What is the Applicable Federal Rate (AFR)?

The applicable federal rate (AFR) is a reference interest rate issued by the IRS. It is used as a benchmark rate for family loans and private lending arrangements.

A lender must charge a minimum interest rate on loans to keep the arrangement consistent with the IRS tax avoidance rules. Hence, they use AFR as a reference to set that benchmark rate.

Let us discuss what is AFR, how it works, and where it is applicable.

What is the Applicable Federal Rate (AFR)?

The Applicable Federal Rate (AFR) refers to the minimum interest rate that applies to personal loans under US law.

The AFR is issued monthly by the Internal Revenue Service (IRS) in the US. It applies to personal and private loans under certain conditions. The AFR can change as determined by the IRS periodically.

Lower interest rates below a threshold come with tax implications. Therefore, the IRS issues a standardized interest rate (a reference rate) for private loans under Section 1274(d).

This reference interest rate applies to loans where the charged interest rate is lower than the market interest rate. Therefore, the AFR becomes the minimum payable interest rate.

How Does the Applicable Federal Rate (AFR) Work?

The IRS sets AFR as the minimum interest rate to curb tax avoidance practices in gifts and family loans. It applies to all types of personal and private loans offered without formal or commercial banking arrangements.

When a lender lends money to a family member or an acquaintance, there must be interest charged to it. If there is no interest charged or the rate is significantly lower, the IRS will consider it as taxable income.

This taxable income will be calculated by using the AFR as a reference rate to the interest rate charged by the lender in a private loan. Therefore, the borrower cannot receive a loan even from a family member without interest charges.

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When a borrower receives money at or above an interest rate equal to the applicable federal rate, there will be no tax obligations for both parties.

The same AFR working methodology applies to gifts as well. You can offer a gift of up to $16,000 per year without paying any taxes to the IRS. If the gift value exceeds that limit, you’ll report that amount to the IRS.

The lifetime value of tax-free gifts to family members is currently set at $12.06 million by the IRS. However, this amount can change as the IRS adjusts it for inflation.

What is Imputed Interest Rate?

The difference between the interest rate on private loans and the applicable federal rate is called an imputed interest rate.

When private loans and family transfers are made, they must include an interest rate. Otherwise, the IRS will consider these transfers as gifts or taxable income depending on the situation.

Even when the lender imposes an interest rate, it can be lower than the reference AFR rate. For instance, the AFR is 3.5% and the lender to a family member is charged an interest rate of only 2.5%.

The difference here (3.5% – 2.5%) 1% is imputed interest rate. The lender must report these interest savings as taxable income to the IRS.

The rationale behind charging imputed interest by the IRS is to curb tax avoidance when declaring dividends, gifts, and compensations by taxpayers.

So, the imputed interest rule allows the IRS to collect the right tax amount from private loans even when there is no cash flow due to a lower or zero interest rate charged by a lender.


Let us understand the concept of applicable federal rates with the help of a hypothetical scenario.

Suppose you lent a family member $25,000 for one year. This private loan falls under the short-term loan AFR category by the IRS.

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The current AFR for short-term loans is set at 4.10% charged annually. If you received an interest rate of 4.10% from the family member, you will not require to pay any imputed interest.

It means you should charge interest of $ 1,025 for one year. If you received any amount less than that, it would count as taxable income under the AFR rules.

In another scenario, suppose you charged only 3% and received an interest amount of $750. Then, the difference of $275 ($1,025 – $750) is the imputed interest that will count towards your taxable income.

How the IRS determines the AFR?

The IRS categorized the applicable federal rate into three categories; short-term, mid-term, and long-term interest rates.

  • Short-term AFR applies to loans with a maturity date of up to three years.
  • Mid-term AFR applies to private loans with a maturity of up to nine years.
  • Long-term AFR applies to private loans with a maturity date of above nine years.

The IRS and the US Treasury determine the applicable federal rates and the adjusted AFRs. The IRS uses historical short-term to long-term commercial lending rates on different products in the market as references.

Short-term AFR is calculated by determining the yield from marketable securities (debt instruments) with a short-term maturity of fewer than three years.

Mid-term AFR is calculated similarly by analyzing the debt instruments of maturities with up to nine years. Similarly, long-term AFR corresponds to the bond market interest rates.

Current Applicable Federal Rates by the IRS

Let us take a look at some of the current applicable federal rates announced by the IRS for the month of November 2022 as guidance.

 Short-Term AFR

AFRAnnually %Semi-Annually %Quarterly %Monthly %
110% AFR4.524.474.454.43
120% AFR4.934.874.844.82
130% AFR5.355.285.255.22

 Medium-Term AFR

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AFRAnnually %Semi-Annually %Quarterly %Monthly %
110% AFR4.374.324.304.28
120% AFR4.784.724.694.67
130% AFR5.

Long-Term AFR

AFRAnnually %Semi-Annually %Quarterly %Monthly %
110% AFR4.324.274.254.23
120% AFR4.714.664.634.62
130% AFR5.

Where Does the AFR Rule Apply?

As mentioned above, the applicable federal rate comes into play with the “Below Market Interest Rate” loans. These loans are usually non-formal lending to family members.

Some common examples of below-market interest rate loans include:

  • Loans between family members at zero or very low-interest rates (gift loans).
  • Compensational loans are made by employers to their employees as a form of compensation with lower interest rates.
  • Companies issuing loans to their shareholders are lower rates.
  • Any other private loan to reduce the tax obligation of the borrower.
  • Any loan made under the obligation of continuous care for someone.

Generally, the IRS will determine the nature of the loan as a gift or non-gift loan. Then, if there is any difference between the AFR and the interest rate charged, the lender must include the imputed interest as taxable income.

What are the Exceptions to the AFR Rule?

You can lend gift loans of up to $16,000 with the current IRS rules. The limit can change at any time as decided by the IRS.

Then, there are certain situations where a lower interest rate than AFR will be exempted. For instance, if it is a regular business of the lender to offer lower interest rate debt products.

Here are a few common examples of exempted loans from the AFR rule:

  • Gift loans and compensation loans within the allowed limits.
  • Government loans providing subsidized interest rates like student loans.
  • Commercial loans that are considered a regular business of the lender, for instance, banks offering 0% APR loans or credit cards.
  • Loans offered by non-US residents who are not subject to the IRS tax regulations.
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