Have you ever had to pay taxes on a personal loan?

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Have you ever had to pay taxes on a personal loan?

When you take out a personal loan, you receive a lump sum that you can spend as you see fit. Is this pile of money ever taxable?

This could become a common question, as personal loans are expected to explode in popularity this year. The TransUnion credit bureau predicts that personal borrowing in the spring quarter (April, May and June) will increase 62.3% from a year ago.

If you have a personal loan, it’s usually not something you need to worry about when completing your tax return. But there are a few times when things can get a little more complicated.

First of all, what exactly is a personal loan?

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Personal loans are a great option when you need an influx of cash to cover a big expense, like an unexpected medical bill, a wedding, or a home repair project.

Loans are usually unsecured debt, which means you don’t have to put any asset as collateral.

Personal loans are versatile – you can use them for just about anything. They can save your life when urgent expenses arise, and they are also useful for consolidating debt. You can convert expensive credit card balances into a personal loan at a lower interest rate to pay off debt faster and at lower cost.

When you take out a personal loan, there are no surprises. You will usually borrow a fixed amount at a fixed interest rate and you will have a fixed term to repay the money.

Interest rates vary by lender and will depend on factors including your credit score.

Does personal loan proceeds count as income for taxes?

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A loan is money that you borrow and have to pay back – so no, it’s not considered income. Since the IRS is primarily interested in the funds you earn and keep, loans are generally not taxable.

This remains the case as long as you stay up to date on your loan and pay off your debt on time and in full.

But if you fall behind on your payments or stop making them, the tax question may have a different answer.

When a personal loan can trigger taxes

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If your income or situation changes and you can no longer afford to repay your loan, you could end up in default – and all or part of it could eventually be set aside, either by bankruptcy or if you are working with a credit management agency.

When the cancellation occurs, your lender will issue you with a Form 1099-c, which you will need to include with your tax return to show the amount of debt that was canceled.

The IRS is interested because when you don’t pay back the loan money, you no longer borrow it, but instead received it as income in the eyes of the tax authorities.

Let’s say you borrowed $ 20,000 and managed to repay half of it before you default on the loan. If you never intend to repay the remaining $ 10,000, the IRS will expect you to report it as income on your tax return and pay taxes on it.

The case of truly personal personal loans

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There is another time when a personal loan can have tax implications, and that is when the loan is really personal – made between friends or family.

If you give someone a “loan” that is interest free or at a below-market interest rate, the IRS may consider it a gift rather than a loan. And taxes on donations can come into play.

They are usually not a problem for the recipient – the responsibility for reporting lies with the lender or donor. If this is your role in the transaction and the amount is greater than the exclusion of tax on donations ($ 15,000 for 2020, or $ 11.58 million over a person’s lifetime) , you will probably only have to fill out an additional form when submitting your tax return.

The person receiving the money will not have to report it as income or pay taxes on it, even if the loan is never repaid.

What about interest paid on a personal loan?

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If you deduct interest on loan payments each year, including student loans and your mortgage, you might be wondering: can I claim my personal loan interest as well?

In most cases, it just doesn’t work that way. There is no write-off for a personal loan unless you can prove that you used the funds for business expenses. If this is the case, you’ll want to consult a tax professional before you file your return – to make sure you’re eligible for tax relief and claiming it correctly.

Today’s best tax software providers will put you in touch with a tax professional if you need to talk to someone about your loan.

But usually during tax season, a simple personal loan used for personal expenses won’t increase or decrease your tax liability.

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