Blended Annual Rates for Demand Loans: Forgone Interest and Gift Cap

The IRS blended annual rate for demand loans is 4.22% for 2025, published in Revenue Ruling 2025-13.¹ The 2026 rate has not yet been released and will appear in a mid-year revenue ruling. This single number is what you use to figure out how much phantom interest the IRS attributes to a below-market demand loan between related parties, and therefore how much the lender has to report as taxable interest income.

What the Blended Annual Rate Does

The blended annual rate, or BAR, is a once-a-year interest rate the IRS publishes for calculating imputed interest on below-market demand loans under Internal Revenue Code Section 7872.² Without it, you would have to track the Applicable Federal Rate every month and compute a weighted average across the year. The BAR collapses that into one number.

The rate for each calendar year appears in a revenue ruling released around July and applied retroactively back to January 1. The 2024 BAR was 5.03%, published in Revenue Ruling 2024-13.³ The 2025 rate is 4.22%.¹ The rate lives in Table 6 of the ruling. Only the officially published number counts; using anything else produces the wrong answer.

Which Loans the Rate Actually Applies To

The BAR only comes into play when a loan is both below-market and a demand loan. Miss either condition and this rate is not the one you want.

A loan is below-market when its stated interest rate is lower than the Applicable Federal Rate, the minimum rate the IRS sets monthly based on U.S. Treasury yields.⁴ Charging less than the AFR signals to the IRS that part of what looks like a loan is really a gift, a dividend, or disguised compensation.²

A demand loan is any loan the lender can call in for repayment at any time. The statute also treats as demand loans any loan whose benefits are tied to the borrower’s future services and are nontransferable, plus any loan with an indefinite maturity.⁵ That last piece sweeps in most informal family loans. If you lent a relative money with a loose understanding that they would pay it back “someday,” the IRS very likely sees a demand loan.

Term loans with fixed maturity dates work differently. Forgone interest on a below-market term loan is treated as original issue discount imputed at origination, not recalculated year to year, and the BAR does not enter the calculation.⁵

There is also a small-loan carve-out. If the aggregate outstanding balance of all loans between the same lender and borrower stays at or below $10,000, the imputed interest rules do not apply. The ceiling is aggregate, so splitting a $15,000 loan into two notes does not work. The exception also disappears for gift loans used to buy or carry income-producing assets, and for compensation-related or corporate-shareholder loans where tax avoidance is a principal purpose of the interest arrangement.⁵

Calculating Forgone Interest With the BAR

Once the small-loan exception is off the table and you know the loan is a below-market demand loan, the calculation is short.

Step 1: Pull the Published Rate

Find the BAR for the tax year in the IRS revenue ruling. For 2025, that is 4.22%.¹ For 2026, wait for the mid-year revenue ruling.

Step 2: Find the Average Outstanding Balance

Figure out the average principal balance for the period the loan was outstanding during the tax year. If the balance never changed, that is simply the loan amount. If the borrower made partial repayments or received additional advances, use a daily or monthly weighted average and keep records of every principal change.

Step 3: Multiply

Multiply the BAR by the average outstanding balance. That is the total interest the IRS deems should have been charged. At the 2025 rate of 4.22%, a $100,000 loan produces $4,220 of imputed interest.

Step 4: Subtract Interest Actually Paid

Subtract any interest the borrower actually paid during the year. What is left is the forgone interest, and it is the number that drives the tax consequences below.² If actual interest paid meets or exceeds the BAR figure, there is no forgone interest and nothing to report.

How Forgone Interest Gets Taxed

The IRS treats forgone interest as two deemed transactions occurring on December 31. First, the lender is treated as transferring the forgone interest amount to the borrower. Second, the borrower is treated as paying that same amount back to the lender as interest.² What that first leg looks like depends on the relationship between the parties:

Corporation to shareholder: the deemed transfer is a dividend distribution.
Employer to employee: the deemed transfer is additional compensation income.
Family member to family member: the deemed transfer is a gift.

Regardless of category, the lender reports the deemed repayment as interest income, typically on Schedule B of Form 1040.⁶ No cash actually changes hands, but for tax purposes the interest is real.

Whether the borrower can deduct the deemed interest depends on how the loan proceeds were used. Investment use may allow an investment interest expense deduction subject to the limitations of IRC 163(d). Business use may support a business interest deduction. Personal use gets no deduction.

For gift loans, the deemed gift may push the lender into gift tax reporting. The federal annual gift tax exclusion for 2026 is $19,000 per recipient.⁷ If the imputed interest plus any other gifts to the same person crosses that threshold in a calendar year, the lender files Form 709 by April 15 of the following year.⁸ For most family loans the imputed interest sits well below the threshold, but large zero-interest balances can climb higher than lenders expect.

The $100,000 Gift Loan Cap

Family lenders get a second, more generous break. When the aggregate outstanding balance of gift loans between one lender and one borrower stays at or below $100,000, the imputed interest for income tax purposes is capped at the borrower’s net investment income for the year.⁹ A borrower with little or no investment income can end up with zero imputed interest even on a substantial loan.

There is a further floor: if the borrower’s net investment income for the year is $1,000 or less, it counts as zero, so no interest is imputed at all.⁹ A parent lending $80,000 to an adult child with minimal savings and no brokerage account often owes nothing under this rule.

Net investment income is defined by reference to IRC 163(d)(4): interest, dividends, annuities, royalties, and net capital gains from investment property, less related expenses, plus certain deferred payment obligations like U.S. savings bonds and market discount bonds.

The cap disappears the moment the balance crosses $100,000. From then on, full imputed interest applies without any tie to the borrower’s investment income. The $100,000 figure is fixed by statute and not adjusted for inflation.⁵ The cap also drops out if a principal purpose of the interest arrangement is federal tax avoidance, regardless of loan size.

Document the Loan or the Whole Analysis Falls Apart

None of the Section 7872 machinery matters if the IRS decides your “loan” was never a loan in the first place. Related-party transfers draw scrutiny, and the burden is on the parties to show a real debtor-creditor relationship. Substance beats labels.

At a minimum, put a written promissory note in place, signed by both sides, covering the principal, the interest rate (even if zero), a repayment schedule or demand provision, and the date. Beyond the paperwork, the IRS looks at whether the parties behaved like a lender and borrower:

Repayments actually happen. A borrower who never pays anything undercuts the arrangement, even on a demand loan.
The borrower had a reasonable prospect of repaying when the loan was made.
The lender follows up when payments stop. Silent forgiveness looks like gifting.
Both sides keep records of advances, repayments, and interest calculations.

If the IRS reclassifies a purported loan as a gift, the whole principal becomes a taxable transfer, not just the imputed interest. Reclassifying a corporate-shareholder loan can turn the full balance into a dividend or constructive distribution. The exposure from weak documentation dwarfs the modest imputed interest the BAR itself produces.

1
Internal Revenue Service. Rev. Rul. 2025-13
2
Office of the Law Revision Counsel. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates
3
Internal Revenue Service. Internal Revenue Bulletin 2024-28
4
Internal Revenue Service. Applicable Federal Rates (AFRs) Rulings
5
Office of the Law Revision Counsel. 26 US Code 7872 – Treatment of Loans With Below-Market Interest Rates
6
Internal Revenue Service. About Schedule B (Form 1040)
7
Internal Revenue Service. What’s New — Estate and Gift Tax
8
Internal Revenue Service. Instructions for Form 709 (2025)
9
GovInfo. 26 USC 7872 – Treatment of Loans With Below-Market Interest Rates – Section: Special Rules for Gift Loans