Harness Money

What is applicable Federal Rate (AFR)?

The Applicable Federal Rate (AFR) is a set of interest rates published by the Internal Revenue Service (IRS) in the United States. These rates are used to determine the minimum interest that should be charged on certain loans, installment sales, gift transactions, and other financial arrangements to avoid triggering unfavorable tax consequences.

The AFR is important in situations where individuals or businesses provide loans or financial transactions with below-market interest rates. If the interest charged on such transactions is below the AFR, the IRS may consider it a gift or income imputation and impose tax consequences accordingly.

There are three main categories of AFR rates:

1. Short-term AFR: This rate applies to loans or financial transactions with a term of three years or less. It is based on the average market yield on Treasury bills with maturities of three years or less.

2. Mid-term AFR: The mid-term AFR is used for loans or financial transactions with terms between three and nine years. It is based on the average market yield on Treasury notes and bonds with maturities of more than three years but less than nine years.

3. Long-term AFR: This rate is applied to loans or financial transactions with terms exceeding nine years. It is based on the average market yield on Treasury notes and bonds with maturities of more than nine years.

The IRS publishes these AFR rates monthly, and they are updated based on prevailing market conditions and Treasury yields. The specific AFR rate to be used depends on the length of the loan or transaction term.

By using the AFR as a guideline, individuals and businesses can ensure that their loans or financial arrangements comply with the IRS requirements and avoid potential tax consequences. It helps establish a fair market interest rate for various transactions, preventing tax evasion or avoidance through below-market interest rates.

It’s important to consult the latest IRS publications or seek professional advice to determine the applicable AFR rates for specific transactions, as they may vary over time and depending on the length of the loan or arrangement term.