Do You Have to Pay Income Tax on a Personal Loan?

If you are thinking about taking out a personal loan, you might be wondering you have to pay income tax on a personal loan? We will answer this question in much detail below.

Do You Have to Pay Income Tax on a Personal Loan?

No, you do not have to pay income tax on a personal loan because personal loans are not taxable since the money you receive from a personal loan does not fall under the definition of income because they are borrowed funds that must be repaid. However, if a portion or all of your personal loan is forgiven, you may need to report the portion forgiven or canceled as taxable income.

Earnings and wages, on the other hand, are income because they add to your wealth, as such they are taxable. So, if you have taken out a personal loan, you do not have to report the funds dispersed to you on your income tax return. This applies to personal loans from banks, credit unions, and even friends.

When you receive a loan from a bank or financial institution, the money is almost always non-taxable because you pay a pre-determined amount of interest on the loan. However, if you take a personal loan from family or friends although you will not need to report the money as taxable income on your personal income tax return, you may be liable for other forms of tax if you receive $15,000 or more in a single year as the IRS may consider the money loaned to you a gift instead of a loan.

Do You Have to Pay Income Tax If Your Personal Loan is Forgiven or Cancelled?

Yes, if all or a portion of your personal loan debt is canceled or forgiven, you need to pay personal income tax on the portion of the loan that’s forgiven or canceled. This is so because the government considers the cancelled debt as taxable income.

For example, if you borrow $4,500 from Bank of America and you were unable to make payments on the remaining $2,000 that you owe them, if the bank forgives the $2,000, you must report the $2,000 that’s forgiven as taxable income because canceled debt is classified as taxable income.

The same logic applies to all other types of canceled debt, including student loan debt and medical bill debt. For example, if you have been paying back your student loan for 15 years and you have 5 years remaining if your $7,500 student loan is canceled out, you will have to report the $7,500 as taxable income on your Federal Tax Return.

That said, some student loan forgiveness programs permit borrowers to exclude the forgiven amount without any tax consequences. That said, if you’ve had any type of debt forgiven or canceled, you should consult with a tax attorney to ask them about any of the consequences.

What Are Personal Loans?

Personal loans include money borrowed from banks, financial institutions, employers, or through peer-to-peer lending networks. The borrowed funds can often be used to make any purchases, consolidate debts, buying a car, paying for a wedding, or making any other type of large purchase.

Personal loans are different from auto loans and home loans in that personal loans do not require collateral, meaning they are unsecured loans. So, in the event that you default on the loan, there is no collateral for the bank to repossess. This is different from car loans where the collateral is the vehicle you’re driving and home loans where the home is the collateral for the loan.

Since there is no collateral for person loans, banks and financial institutions typically charge a higher interest rate on such loans to compensate themselves for taking a bigger risk on lending money.

That said, since personal loans need to be paid back, you are not required to pay income tax on them.

Are Interest Payments on Personal Loans Tax Deductible?

Not all loans are eligible for tax-deductible interest rates. However, with loans such as home loans, student loans, and business loans, you can deduct the interest you pay on such a loan. That is, you can reduce the amount of income you have to pay taxes on by deducting the interest on these loans from your income. That said, you cannot deduct the interest that you pay on a personal loan from your taxable income. However, there is one exception: if you use all or a portion of the money borrowed for a business purpose, such as renting an office or buying supplies for your business, you will be able to deduct that amount from your taxable income. That said, before you utilize this exception, you should consult with a licensed tax attorney in your jurisdiction.

What Are the Best Places to Get Personal Loans?

You can get loans from Banks and other financial institutions, such as credit unions. Credit unions tend to charge lower interest rates than mainstream banks and are more likely to lend money to people with low credit scores. Mainstream banks are likely to lend people only to people with good to excellent credit scores and people with poor credit will find it difficult to qualify for a loan from such banks.

That said, you will be able to get money from the following places:

  • Banks
  • Credit Unions
  • Employer
  • Peer to Peer Lending Networks
  • Online Lenders

Frequently Asked Questions (FAQs)

1. Can you get a person loan to pay off taxes?

If you owe either the State of Federal Government money, it is possible to take out a person to pay off your tax debt. Just keep in mind that you will likely need to pay interest on the loan, but it maybe worth it if the interest on the loan is lower from the interest charged by the IRS or State Government on the outstanding amount that’s due to them.

2. Is a loan considered as income for unemployment purposes?

No, the money you get from a personal loan is not considered as income for unemployment purposes. This is so because personal loans are debts that need to be repaid, therefore, they are not considered as income for purposes for unemployment. So, if you took out a personal loan, you do not have to report it as income to get unemployment. That said, it will be quite challenging to get a personal loan if you’re currently on employment because the bank wants to know that you are capable of repaying them the money that you’ve borrowed.

3. Are loans considered as income?

No, loans, including personal loans, are not considered as income because they are debts that must be repaid. Therefore, if you took out a loan, you are not required to report it as taxable income.