Is personal loan taxable and considered income

By Izzy M Reviewed by Nooreen B Edited by Sarah R
Modified on February 27, 2024
is personal loan taxable

Personal loans are a convenient financing option for people facing unexpected expenses. But do you have to pay additional taxes next year if you get a personal loan? Learn whether a personal loan is taxable and how you can qualify for emergency funding. 

Are Personal Loans Considered Taxable Income?

Personal loans provide a lump sum to eligible borrowers for personal expenses. But are personal loans considered income? The answer is no! 

According to the IRS, a personal loan is not taxable income because you did not earn the loan money through work or investments. Once the repayment period ends, you must pay the money back according to the terms loan agreement. The personal loan tax implications of a personal loan are minimal. Most borrowers do have to worry about reporting personal loans during tax season. Instead, you just need to ensure you are not late filing taxes

In What Situations Is a Personal Loan Considered Taxable Income?

While it’s true that the IRS does not typically label personal loans as taxable income, there are exceptions. Borrowers have to pay income taxes on a personal loan that is forgiven, canceled, or discharged. The debt amount that falls into one of those three categories affects how high your tax bill is during tax season.

Forgiven Debt

A forgiven loan, or debt forgiveness, is when a lender forgives all or a portion of the total loan balance. If a forgiven personal loan is less than $600, you must report the amount, although you may not receive a 1099-C form from the lender.  

Debt rarely gets forgiven, but sometimes lenders extend debt forgiveness to qualified borrowers with a specific type of loan. For example, certain individuals can get their mortgage debt forgiven. And while credit card debt forgiveness is unlikely, you may be able to get a debt settlement if you struggle financially. 

Canceled Debt

A cancelation of debt (COD) is when the financial institution forgives a portion, or the entirety, of the outstanding loan balance. Borrowers usually get a cancelation of debt through a debt forgiveness program. When the amount of canceled debt is more than $600 and taxable, the lender must send you a 1099-C form to report the canceled amount. Canceled debt does not affect a borrower’s credit score unless the debt cancellation resulted from bankruptcy. 

Discharged Debt 

Discharged debt is a loan amount that borrowers do not have to pay back. Loan debt can get discharged when the borrower files for Chapter 7 bankruptcy. Any discharged debt as a result of bankruptcy is not considered taxable income. But if your debt gets discharged for any other reason and you don’t qualify for an exclusion, you must report the amount in your gross income and pay taxes. Borrowers with more than $600 in discharged debt must file Form 1099-C with the IRS. 

What If I Don’t Report a Personal Loan as Taxable Income?

Suppose a personal loan lender issues a cancellation of debt, but the borrower fails to report the canceled amount on their tax return. According to the IRS, failing to report taxable income results in a false return (IRC § 7206(1). False returns are a form of tax evasion, which is a severe crime. A person found guilty of filing a false return is subject to a prison term lasting as long as three years and a fine of up to $250,000. 

Are Personal Loans Tax Deductible? 

Suppose you are thinking of using a personal loan to get emergency cash. In that case, you may ask, “Is a personal loan tax deductible?” It’s possible! The interest payments on a personal loan are tax deductible if the borrower meets eligibility requirements and the money goes toward one of these specific reasons:

  • Investments — Certain investments made with personal loan proceeds are tax deductible. Eligible taxable investments include IRAs, 401(k)s, health savings accounts (HSAs), municipal bonds, etc.
  • Business Expenses — Business owners might get tax deductions on interest payments when business loans pay for startup costs, rent, inventory purchases, utilities, etc. 
  • Stocks — You may be able to deduct the loan’s interest if you use the money for eligible taxable investments. However, you can only deduct up to your annual amount of investment income. Additional amounts can roll over to offset future investment income. 
  • Educational Expenses — You can deduct interest expenses from an unsecured personal loan if you use the money to pay for qualified educational expenses for yourself, a spouse, or a dependent.
  • Loan Refinance — Borrowers can deduct the interest on a personal loan if they use the money to refinance a student loan. 

How To Qualify for a Personal Loan?

Getting approved for a personal loan is relatively simple. Most personal loans are unsecured financing options, so you do not have to use an asset as collateral. Instead, lenders will assess your credit reports and income.

A credit report displays a lot of financial information to help a lender make an informed approval decision. The three major credit reporting bureaus gather information from creditors and public records to create a financial profile for third parties. Pulling one of your credit reports allows a lender to view your accounts, payment history, credit score, and more. 

Certain financial decisions affect your credit score more than others. Take a look at the five main factors for credit score calculation below:

  • Payment History (35%)
  • Total Debt (30%)
  • Length of Credit History (15%)
  • New Credit Inquiries (10%)
  • Credit Mix (10%)

Has your credit score been up and down lately? Consider these five factors and if your recent financial activity has affected any of them. Late payments can significantly affect a credit score, so one of the best ways to obtain and maintain a good credit rating is to avoid missed due dates. Knowing what affects your credit score can help you adjust your financial habits and work towards improving your credit. 

While individuals with bad credit scores can have difficulty getting loan approval, there are many financial institutions that offer inclusive financial relief. While credit plays an essential role during the approval process, you may be eligible despite low credit if you can make on-time payments. And if you want to avoid the damaging effects of a credit pull, you can inquire about online no credit check loans

What Documentation Do I Need for a Personal Loan?

To get fast emergency funding, you need to provide personal loan documentation. The approval process for personal loans is generally quick. Most eligible borrowers can get money in their hands within one business day! But you can prepare your documentation ahead of time to speed up the process. 

If you decide to apply at a local brick-and-mortar, you must bring your documentation to the appointment. But if you apply for an online personal loan, you can easily upload all your documents online! You can take images of your documents using your smartphone and then upload the files to your online account. 

Once an agent verifies your information and documentation, you typically need to provide bank information to receive an electronic deposit. To sign up for a direct deposit, the lender needs to know your bank name, account number, and routing number. 

Loan Application 

The initial loan application will ask you to provide basic personal information. Most financial institutions will ask for your name, address, birth date, Social Security number, contact information, and monthly or annual income. Once you submit these details, you may receive a preapproved loan estimate. 

Proof of Identity 

To prove your identity, most lenders require a government-issued photo ID. The list of acceptable identifying documents varies per lender. Still, most borrowers use a state identification card, driver’s license, or passport. Although, you may be able to use alternative documents in certain situations, such as a military ID, birth certificate, etc. 

Proof of Income 

You must provide official income documentation as proof of your ability to make monthly payments on time. Your income paperwork should have your full legal name and the amount you earn for a specific duration. Acceptable income documents can include paycheck stubs, recent tax returns, bank statements, invoices, etc. 

Proof of Residence 

You need proof of address to qualify for a personal loan in your state. Qualifying documents may include recent utility bills, credit card statements, insurance statements, rental leases, etc. The official document you use as proof of residence must contain your legal name and address.

The Bottom Line

Are personal loans taxable income? The IRS does not consider personal loans taxable income unless the loan is forgiven, canceled, or discharged. You may even be able to qualify for tax deductions on your personal loan if you use the money for specific transactions. 

If a portion, or the entirety, of the personal loan, does not have to be paid back, then you likely need to report the amount. Canceled or forgiven debt is taxable. You must include the forgiven, canceled, or discharged amount in your taxes or face tax evasion charges. Suppose you forgot to include the personal loan as taxable income on your taxes. In that case, you can make an amendment using Form 1040-X, known as the Amended U.S. Individual Income Tax Return. 

If you want to borrow money with a personal loan, rest easy knowing you don’t have to pay a tax bill come tax season! Personal loans are not considered taxable income in most borrowing situations! 

Do You Have to Pay Income Taxes on Personal Loans?│Experian
IRS Penalties for Missed Income on your Tax Return│Golding & Golding

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