The IRS publishes a list of rates called the applicable federal rate each month. The rates are divided into three categories based on the length of the promissory note: short-term, mid-term, and long-term. This article will cover AFR Rates for July 2023.
Each month, the Internal Revenue Service surveys hundreds of interest rates to determine the market yields on US marketable debts. The IRS then publishes these rates in revenue rulings, known as Applicable Federal Rates or AFRs. These AFRs are used for a variety of purposes, including charitable deduction calculations such as original issue discounts and unstated interest. AFR rates are also used as benchmarks for intra-family loans, such as those used in estate tax planning techniques like grantor retained annuity trusts (GRATs). These types of transactions allow family members to provide low-cost capital to other relatives while taking advantage of the lower AFR rate. The AFRs are divided into three categories based on the length of the promissory note, with short-term rates covering demand notes up to three years, mid-term rates for notes ranging from three to nine years, and long-term rates for instruments that exceed nine years.
An AFR rate is a minimum interest rate that must be charged on loans between family members to avoid tax complications. It’s updated monthly by the IRS in a revenue ruling that lists different rates based on the term and compounding frequency of the loan. The IRS calculates these rates based on the market yield of a pool of tax-exempt obligations with similar terms and credit quality to U.S. Treasury obligations. It also takes into account the tax rate of the purchasers of these obligations. The IRS publishes these rates each month, and there are other websites that list them as well. The AFR rate is an important part of estate planning techniques such as grantor-retained annuity trusts (GRATs). The lower the interest rate, the more effective the GRAT will be at reducing taxes.
