Friday, May 25, 2007

Another misconception about loans and campaign finance laws

On a couple of left leaning blogs around Indiana there is some inaccurate information about the income tax consequences of loan repayments. I am going to clear them up here just like I did on WOWO earlier today.

One of the blogs, Taking Down Words, is a Democratic Blog in Indianapolis. Her post on personal loans and the potential IRS consequences for 2006 is misleading and inaccurate:

<http://www.takingdownwords.com/taking_down_words/2007/05/paging_the_irs_.html>

TDW asks the question: Anyone want to bet on whether Kelty reported the extra personal income on his 2006 tax return?

I used to read Taking Down Words; however, I stopped a few months ago because she reminds me of Sean Hannity; except she is a Democrat. I cannot abide people who feel that their Party is always right and that other Parties are evil.

Here are the basic rules concerning the tax consequences of loans:

1. A loan is not considered income since you will be paying back. It is considered a liability.
2. When you repay the principal portion of a loan this does not have income tax consequences for the person you are repaying.

This is best explained with an example. Lets say that I loan TDW $10,000 on Dec 31st 2006 so that she can take some accounting and legal courses to prevent her from posting inaccurate claims on her blog. Lets say she signs a promissory note promising to pay me back $1000 per month plus $100 in interest for the next ten months. Payments will start in January of 2007.

TDW will have no tax consequences in 2006, it will not be reported on her personal tax return in any way. She has not received personal income, she has taken out a loan that she is responsible to pay back.

Lets assume she makes all ten payments to me in a timely fashion...

TDW will have no tax consequences in 2007; however, at the end of the 10th month she no longer will owe me any money. That liability will have been paid off.

I will have tax consequences in 2007. She is paying me ten $100 interest payments in 2007. So I will report $1000 of interest income on my tax return in 2007. The $10,000 in principal payments I received are not taxable; they are a return of principal.

It is that simple.

Mike Sylvester

6 comments:

Tim Zank said...

"I used to read Taking Down Words; however, I stopped a few months ago because she reminds me of Sean Hannity; except she is a Democrat. I cannot abide people who feel that their Party is always right and that other Parties are evil."

Mike, that's why I rarely go back there anymore. I started reading and posting there on the recommendation of Tracey Warner, when he shut down his blog. He thought I might enjoy the banter, and I did for a while, but she's become very partisan. And her participants/posters are pretty rabid....

As for the accounting portion of your post, you explained that very well!

Anonymous said...

Mike, I agree with your example HOWEVER, you are leaving out an important twist. It will take too long to explain in words, but I will give you a call.

Anonymous said...

Mike,

I agree with 100% of your example, but what are your thoughts on the following example.

Candidate A gets a PERSONAL LOAN for 100,000 which according to the candidate can be used for anything he wants. (We all agree the 100K is NOT income to Candidate A)

Candidate A then contributes the 100K to his campaign in the form of a loan. No deduction for contribution and no income regognized.

Candidate A then uses other campaign contributions to retire his Personal Loan (which according to candidate was a personal loan that could be used for anything)

Please explain to me how the contributions do not become income to the Candidate when he uses them to retire his personal debt. Remember if not for the contributions, he would likely have to use POST tax dollars like salary ect to pay off the personal loan.

Its this last step that you are not considering. And, with all due respect to your new CPA status, you might be wrong on this one. Maybe not, but you might be.

Dave MacDonald said...

Anonymous,

Re: "Please explain to me how the contributions do not become income to the Candidate when he uses them to retire his personal debt. Remember if not for the contributions, he would likely have to use POST tax dollars like salary ect to pay off the personal loan."

Repaying the loan to the candidate using other's contributions is exactly that - reducing the debt of the campaign to the candidate (principal in - principal out). I believe the contractual terms of the repayment to the candidate would be stated explicitly at the time the candidate made the loan (e.g., campaign will repay x at y interest rate). As Mike so eloquently stated in his example, the principal payment (x) repaid to the candidate would not be income but debt reduction (reducing the funds the candidate initially loaned to the campaign). Any interest paid (y) WOULD be considered income in the tax year the interest is repaid (and therefore subject to income tax). Of course, this wouldn't be declared on the candidate's personal tax return until the following year.

The candidate's repayment of his/her personal loan to the party granting the funds initially is a separate matter (with it's own contractual obligations).

This is probably why the election board wants to see any and all of these contracts to determine the nature of the lending relationship.

I'm no CPA, but this is basic accounting.

LP Mike Sylvester said...

Anonymous 9:30

Thanks for leaving an example, it makes it easier for me to see what you are asking.

In the example you left there are no tax consequences of any kind to the candidate when the loan is paid back. It is a return of principal.

I am considering the last step!

The return of principal is 100% tax free.

Mike Sylvester

ROACH said...

KELTY-GATE!