Are personal loans taxable? This question comes up often when people are considering a personal loan.
No wonder why. Tax law is complicated, and most of us aren’t accountants or legal professionals. So, what’s the deal?
Personal loans aren’t generally taxable. But there are some complex stipulations that may make them taxable.
Here’s the skinny on personal loans and taxes.
Are Personal Loans Taxable?
Personal loans may seem like a good idea for a lot of reasons. People often consider personal loans in the following situations:
- When consolidating debt
- Making a significant purchase
- For vacation
- For improving the home
- Financing your business
- Paying for medical bills or life events
Personal loans can offer relief when you need it most. But as with most things that involve large sums of money, there are nuanced tax implications to watch out for.
This is especially true when it comes to taxes. As mentioned above, personal loans usually aren’t taxable.
But if you are someone who ends up with a personal loan that has become taxable, it’s something you ought to know before tax time comes and you get blindsided with a 1099-C and a hefty payment.
Below we will look at what constitutes taxable income and what’s a personal loan.
Is A Loan Considered Taxable Income?
Taxable income is a term used to describe all of the following income sources:
- Fees that accompany estate administration, jury duty or serving on a board of directors
- Real estate monies, like tenant rental fees
- Checks received, even if they weren’t cashed until the next calendar year
- Income you’ve authorized another person to receive on your behalf, like alimony
- Forgiven debts, we will talk about that more in depth later in this article
- Any contest winning or award money
- Back pay from lawsuits or other resources
- Company severance, unemployment or strike benefits
- Most capital gains
- Money made as a freelancer
- Dividends and interest
- Sale profits and royalties
- Value of bartered services
- Gambling or lotto
- Embezzlement, if convicted embezzled monies are required to be reported as taxable
Taxable income is varied and includes everything from lotto winnings to embezzlement gains, as shown above. But what it does not include is personal loan money, in most cases.
However, there are some notable exceptions that will be highlighted below.
The most typical case in which someone finds themselves owing taxes on a personal loan is a cancellation of debt (COD).
But when considering do loans count as income, other circumstances like family gifting and sale income present a fine distinction. The aforementioned can sometimes cause your personal loan to be viewed differently by the IRS.
Keep reading to determine if your loan money is taxable.
Cancellation of Debt
In most cases, personal loans are not considered taxable by the government, but a loan that has been issued a “Cancellation of Debt” is an exception.
A COD is a loan forgiveness option. Generally speaking, when a debt is forgiven, any monetary value received from it becomes taxable income.
If a debt is forgiven for less than the amount owed, the amount of that debt is now considered income that you received.
Once someone becomes relieved of paying off a loan, any money received is as good as cash to the government and is taxed accordingly.
Exceptions to the COD Rule
As stated above, COD income is generally taxable. But sometimes it’s not. If all of these nuances are making your head sit on a swivel, you aren’t alone.
That’s why we chose to write this blog, some of this stuff can be confusing to someone without an extensive history with tax law.
Here are some examples of when COD income may not be viewed as taxable income:
- If a loan forgiven by a private lender is considered a gift under a certain amount, that’s not typically taxable, although some tax considerations must be made for gifting
- An additional tax stipulation of gifting is that if the amount from the lender is more than $13,000 — the gift then aggregates toward the $1 million lifetime exemption from the gift tax
Similarly to COD, loan debt that has been discharged due to bankruptcy or qualifying financial hardship is not taxable.
This becomes more of an issue during times when the economy is low. For instance, during the Great Recession, mortgages that were foreclosed became discharged by the US government.
In some rare cases, how you structure a private personal loan can have repercussions.
In the legal cases of Shao v Commissioner and Kurata v Commissioner, it was established that in cases where securities are used as collateral for a loan and then sold by the lender, the loan may be considered sale income.
While these cases are few and far between, we still believe they are worth a mention because it’s important to understand your loan’s structure and what implications collateral has for you as a taxpayer.
When Taxation is Involved in Family Lending
In many cases, family member-to-family member loans, namely parents lending money to children, are not taxable.
You can establish a loan agreement with your child by writing out the terms of a loan and having both parties sign it.
If done correctly, this should exempt you from the IRS viewing the transaction as a gift and requesting you fill out a gift return.
These loans are not taxed in the following cases:
- The amount of the loan is $10,000 or less and it isn’t used for investments that stand to grow your wealth
- The amount of the loan is $100,000 or less and your net investment income isn’t more than $1,000 annually
It’s important to note that if done incorrectly, the IRS may look at the money you reported as a “personal loan” and decide that it’s a gift and requires more information to be filed.
What is Form 1099-C?
Form 1099-C is sent from lenders to customers when a cancellation of debt has been authorized.
The 1099-C is the form that outlines how much debt was canceled. And furthermore, it helps you calculate how much you owe.
This usually occurs when you are having trouble making payments and you negotiate total debt down with your lender.
While doing so may seem like a good way to cut through some of your debt, it also leaves you with a hefty tax burden.
Other times you may see a 1099-C form come in the mail is as follows:
- Mortgage loan forgiveness: after the housing bubble burst, homes that were foreclosed underwent loan forgiveness un the Mortgage Forgiveness Debt Relief Act of 2007
- Bankruptcy: People who file for Chapter 7 or Chapter 13 bankruptcy will likely see some debt forgiven, and for this reason will receive this form from creditors and or lenders
When you have a tax burden due to personal lending, in most cases you will need to use this form to calculate your taxes due to the IRS.
Are Personal Loans Tax Deductible?
Similarly to credit cards, interest paid on personal loans is not tax deductible, unfortunately.
Types of loans in which the interest is usually tax deductible are mortgage loans, student loans, and business loans.
As usual, there are some exceptions. For instance, proving a personal loan was used for business expenditures. But there are stipulations that come along with that also.
Likewise, if you use a loan to buy a business vehicle you may be able to deduct interest on the loan in your annual filings. This benefit could also apply to those people who use personal loan money to invest in certain types of businesses.
Personal Loans and Taxes
When exploring are personal loans taxable, here’s the breakdown.
Simply put, they aren’t taxable. But like most things that involve the IRS, that’s not the whole story.
Here are some instances when a personal loan may be taxable:
- When cancellation of debt occurs and there aren’t any extenuating circumstances
- When a loan is considered sale income by the IRS
- When a loan is considered a gift it’s not necessarily going to be treated as taxable by the IRS but there are still important tax considerations to make
Unlike student loans, business loans and most mortgages, personal loans are almost never tax deductible, which is unfortunate for consumers looking to itemize higher deductions.
However, the fact that they aren’t generally considered taxable income can provide some tax relief to loan consumers trying to get out of debt.