Tax treatment of loan repayment
February 1, 2012 | 50,00 EUR | answered by Oliver Burchardt
Dear Madam, dear Sir,
Regarding the situation outlined below, I kindly request answers to my questions:
- A and B (married couple) have given C (A's cousin) several interest-bearing loans
- C has failed to make any interest payments for many years
- A and B have then terminated the contracts with C, but C has also failed to repay the amounts given
- Therefore, C was sued and ordered to repay the amounts given, loan interest, and default interest from the due date
- C is in a very strained financial situation, and enforcement of the judgment would likely lead to personal bankruptcy. We have now offered C to refrain from enforcing the judgment as long as monthly payments of €500.00 are made. This would be documented in a payment plan, where the payments would first cover the costs, then the interest, and finally the principal amount.
Questions: How should the monthly payment be treated for income tax purposes, i.e. how to determine the portion of loan interest included in this payment? Where should this be reported on the KAP attachment?
Variation: How would it be treated for income and gift tax purposes if A and B now decide to reach a settlement with C due to his very poor financial situation and imminent bankruptcy, and waive the loan and default interest, so that only the principal amount plus costs would be repaid by C? Or should at least a low interest rate be agreed upon (minimum interest rate)?
Thank you in advance for your efforts!
A and B
Dear inquirer,
Thank you for your inquiry, which I am happy to answer as part of an initial consultation.
Please note that the tax assessment is based on the information provided. Adding, changing, or omitting information can potentially alter the result, possibly significantly.
If you enter into an agreement with C regarding the allocation of the respective payments, this civil law agreement must be assessed differently for tax purposes. The interest component needs to be determined. The interest component can be calculated either simplistically with an interest rate of 5.5% or using the income value table contained in § 22 No. 1 sentence 3 letter a EStG or § 55 EStDV. To do this, take the remaining term of the loan and read the income share from the table. For example, if the loan still has 10 years to run, then according to § 55 EStDV, the income share is 12%. I understand that this may seem very abstract to you in this forum, but looking at the relevant laws should make it clear what needs to be done.
The interest must be stated in attachment KAP in line 15 (domestic capital gains not subject to tax deduction).
Waiving the interest would be subject to gift tax. However, C would be liable for the tax. From an income tax perspective, nothing would result for you, as you would no longer receive any interest and the pure capital repayment has no tax implications.
I hope my explanations have been helpful to you. Otherwise, please use the follow-up function.
Best regards,
Oliver Burchardt
Auditor
Tax advisor
