When you receive interest on a loan or an investment, you must include it on your taxes. Fair enough. The Internal Revenue Code, however, takes interest reporting a step further, sometimes requiring it even though you haven't actually received any money, such as when you buy a zero-coupon bond or make a below-market interest rate loan to a friend or relative. For example, if you make an interest-free loan to your friend so he can buy a house, the IRS treats the exchange as if you actually charged him the market interest rate and then refunded the interest to him.
Add all of your taxable interest income, including your imputed interest income, to find the total for the year. If it is $1,500 or less, skip Step 2; you are not limited as to which tax return form you can use. If your taxable interest income exceeds $1,500, however, you must use Form 1040 or Form 1040A.
Complete Schedule B, report each source of interest income in Part I. Write the name of the person or financial institution that paid you the interest and the amount for each source. For example, if you made a loan to a friend and had $1,500 of imputed interest income as a result, write your friend's name in the first column and "$1,500" in the second. Total the entries as instructed by Schedule B's Steps 2, 3 and 4.
Report your total interest income on your tax return. If you use Form 1040EZ, it goes on line 2. If you use Form 1040 or Form 1040A, it goes on line 8a. This amount is added to your other taxable income for the year.
- You don't have to pay taxes on imputed interest on loans under $10,000 if the loan is not used to invest in income-producing assets. This exception does not apply if, for example, you loan a friend $5,000 to invest in the stock market.
Mark Kennan is a writer based in the Kansas City area, specializing in personal finance and business topics. He has been writing since 2009 and has been published by "Quicken," "TurboTax," and "The Motley Fool."