a reduced interest rate (below the AFR) or completely interest free, as an original issue discount. The spread between the reduced interest rate and the market rate of interest (the AFR) is recognised as compensation income to the employee.

Employee forgivable loan
Employers often issue these loans as sign-on or retention bonuses to retain and attract top executives. The concept is for an employee to receive an upfront cash payment structured as a loan contingent on the employee's continued service with the company. The income recognition from the employer's forgiveness of the underlying principal and interest payments is generally intended to be tax deferred to the employee and recognised over the life of the loan.

Discover more: The tax consquences of employee loans

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Brian Cumberland
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Taxand's Take

Organisations operating in the US should note that documentation is essential to ensure that loans to employees are treated as such for tax purposes. An arrangement may appear to be an employee loan, but if it does not look like one or sound like one on paper, it will not receive favourable tax treatment from the IRS. The best way to structure an employee loan is to satisfy all the formal requirements as though the company were loaning money to a third party.

Taxand's Take Author