Don’t get caught off guard during tax season. Here’s what you need to know about taxes and personal loans.
Refinancing student loans, major life events, buying a car or even funding a vacation can all lead you to consider a personal loan. However, additional income can mean additional work when it comes to taxes. Get the facts about what you should look out for, what’s deductible and the paperwork you might need.
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Borrowing money? Here are the tax implications
Are personal loans considered taxable income?
For the most part, no. When you receive a loan, it’s not considered taxable income. Taxes come into play on the part of the lender and usually aren’t something that you need to worry about.
The only exception is when a loan is forgiven. Cancellation of debt (COD) income is when your lender doesn’t require you to repay your loan’s principal or interest. Suddenly the loan becomes income simply given to you by the lender. Typically, if you receive a Form 1099-C from a lender, then you’ll have to report the amount on that form to the IRS as taxable income. Examples of when you might receive this form include: repossession, foreclosure, return of property to a lender, abandonment of property or the modification of a loan on your principal residence.
Even with COD income, there are exceptions. If you filed for Chapter 7 or Chapter 13 bankruptcy and your debt was discharged in a Title 11 bankruptcy proceeding, then you won’t have to pay taxes on that debt. Another example is forgiveness in the form of a gift. If you’re forgiven an amount that’s less than your liabilities minus your assets, you’re off the hook for paying taxes for that amount.
Are personal loans tax-deductible?
No, repayments on a personal loan are not tax-deductible. Just as funding from it isn’t considered taxable income, making payments on a personal loan — or on interest for it — isn’t deductible.
However, there are some exceptions. Here are a list of uses for personal loans that are tax-deductible:
- Investments
- Business expenses
- Qualified education expenses
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What loans are tax-deductible?
You may have heard that certain loans are tax-deductible, and you heard right. Interest payments on the following loans are usually tax-deductible:
- Student loans. If you’re paying off your student loans, you can deduct the interest that you’ve paid up to $2,500 per year. Deductions only apply if you’ve taken the loan out from a qualified lender. Private loans from friends and family aren’t considered deductible. Use the IRS’s tax assistant tool to see if you can deduct the interest you paid on a student or educational loan.
- Mortgages and home equity loans. Any interest paid on your first or second mortgage is deductible up to $1 million. For home equity loans, your qualifying balance is the equity of your home or $100,000, whichever is less. However, President Trump’s new tax plan will affect the tax deductions on mortgages and home equity loans when you file taxes for year 2018 and onward. Under his new plan, the deductions will be limited to $750,000 in mortgage debt for new house purchases, and you won’t be able to deduct interest on home equity loans at all.
- Business loans. Very specific requirements and qualifications go into deducting business loan interest payments from your taxes. If you’re using the loan for business and personal reasons, then you cannot deduct the entirety of the interest payments — but only the percentage of those used to fund your business.
Remember that with all things tax-related, there are exceptions. Be sure to double-check with your CPA before filing.
An example of how these tax deductions could affect your tax payments
Let’s say you made $100,000 last year and you paid $15,000 in interest on your mortgage. You can deduct $15,000 from $100,000 for a new taxable income of $85,000. This drops you from a 28% tax bracket to a 25% tax bracket, saving you money. The difference between 28% of 100,000 and 25% of $85,000 is $6,750. This is how much the mortgage interest tax deduction dropped your tax bill.
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Lending money? Here are some tax implications you need to know
I lent money to a friend and am receiving interest. Is the interest considered taxable income?
Yes, the interest payments you receive are taxable. Even when you don’t include interest, the IRS may treat would-be interest as taxable.
When it comes time to do your taxes, you’ll need to file Form 1099-INT to avoid being dinged by the IRS. For Form 1099-INT, you’ll need a few pieces of information:
- Your full name and address.
- The Social Security number of the person you loaned money to.
- The income you made on interest.
- Any tax-exempt interest.
Do I have to charge interest on a loan to a family member?
There is no easy answer to this one. Some experts advise that you charge interest on a loan to a family member no matter what to avoid tax complications. The government may end up taxing you on interest that you should have charged, or taxing it as a gift.
Gifts come with an annual exemption limit. In other words, every year there is an amount that you can “gift” to someone without paying taxes on that gift. For 2017, that amount is $14,000. If you were to gift your family member $10,000 and he/she were to gift you that amount back over time, you could be circumventing certain rules. No taxes would need to be filed, and no interest would need to be charged.
What’s the difference between a gift and a loan?
Gifts are any amount that you give under $14,000 a year. For anything below that, the government doesn’t need to know why it was given or if it’s being paid back.
For loans greater than that, you should follow the IRS guidelines for charging interest. This includes looking at the applicable federal rate (AFR) and filing income tax on the interest payments you receive.
If you give more than $14,000 to one person throughout the year as a gift, then you’re required to file a gift tax form.
What to keep in mind when lending money to friends and family
Remember that unless you draw up a full loan contract with the person you’re lending to, the person may not be legally obligated to pay you back. If you’re lending a large amount of money, you may want to consider having a documented contract.
In general, lending money to family or friends could cause tension in the relationship. One idea to consider is only giving money to family or friends that you can afford to not get back.
It’s also important to talk through the tax implications with a tax professional if you’re unsure of what to file. Instead of getting through your taxes and finding out that you owe much more than you set aside, work it out beforehand to save yourself potential frustrations.
Bottom line
The tax implications of personal loans can be confusing. Keep in mind that whether you’re borrowing or lending, there are ways for you to investigate deductibles and payments. As frustrating as it can be, getting the research done ahead of time can save time and money down the road.
Before you file, be sure to speak with a qualified tax professional if you have any questions.
Do I need to pay taxes on my loan coming from India bank? He wants me to settle tax for the non-residential tax before he transfers my loan to my bank account. He explained that I need to pay taxes to prove that I am a citizen of Taiwan.
Hi Rhubie,
Thanks for your inquiry.
The tax mentioned on the above article is applicable to the US only so I’m afraid I could not really give a comment for possible tax implications on your loan in India. It would be best that you contact the bank or your lender directly on this matter.
Best regards,
Rench