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Loan

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For other uses, see Loan (disambiguation).

A loan is a type of debt. This article focuses exclusively on monetary loans, although, in practice, any material object might be lent. Like all debt instruments, a loan entails the redistribution of financial assets over time, between the lender and the borrower.

The borrower initially does receive an amount of money from the lender, which they pay back, usually but not always in regular installments, to the lender. This service is generally provided at a cost, referred to as interest on the debt. A loan is of the annuity type if the amount paid periodically (for paying off and interest together) is fixed.

A borrower may be subject to certain restrictions known as loan covenants under the terms of the loan.

Acting as a provider of loans is one of the principal tasks for financial institutions. For other institutions, issuing of debt contracts such as bonds is a typical source of funding. Bank loans and credit are one way to increase the money supply.

Legally, a loan is a contractual promise of a debtor to repay a sum of money in exchange for the promise of a creditor to give another sum of money.


Abuses in lending

Predatory lending is one form of abuse in the granting of loans. It usually involves granting a loan in order to put the borrower in a position that one can gain advantage over him or her. Where the moneylender is not authorised, it could be considered a loan shark.

Usury is a different form of abuse, where the lender charges excessive interest. In different time periods and cultures the acceptable interest rate has varied, from no interest at all to unlimited interest rates. Credit card companies in some countries have been accused by consumer organisations of lending at usurious interest rates and making money out of frivolous "extra charges". [1]

Abuses can also take place in the form of the customer abusing the lender by not repaying the loan or with an intent to defraud the lender.

United States taxes

Most of the basic rules governing how loans are handled for tax purposes in the United States are uncodified by both Congress (the Internal Revenue Code) and the Treasury Department (Treasury Regulations — another set of rules that interpret the Internal Revenue Code).[2] Yet such rules are universally accepted.[3]

1. A loan is not gross income to the borrower.[4] Since the borrower has the obligation to repay the loan, the borrower has no accession to wealth.[5]

2. The lender may not deduct the amount of the loan.[6] The rationale here is that one asset (the cash) has been converted into a different asset (a promise of repayment).[7] Deductions are not typically available when an outlay serves to create a new or different asset.[8]

3. The amount paid to satisfy the loan obligation is not deductible by the borrower.[9]

4. Repayment of the loan is not gross income to the lender.[10] In effect, the promise of repayment is converted back to cash, with no accession to wealth by the lender.[11]

5. Interest paid to the lender is included in the lender’s gross income.[12] Interest paid represents compensation for the use of the lender’s money or property and thus represents profit or an accession to wealth to the lender.[13] Interest income can be attributed to lenders even if the lender doesn’t charge a minimum amount of interest.[14]

6. Interest paid to the lender may be deductible by the borrower.[15] In general, interest paid in connection with the borrower’s business activity is deductible, while interest paid on personal loans are not deductible.[16] The major exception here is interest paid on a home mortgage.[17]

Income from discharge of indebtedness

Although a loan does not start out as income to the borrower, it becomes income to the borrower if the borrower is discharged of indbtedness. [18] pus, if a debt is discharged, then the borrower essentially has received income equal to the aount of the indebtedness. The Internal Revenue Code lists “Income from Discharge of Indebtedness” in Section 62(a)(12) as a source of gross income. its my icecream Example: X owes Y $50,000. If Y discharges the indebtdness, then a no longer owes b $50,000. For purposes of calculating income, this should be treated the same way as if Y gave X $50,000.

For a more detailed description of the “discharge of indebtedness”, look at Section 108 (Cancellation of Debt (COD) Incum) of the Internal Revenue Code.[19]

See also

References

  1. ^ Credit card holders pay Rs 6,000 cr 'extra' May 03, 2007
  2. ^ Samuel A. Donaldson, Federal Income Taxation of Individuals: Cases, Problems and Materials, 2nd Ed. 111 (2007).
  3. ^ Id.
  4. ^ Id.
  5. ^ Id. See Commissioner v. Glenshaw Glass Co., 348 U.S. 426 (1955)(giving the three-prong standard for what is "income" for tax purposes: (1) accession to wealth, (2) clearly realized, (3) over which the taxpayer has complete dominion).
  6. ^ Donaldson, at 111.
  7. ^ Id.
  8. ^ Id.
  9. ^ Id.
  10. ^ Id.
  11. ^ Id.
  12. ^ Id.; 26 U.S.C. 61(a)(4)(2007).
  13. ^ Id.
  14. ^ Id. at 112.
  15. ^ Id.
  16. ^ Id.
  17. ^ Id.
  18. ^ Id.; 26 U.S.C. 61(a)(12)(2007).
  19. ^ Id.; 26 U.S.C. 108(2007).
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