Personal loans are usually not considered income and are therefore not taxable. Rather, they are viewed as a kind of debt. There are, however, some exceptions to this rule which create situations in which a personal loan could be taxable.
Read on to learn the details about personal loans and their tax implications.
What Constitutes Taxable Income?
Taxable income is money that’s been earned and is subject to tax, such as your salary, investment income, and even lottery winnings. To figure out your taxable income, you take your gross income and subtract your exemptions and itemized or standardized tax deductions.
Definition and Examples
Taxable income falls under two main camps. Taxable income can include earned income, such as:
• Wages
• Salaries
• Bonuses
• Tips
• Investment income
It also includes “unearned” income, such as:
• Taxable interest earned
• Ordinary dividends
• Capital gains distributions
• Alimony payments
• Social Security benefits
• Inheritances
• Property income
As you can see, income can come in many different forms, such as money, goods, services, and property. Generally speaking, most income is taxable. It’s only non-taxable if it’s specifically exempted by law.
Personal Loans and Taxation
The Internal Revenue Service, or IRS, does not and cannot tax personal loans. That’s because a personal loan represents a kind of debt. The proceeds from this loan need to be repaid, and therefore personal loans aren’t considered taxable income.
That means they aren’t taxed — for the most part — and it doesn’t matter how small or large a loan may be or what you use the proceeds for. Neither the principal nor the interest paid can usually be taxed.
What’s more, there’s also zero impact on taxation whether you’ve taken out an unsecured personal loan or a secured one.
Worth noting: While personal loans aren’t usually taxable, they’re not tax-deductible either. (This differs from the situation with mortgages and student loans, in which cases the interest is typically tax-deductible.)
To sum it up, your personal loan usually won’t impact your tax situation in any way. In turn, you probably don’t need to note the loan on your tax returns. No additional forms need to be filled out and added to your return.
Recommended: Using a Personal Loan to Pay Off Credit Card Debt
Exceptions and Special Cases
While personal loans aren’t generally taxable, there is an exception. If the lender cancels the debt or gives you loan forgiveness, the proceeds of the loan then fall under cancellation of debt (COD) income. Once proceeds from the loan are forgiven, it then can be taxed.
While loan forgiveness isn’t too common (except for student loans), a portion of your personal loans can be nixed if you reach an agreement with the lender where you’re no longer responsible for paying back the remaining balance.
If you’re financially stretched thin and unable to repay the remainder of your loan, you can receive forgiveness in a couple of ways:
• One, you enter debt settlement, where you negotiate with your lender by paying less than the amount owed.
• Another way you can be cleared of your debt is if your lender has a hardship program. If you meet the eligibility requirements, the lender might wipe part or all of your remaining debt.
There are a few instances where canceled debt usually isn’t taxable, however:
• A loan that’s forgiven by a private lender (i.e., family, friend) or an intra-family loan (aka a loan between two family members) is forgiven as a gift. Because these are treated as gifts, they are exempt from the gift and estate tax up to certain limits. In 2024, up to $18,000 in gifts can be excluded from taxation per donee (or recipient).
• Canceled debt from a Chapter 11 bankruptcy (which is a legal process, when a person or entity declares they cannot pay creditors)
• Canceled debt from insolvency (defined as a financial state in which a person is unable to pay bills)
Recommended: Guide to Insolvency vs. Bankruptcy
Reporting Loans on Tax Returns
Generally, you won’t need to report money you get from loans on tax returns — that is, unless it gets canceled or forgiven.
Getting into the weeds, the IRS usually requires you to report the canceled amount to the IRS on Form 1099-C, which is used for cancellation of debt (COD). To fill out the form, you’ll need to provide the following information:
• Creditor’s name
• Creditor’s address
• Creditor’s tax ID (TIN)
• Debtor’s name
• Debtor’s address
• Debtor’s tax ID (TIN, which may be an SSN)
• Date of loan forgiveness
• Amount cleared
• Interest paid on the canceled debt
Recommended: Personal Loan Calculator
Avoiding Tax Pitfalls with Personal Loans
As mentioned, usually your personal loans won’t impact your tax situation in any way. Uncle Sam doesn’t need to know when you take out the loan or when you pay off your balance. Neither the lump sum you receive in the form of a personal loan nor the interest you pay is taxable. What’s more, they aren’t typically tax-deductible either, meaning you won’t receive any tax breaks.
To steer clear of potential tax pitfalls, consider following this advice:
• Don’t report the proceeds of the loan or how much you paid off in a given year. Remember: A personal loan isn’t considered income. It’s money you owe and need to be repaid.
• Money you pay back on a personal loan isn’t tax-deductible — neither the principal nor the interest.
• If part or all of the remaining balance of the loan is forgiven or canceled, you’ll likely need to pay taxes on the forgiven amount. A form 1099-C (COD) will need to be completed by the tax deadline for individual tax returns.
• Know that in some instances, you might not have to pay taxes on the forgiven amount of a personal loan. For instance, if the personal loan was from a friend or family member and forgiven as a gift, taxes won’t likely be due up to gift tax limits. The same can hold true if you filed Chapter 11 bankruptcy or are insolvent; you may not have to pay taxes.
• If you have any questions, consult with a tax professional for guidance and one-on-one advice.
Speaking of taxes, if you owe a sum, you can use a personal loan to pay off taxes. However, it can be a smart idea to explore other options, such as an IRS payment plan, as well.
When comparing options, you’ll want to look at the personal loan interest rate, fees, monthly payment, and total cost of a personal loan to see if it fits your budget.
The Takeaway
For the most part, a personal loan doesn’t count as taxable income. It’s a debt, so you don’t have to fret over owing the IRS anything on the interest or the principal. There are a few exceptions, such as personal loans that are forgiven by a private lender or canceled due to, say, bankruptcy or insolvency.
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FAQ
Do I report a personal loan as income on taxes?
Personal loans don’t count as income, so they don’t need to be reported to the IRS for tax purposes. To be a bit more specific: Because proceeds from personal loans aren’t taxable, the interest paid or the amount paid back don’t need to be reported to the IRS.
What if a personal loan is forgiven or canceled?
If a personal loan is forgiven or canceled, you’ll most likely need to pay taxes on the amount that’s forgiven or canceled. You’ll also need to complete and submit a tax form 1099-C (Cancelation of Debt) form as part of this process. There are some exceptions to this, however, so delve into your specific situation, possibly with a tax professional, to understand it in detail.
Can interest paid on personal loans be tax-deductible?
No part of a personal loan is typically tax-deductible, and that includes the interest paid. With other kinds of loans, such as home mortgages and student loans, the interest may be tax-deductible.
Photo credit: iStock/shurkin_son
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