Wally is employed as an executive with Pay More Incorporated. To entice Wally to work for Pay More, the corporation loaned him $20,000 at the beginning of the year at a simple interest rate of 1 percent. Wally would have paid interest of $2,400 this year if the interest rate on the loan had been set at the prevailing federal interest rate.
a. Wally used the funds as a down payment on a speed boat and repaid the $20,000 loan (including $200 of interest) at year-end. Does this loan result in any gross income to either party, and if so, how much?
b. Assume instead Pay More forgave the loan and interest on December 31. What amount of gross income does Wally recognize this year? Explain.