ASC 835-30 Interest Imputation: Rate, Amortization, and Tax Rules

Under ASC 835-30, interest imputation is required whenever a note’s stated interest rate is missing, zero, or clearly below what an independent lender would charge for a comparable loan. You record the note at the present value of its future payments using a market rate, book the gap between face and present value as a discount, and amortize that discount into interest income or expense over the note’s life. The result is a balance sheet that reflects what the note is actually worth today and an income statement that shows the real economic cost of the financing.

When You Have to Impute

The rule reaches both notes receivable and notes payable that come out of specific transactions. If a company issues a note purely for cash and the stated rate is not a fair market rate, the note is recorded at the cash actually received rather than the face amount.¹ The more common trigger is a note exchanged for property, goods, or services with either no stated interest or a rate clearly below market.

The logic is economic substance. A buyer who signs a $100,000 non-interest-bearing note due in three years is paying for the goods and for the privilege of paying later. Recording the note at face on day one overstates both the asset for the seller and the liability for the buyer, and it buries the financing cost that will actually be incurred.

When You Don’t

ASC 835-30-15-3 lists eight categories that fall outside the imputation requirement.¹ Short-term trade payables and receivables with customary terms of roughly one year or less are exempt. So are prepayments that reduce a purchase price rather than get repaid, security deposits and retainages held to guarantee performance, and the customary cash lending and deposit activity of banks and similar institutions. Notes where a governmental agency prescribes or restricts the rate, such as industrial revenue bonds, are outside the rule. Present-value estimates of contractual obligations like product warranties are outside the rule. Notes between a parent and its subsidiaries, or between subsidiaries of a common parent, are outside the rule. And receivables, contract assets, and contract liabilities within the scope of ASC 606 follow that standard’s rules on significant financing components instead.

Two boundaries on the exceptions are worth flagging. First, the parent-subsidiary carve-out only turns off GAAP imputation on the individual-entity books; the IRS still applies IRC §7872 to below-market intercompany loans, discussed below. Second, exempted notes are not exempt from the presentation rules. Any discount or premium that happens to exist on an exempt note still has to be presented as a direct deduction from the face amount.¹

Picking the Discount Rate

Rate selection is the judgment call that draws the most auditor scrutiny. The objective is the rate an independent borrower and independent lender would have negotiated for a similar note under comparable conditions.¹ Prevailing rates for instruments of issuers with similar credit ratings are the primary benchmark. From there, collateral, covenants, term, payment structure, and any relevant tax attributes push the rate up or down.

When the borrower has no recent comparable debt outstanding, a build-up approach is permitted. You start with the risk-free yield curve and layer on a credit spread appropriate to debt with similar seniority, collateral, and term, maximizing observable inputs and minimizing unobservable ones consistent with the fair value hierarchy in ASC 820.

One timing rule catches people out. The rate is locked in at the date the note is issued, assumed, or acquired. Later swings in market rates do not change the carrying value or the amortization schedule.

The IRS Applicable Federal Rates are a separate concept, but they work as a floor for a sanity check. For May 2026, the AFRs compounded annually are 3.82% short-term (three years or less), 4.08% mid-term (over three but not over nine years), and 4.83% long-term (over nine years).² A defensible GAAP rate for a credit-risky borrower will sit above the AFR once a credit spread is added; an imputed rate below the AFR invites questions from both auditors and the IRS.

A Worked Example

Company A sells equipment to Company B for a $100,000 non-interest-bearing note due in a single payment in three years. The market rate for a borrower with Company B’s credit profile is 6%. Present value is $100,000 ÷ (1.06)³ = $83,962. The $16,038 gap is the discount.

Company A, holding the receivable, records at inception:

Debit Notes Receivable $100,000
Credit Discount on Notes Receivable $16,038
Credit Sales Revenue $83,962

The discount is a contra-asset that pulls the receivable down to present value on the balance sheet. Revenue is recognized at the economic value of what was actually received. Company B mirrors this: note payable at face, debit to a contra-liability discount, and the asset booked at $83,962.

Amortizing the Discount

After inception, the discount is unwound into interest using the effective interest method. Each period, multiply the carrying value by the market rate to get interest for the period, then step the carrying value up by that amount.¹ Continuing the example, from Company A’s side:

Year 1: $83,962 × 6% = $5,038 interest income; carrying value rises to $89,000.
Year 2: $89,000 × 6% = $5,340 interest income; carrying value rises to $94,340.
Year 3: $94,340 × 6% = $5,660 interest income; carrying value rises to $100,000.

The three years of interest total $16,038, exactly the original discount, and the carrying value lands on face at maturity. Each year’s entry debits Discount on Notes Receivable and credits Interest Income. Interest grows year over year because a constant rate is applied to an increasing balance; that compounding is the point.

ASC 835-30-35-4 allows straight-line amortization, but only when the numbers are not materially different from the effective interest method. In practice that limits straight-line to short notes with small discounts. Anything longer than a couple of years or with a meaningful discount effectively requires the effective interest method.

Where the Discount Shows Up on the Financials

ASC 835-30-45-1A requires the discount to be presented as a direct deduction from the face amount of the note, not as a separate deferred charge or credit.¹ The same rule covers any premium and any debt issuance costs. On the income statement, amortization is reported as interest expense for the borrower and interest income for the lender.³

Disclosures

For each outstanding debt instrument subject to imputation, disclose the face amount and the effective interest rate used, either in the footnotes or on the face of the financial statements.³ Convertible instruments require more: the unamortized discount at each balance sheet date and a breakout of contractual interest expense versus discount amortization for each reporting period.

Early Payoff

If the note is settled before maturity, any remaining unamortized discount is not simply written off to interest or accelerated in the last period. It rolls into the gain or loss on extinguishment. Compare the reacquisition price against the net carrying amount of the note, which includes unamortized discount, premium, and issuance costs.

Suppose Company B negotiates an early payoff at the end of Year 1 for $90,000 in cash. Carrying value at that point is $89,000 (face of $100,000 less $11,000 of remaining unamortized discount). Company B recognizes a $1,000 loss on extinguishment. For a partial payoff, allocate a proportionate share of the unamortized discount to the retired portion.

How the Tax Rules Diverge

GAAP imputation and tax imputation run on parallel tracks that do not always match. Two Internal Revenue Code sections drive the tax side.

IRC §1274 for Notes Issued for Property

When a debt instrument is issued for property rather than cash, §1274 sets the issue price for tax. If the stated principal does not exceed the imputed principal amount, the note has adequate stated interest and is recorded at stated principal. Otherwise the issue price is the present value of all payments, discounted at the AFR compounded semiannually.⁴

Which AFR tier applies depends on the term: short-term for three years or less, mid-term for over three but not over nine years, long-term beyond nine years. You use the lowest AFR in effect during the three-month window ending with the month the binding contract was signed, not necessarily the rate on the closing date.

Several transactions are exempt from §1274: sales where total payments do not exceed $250,000; sales of farms by individuals, estates, testamentary trusts, or qualifying small business entities where the price cannot exceed $1,000,000; debt from the sale of an individual’s principal residence; and notes that are publicly traded or issued for publicly traded property.⁴

IRC §7872 for Below-Market Loans

Where §1274 handles notes for property, §7872 targets related-party loans that charge less than the AFR: gift loans, employer-employee loans, corporation-shareholder loans, and any arrangement with a principal purpose of federal tax avoidance.⁵ The IRS treats foregone interest as if it were paid, generating phantom income for the lender and a deemed payment from the borrower. In a corporation-shareholder loan, foregone interest is recharacterized as a distribution from the corporation and a matching interest payment back to it.

A $10,000 de minimis exception covers gift loans between individuals and compensation-related or corporation-shareholder loans, as long as aggregate balances stay at or below that threshold.⁵ The exception disappears for gift loans used to acquire income-producing assets, and it does not apply where tax avoidance is a principal purpose.

Form 1099-OID

When imputed interest produces original issue discount of $10 or more, the holder files Form 1099-OID.⁶ The recipient statement is due by January 31 and the IRS filing by February 28 on paper or March 31 electronically. Filers with 10 or more information returns for the year must file electronically.

Book-Tax Differences to Track

The ASC 835-30 rate and the §1274 rate are set independently. GAAP wants the rate a market lender would charge the specific borrower, which includes a credit spread. Tax defaults to the AFR, a risk-free rate with no credit spread. For any borrower with real credit risk, the GAAP rate exceeds the AFR, producing a temporary difference between book and tax basis that runs through deferred taxes.

The scope exceptions also fail to line up. GAAP exempts parent-subsidiary notes entirely, but §7872 still reaches intercompany loans priced below the AFR. Companies that rely on the GAAP carve-out without a separate tax analysis end up with imputed interest on the return that never hit the books. In the other direction, §1274 exempts sales under $250,000 and principal residence sales, neither of which appears in the ASC 835-30 exception list. A reconciliation schedule for these gaps keeps the deferred tax provision accurate.

1
Deloitte. Roadmap: Issuer’s Accounting for Debt – 4.3 Debt Subject to ASC 835-30
2
Internal Revenue Service. Rev. Rul. 2026-9 – Applicable Federal Rates for May 2026
3
Deloitte. Roadmap: Issuer’s Accounting for Debt – 14.4 Disclosure
4
Office of the Law Revision Counsel. 26 USC 1274 – Determination of Issue Price in the Case of Certain Debt Instruments Issued for Property
5
Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates
6
Internal Revenue Service. General Instructions for Certain Information Returns (2026)