Blended Annual Rates for Demand Loans

Under section 7872 of the Internal Revenue Code, there is “forgone interest” imputed on “below market loans” between family members, employers and employees, corporations and shareholders, and in other situations. For a loan payable on demand, I.R.C. section 7872(f)(2)(B) states that the applicable federal rate is the federal short-term “for the period for which the amount of foregone interest is being determined, compounded semi-annually.” Because federal rates can change can change monthly, the calculation of interest would have to be month-by-month, although it is not clear how interest should be compounded semi-annually when the rates change monthly.

To simplify calculations of interest for demand loans, Rev. Rul. 86-17, 1986-1 C.B. 377, allows the use of a “blended annual rate” for demand loans with a fixed principal amount outstanding for an entire calendar year. 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. (The actual formula is (1+a/2)*(1+b/2)-1, where “a” is the January rate and “b” is the July 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.

The following is a chart of the blended annual rates from 1985 to the present. For the interest rates to apply to low-interest (or interest-free) demand loans before 1985, see Rev. Proc. 85-46, 1985-2 C.B. 507.

[The above explanation was amended on 10/3/2021 to correct the summaries of Rev. Rul. 86-16 and I.R.C. section 7872.]

— Blended Annual Rates Under Section 7872 —