When you need money, you may be inclined to apply for a personal loan for the benefits and flexibility. Unlike a mortgage, which can be used only to finance a home purchase, or an auto loan, which can be used only to finance a car, a personal loan can generally be used for almost any purpose. You can take out a personal loan to improve your home, go on vacation or pay off your credit card balances.
You may be wondering if a personal loan has an impact on your taxes. Generally speaking, a personal loan won’t affect your taxes. But there can be some exceptions.
Key Takeaways:
- Generally speaking, a personal loan does not affect your taxes.
- A personal loan is not considered taxable income because it’s a debt you’re obligated to repay.
- In some cases, personal loan interest can be tax deductible, and if a portion of your loan is forgiven, it’ll impact your tax return.
What Is A Personal Loan?
A personal loan is an unsecured loan you can borrow to use how you see fit. Whether you need money for home improvements or debt consolidation or to pay for a wedding or another significant expense, you can take out a personal loan and use the proceeds as you wish.
Because a personal loan is not tied to a specific asset like a home or car purchase, lenders take on a fair amount of risk in writing these loans. For this reason, it’s important to try to have good credit when applying for a personal loan. The higher your credit score is, the more competitive the interest rate you might get, leading to more affordable payments.
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What Are The Benefits Of A Personal Loan?
The nice thing about a personal loan, aside from getting flexibility in how you use the loan proceeds, is that it comes with a fixed interest rate. This means your monthly payments are predictable.
A personal loan can also be a good means of consolidating debt. If you’re juggling multiple credit card balances, for example, with variable interest rates, consolidating them into a personal loan could leave you with a single monthly payment and a lower interest rate on your debt overall.
Also, personal loans tend to close fairly quickly, often within 1 – 7 business days. If you need access to money quickly, a personal loan could be a good solution.
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What Are The Drawbacks Of A Personal Loan?
While personal loans can be an affordable and convenient way to borrow money, they’re a form of debt nonetheless. If you don’t pay your personal loan on schedule, you’ll typically be reported to the credit bureaus as late or delinquent. That could result in credit score damage, making it harder for you to borrow money in the future.
Also, because personal loan lenders typically allow you to use your loan proceeds for any purpose, you might borrow money for a nonessential purchase that would be better to save up for instead. And if you’re paying off a personal loan at the time you apply for a mortgage, you may have trouble qualifying if you have too much debt relative to your income (known as your debt-to-income ratio).
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Are Personal Loans Taxable?
When you earn money, whether it’s from your main job, a side hustle, a savings account or an investment that pays dividends, that income is generally taxable. However, a personal loan is not a type of income. Rather, it’s a debt.
With a personal loan, you’re borrowing money that must be repaid over time. Nobody is giving you that money for free, and you’re not earning it. For this reason, the IRS doesn’t consider money received from a personal loan to be taxable income.
Are Forgiven Personal Loans Taxable?
When you take out a personal loan, you’re supposed to repay the entire sum you’ve borrowed. But sometimes, life gets in the way of that.
If you lose your job or your financial situation changes, and it becomes clear that you’re not going to be able to repay your personal loan in full, you may be able to negotiate with your lender. Your lender may agree to settle for a reduced amount and not come after you for the remainder of your balance.
In a situation like this, where a portion of your personal loan debt is forgiven, that portion is generally considered taxable income. So, let’s say you borrow $10,000 but get your personal loan lender to agree to settle that debt for $4,000. This means that, generally, you can expect the remaining $6,000 to be taxable as ordinary income.
Are There Exceptions To Taxing Loan Forgiveness?
When a personal loan (or any type of debt) is canceled, you should expect to receive Form 1099-C, Cancellation of Debt, showing the amount of debt canceled and the date it was canceled. However, in some cases, a canceled personal loan may not count as taxable income, such as if it’s canceled in connection with a personal bankruptcy filing.
You should also know that some types of debt can be canceled without creating a taxable event. Student loans that are eligible for forgiveness, for example, fall into this category and typically do not result in a larger tax obligation.
Is Personal Loan Interest Tax Deductible?
If you’re wondering, “Are personal loans taxable?” the answer is no. And in most cases, the interest you pay on a personal loan is not tax deductible, either. However, there are a few rare instances where you may be able to deduct the interest paid on a personal loan.
Business Purposes
If you take out a personal loan to pay for business expenses, you may be able to write off the interest on your taxes. First, though, you must verify that your lender allows your loan proceeds to be used for business purposes. You must then make sure to include those expenses as itemized deductions on your tax return.
Some examples of business expenses include:
- Travel to see clients
- Entry fees for business conferences or events
- Home office supplies and equipment
- Communication services needed for your business, like internet and phone
Educational Expenses
If you use a personal loan to pay for qualified educational expenses or to pay off student loans, you may be able 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.
Taxable Investments
If you take out a personal loan to purchase assets as an investment, you may be able to deduct the interest. However, you’ll need proof that you used your loan proceeds for investing purposes.
Can You Use A Personal Loan To Pay Your Taxes?
Personal loans are generally quite flexible, allowing you to use your loan proceeds for almost any purpose. For this reason, you generally can use a personal loan to pay a tax bill. And in some cases, that could make sense – particularly if you’re able to get a lower interest rate on a personal loan than the interest and penalties the IRS will charge you for being late with your tax bill.
One benefit of using a personal loan to pay a tax bill is that it might help you enjoy better cash flow. If you owe the IRS $5,000 and empty your savings account to pay that bill, you might end up in a jam if a surprise expense arises. But if you’re able to lock in an affordable personal loan, you won’t be paying that $5,000 all at once. Instead, you can make small monthly payments until your loan is paid off.
Before you take out a personal loan to pay your taxes, though, find out what sort of payment arrangement you can have with the IRS directly. There are different repayment plans you can qualify for that may be more advantageous.
Also, some personal loans may charge a penalty for paying off your balance early. The IRS, on the other hand, will not penalize you if you establish an installment plan to pay off a tax bill and end up coming up with the money sooner than expected.
The Bottom Line
Personal loans are not taxable. They don’t count as income and therefore will not add to your IRS bill. In some cases, though, if you get a personal loan forgiven, the amount of that loan that’s canceled will count as taxable income. You may also, in certain cases, be able to write off the interest on a personal loan as a tax deduction. If you’re not sure whether you can do this, consult an accountant or tax professional so you don’t make a mistake.
Maurie Backman
Maurie Backman has more than a decade of experience covering personal finance topics that include mortgages, loans, retirement, Social Security, and investing. Prior to becoming a full-time writer, she worked in the financial industry as well as in product design and marketing. Maurie holds a bachelor's degree from Binghamton University, where she studied creative writing and finance. She was happy to combine her two areas of study into a career that allows her to educate consumers on a host of financial topics.
