if below-market interest is charged then IRC Section 7872 comes into play. if the loan interest rate is above the applicable federal rate and the amount loaned does not exceed $10,000 this section does not apply. if $10K or more and interest below the AFR the IRS requires the imputation of interest as follows
(2)Applicable Federal rate
(A)Term loans
In the case of any term loan, the applicable Federal rate shall be the applicable Federal rate in effect under section 1274(d) (as of the day on which the loan was made), compounded semiannually.
(B)Demand loans
In the case of a demand loan, the applicable Federal rate shall be the Federal short-term rate in effect under section 1274(d) for the period for which the amount of forgone interest is being determined, compounded semiannually.
For purposes of this title, in the case of any below-market loan to which this section applies and which is a gift loan or a demand loan, the forgone interest shall be treated as—
(A)transferred from the lender to the borrower, and
(B)retransferred by the borrower to the lender as interest.
to avoid such issues the loan should be documented in writing and specify an interest rate not below the required rate. the shareholder should abide by the terms especially repayment of principal and interest.
