The IRS issues each month their applicable federal rates (AFRs). The AFR is the minimum amount of interest that either must be in a contract or if not, will be imputed by the tax rules. For example, assume the AFR is 1% and a son borrows $100,000 from mom and it is outstanding for a full year. If mom charges at least 1% on the note, then nothing needs to be imputed. However, assume that mom does not charge interest. In this case, mom will have $1,000 of interest income that she will be required to report on her tax return and son will likely have non-deductible interest expense of $1,000.
AFRs are segmented into three terms:
- Short-term is any debt with a term shorter than three years,
- Mid-term is debt longer than three years and less than nine years
- Long-term is debt with a term longer than nine years.
The trend in AFRS was up right before the pandemic hit in early 2020. Once the pandemic hit, AFRs dropped dramatically. As an example, the long-term AFR rate in January 2020 was 2.07%. This same rate a year later dropped to 1.35%. The change in short-term rates was even more dramatic. The January 2020 rate was 1.60% while a year later is was a miniscule .14%.
But what is it now? The February 2021 rate is as follows:
- Short-term - .59%
- Mid-term - 1.40%
- Long-term - 1.92%
For about the last four months the short-term rate has been climbing by about 10 basis points each month. If the Federal Reserve bumps rates 50 basis points in March you will likely see this rate jump by 40 basis points or more.
Low rates are great for making inter-family loans. As rates increase, the value of these loans get less and less valuable. However, on the other side, if a farmer is interested in doing a charitable remainder trust (CRT), higher rates lead to increased annuity payments to the farmer.
There is a chance that we may see short-term rates exceed long-term rates. This is called an inverted yield curve and historically this has usually forewarned some type of recession may be imminent. We shall see and we will keep you posted on future trends in rates.
