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Can A Personal Loan Affect Your Taxes?

3-Minute Read
Published on August 16, 2022

A personal loan provides you with a lump sum from the bank when the loan closes. But, since you pay taxes on any income you earn, you may wonder, do you have to pay personal loan taxes?

The answer is “maybe not,” because it depends on the situation of the loan and the reason you’re borrowing the money.

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Is A Personal Loan Taxable Income?

Are personal loans taxable? A personal loan is an unsecured loan you can borrow to use how you see fit. So whether you need money for home improvements, debt consolidation, to pay for a wedding or another significant expense, you don’t have to get the reason approved, and you don’t have to put up collateral.

You receive the money as one lump sum, so you might wonder, do you pay taxes on personal loans?

The good news is the IRS doesn’t consider the money received from the personal loan as taxable income. So instead, you borrow the money but must pay it back with your earned income which you pay taxes on already.

How much you pay in taxes depends on your federal income tax bracket. The more money you make, the higher your tax bracket, which means you pay more taxes on your tax return. The tax brackets vary from 10% – 37%, depending on your income.

Are Personal Loans Ever Taxable?

While the IRS doesn’t consider a personal loan taxable income, there are certain situations you might owe taxes on personal loans.

For example, if you file bankruptcy and include the personal loan, it becomes a canceled loan. If the lender canceled $600 or more, you might owe taxes on the money. You’ll know because you’ll receive Form 1099-C, which shows how much the lender wrote off so you can add it to your taxable income.

This only happens when a borrower defaults on a loan, aka doesn’t follow the repayment schedule, and a portion of the loan amount is canceled.

Are Personal Loans Tax Deductible?

You might wonder if personal loans are tax deductible. Since you can deduct your mortgage interest if you itemize your deductions on your tax return, why not personal loan interest, right? But, because personal loans are usually for personal reasons, the interest isn’t tax deductible.

Is Personal Loan Interest Tax Deductible?

Most uses of personal loans aren’t tax deductible because they are for personal use. However, there are a few rare instances when you can deduct interest payments made on a personal loan.

The exceptions include the following.

If you use the money for business expenses, you may be able to write off the interest on your taxes. First, you must ensure the lender allows you to use funds from a personal loan for business use. You must also keep a record of where you spent the funds.

If you use the money to cover qualified educational expenses or to pay off student loans, you may qualify to write off up to $2,500 in interest per year. Before you take out a personal loan for educational expenses, make sure the lender allows it for this use.

The final way to deduct personal loan interest is if you use the money to invest in taxable investments. This doesn’t apply if you use your retirement account to buy stocks or bonds in a regular investment account. In addition, you can roll over unused interest deductions.

Can You Use A Personal Loan To Pay Your Taxes?

If you have a large tax bill that you can’t afford to pay, you can take out a personal loan to pay your taxes. The interest you pay on a personal loan may be much lower than the interest and penalties the IRS charges, keeping your costs down.

If you don’t qualify for a personal loan or don’t want another loan, you have a few other options, including charging the debt. However, credit card interest rates are usually higher than personal loan interest rates so compare your costs.

You can also work with the IRS on a short-term repayment plan that gives you 180 days to pay the total bill or set up a long-term payment plan that breaks up your payments over a longer period. Remember, though, that the IRS still charges interest and penalties when you are in a payment arrangement.

While an IRS payment plan doesn’t hurt your credit score, using a personal loan or credit card may affect your score.

The Bottom Line

You can use a personal loan for many uses, and most people won’t pay taxes on the money borrowed. Of course, if you default on the loan, you’re likely to owe taxes, but otherwise, it’s tax-free money.

If you’re considering borrowing a personal loan to cover some expenses or personal goals, get approved for a personal loan with Rocket Loans℠ today.

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Sam Hawrylack

Samantha is a full-time personal finance and real estate writer with 5 years of experience. She has a Bachelor of Science in Finance and an MBA from West Chester University of Pennsylvania. She writes for publications like Rocket Mortgage, Bigger Pockets, Quicken Loans, Angi, Well Kept Wallet, Crediful, Clever Girl Finance, AllCards, InvestingAnswers, and many more.