Employer loans to employees: below-market interest rules

The rule

Publication 15-A (2026) states it in two sentences. In general, if an employer lends an employee more than $10,000 at an interest rate less than the current applicable federal rate, the difference between the interest paid and the interest that would be paid under the AFR is considered additional compensation to the employee. The rule also applies to a loan of $10,000 or less if one of its principal purposes is the avoidance of federal tax. The statutory source is section 7872 and its regulations, which the publication cites for further detail.

How the money is taxed

The additional compensation is subject to social security, Medicare and FUTA taxes, but not to federal income tax withholding. That is an unusual combination, and it matters for payroll: the employer includes the amount in the wage bases for FICA and FUTA, withholds the employee’s share of social security and Medicare, and does not run it through income tax withholding. The amount is included in compensation on Form W-2, or on Form 1099-NEC if the borrower is an independent contractor. The employee is still taxed on it through their return.

The AFR and where to find it

The AFR is not a fixed number. The publication says it is established monthly and published by the IRS each month in the Internal Revenue Bulletin, and gives IRS.gov/AFR as the place to get the rates. Which AFR applies to a particular loan is determined under section 7872 and its regulations, which this page does not cover. So the calculator on this page asks you to enter the AFR yourself. We do not guess a current rate, because rates change monthly.

A worked example

An employer lends an employee $50,000 for a full year at 1%, when the applicable federal rate is 4.5%. The loan is over $10,000 and the rate is below the AFR, so the rule applies. The interest at the AFR would be $2,250 (4.5% of $50,000), the interest actually charged is $500, and the difference is $1,750. The calculator reproduces this: enter 50000, 1, 4.5 and 12 to see $1,750. That $1,750 would be added to the employee’s compensation, subject to social security, Medicare and FUTA taxes and reported on Form W-2, with no income tax withholding on it.

The example is our arithmetic built on the publication’s description, and the inputs are illustrative rather than a real AFR. It is a simple-interest approximation. The precise computation under section 7872, including how interest compounds and how the AFR is chosen for the loan type, is in the regulations and can produce a somewhat different figure.

What the small loan exception does and does not do

The $10,000 line is not a free pass. A loan of $10,000 or less is outside the general rule, but the publication states that the rule still applies if a principal purpose of the loan is avoiding federal tax. Repeated small loans to the same employee can raise that question. The calculator flags this: if you enter $10,000 or less and a rate under the AFR, it reminds you of the exception rather than showing a number.

Checklist for employers

Identify the loan and its terms. Decide whether the principal exceeds $10,000 or the purpose raises the avoidance question. Look up the AFR on IRS.gov/AFR for the right month and term. Compare the interest charged with the AFR interest for the period. Include any shortfall as compensation for FICA and FUTA, withhold the employee share of social security and Medicare, and report it on Form W-2. The details of timing and of loans outstanding for part of a year need the regulations or a payroll professional. For the basic payroll arithmetic, see our FICA tax calculator and the deposit schedule.

Sources

• IRS Publication 15-A, Employer’s Supplemental Tax Guide (2026): section 5, Wages and Other Compensation: Interest-Free and Below-Market-Interest-Rate Loans. Read November 2, 2026.
• IRS Applicable Federal Rates (AFR): the page Publication 15-A cites for monthly rates. Cited, not separately read.

Edition read: Publication 15-A (2026), for use in 2026. Rates, wage bases and dollar limits on this page are the 2026 figures printed in that edition; check the current publication and the IRS employment tax pages for your tax year. This page summarizes the publication and does not replace it.