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Employee loans creative benefit

When your compensation at work is not what you'd like, what can you do? If you are Enrique Watson, principal of a Washington public school, you become a bus salesman. According to The Washington Post, Mr. Watson was dismissed after officials determined that he had purchased two buses with school money and allegedly sold one to someone in Panama and pocketed the cash.

There are two lessons here. First, if you're a school principal, stay out of school bus sales. Second, if you're an employee, approach your employer for more creative compensation than just salary. A loan from an employer can be a terrific benefit. Let me explain.

Employee loans

If your employer is willing to lend you money, you could be better off than borrowing from the bank. Employees who receive an interest-free or low-interest loan will face a taxable benefit equal to the prescribed rate of interest (which dropped to 2 per cent on July 1, and has never been lower) multiplied by the outstanding loan balance (calculated daily). This taxable benefit can be reduced by any interest you pay on the loan within 30 days after the end of each year.

You may even be entitled to an interest deduction for that same taxable interest benefit where you use the borrowed money for an income-producing purpose, such as investing in shares or other securities, or buying an automobile used in the course of your employment (subject to the normal limitation for vehicles).

Housing loans

If your employer lends you money for a home purchase, there's even better news. The rate on the loan will be fixed at the initial rate for a full five years (just 2 per cent for loans made today). If the loan term exceeds five years, the interest rate will be reset every five years based on the prescribed rates at that time.

What's a home purchase loan? Generally, it's any loan used by the employee to purchase a home for his own use, or the use of a related person. It can also include loans used to repay an existing loan or mortgage used for this purpose. As you'd expect, the loan has to be received because of, or as a consequence of a previous, current, or intended office or employment. That's as technical as I'm going to get on this point. My advice? Visit a tax pro to ensure any loan will qualify as a home purchase loan.

Here's a nifty idea: Your employer can offer to pay a portion of your home mortgage interest. The mortgage may be considered a home purchase loan received by virtue of your office or employment when set up properly. In this case, you'll face no taxable benefit at all as long as you pay the prescribed rate.

For example, a plan set up today will require you to pay the prescribed rate of 2 per cent. If the interest rate on your mortgage is, say, 5 per cent, your employer can pay the 3-per-cent difference with no tax cost to you at all. And, if your mortgage does qualify as a home purchase loan, the 2-per-cent rate that you're required to pay will be locked in for five years before being reset.

A couple of last points: If you're a shareholder as well as an employee, any loan to you may be taxable unless the loan is received in your capacity as an employee, not as a shareholder. (This can be tricky to overcome, but speak to a tax pro). Finally, if an employer ever forgives a loan made to you, you'll face tax on the outstanding balance as employment income.

Tim Cestnick, FCA, CPA, CFP, TEP is author of Winning the Tax Game 2004, and The Tax Freedom Zone. He is managing director, Tax and Estate Planning, AIC Ltd.

tcestnick@aic.com.



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