Personal loans are not considered income because they need to be paid back. That means they are not reported to the IRS, so feel free to apply for emergency loans without worrying about the additional burden of tax liability. That only comes into play if you default on the loan or use it to generate income.
Why Would A Loan Default Get Reported To The Irs?
A loan default itself won’t be reported to the IRS unless part of the amount is forgiven or discharged. According to the IRS, “if your debt is canceled, forgiven, or discharged for less than the amount owed, the amount of the canceled debt is taxable.” However, there are some exceptions where a discharged sum is not considered canceled debt. You’ll likely receive a 1099-c form reporting it if part of your loan amount is canceled, forgiven, or discharged.
Managing a Personal Loan to Ensure Repayment
Avoiding a default is simple if you manage your loan correctly. That starts with evaluating your finances and creating a plan before submitting a loan application.
Check Your Monthly Budget
Check your budget and add up your income and expenses. Weigh them against each other to see what’s left after you pay all the bills.
That’s the amount of money you have to make a payment on your loan each month.
Compare Loans
The next step is to shop for the right loan. Lenders have different standards for loan approval, and their interest rates and loan terms may vary. It’s best to shop around before signing a final loan contract. Fill out pre-application forms to get several loan offers without affecting your credit score. Final applications for approval could lower your credit score by a few points.
Set Up Automated Payments
When the loan is approved, set up automated monthly payments, so you’re never late. That will ensure the loan gets paid off on time and prevent any negative reports from going to the credit reporting bureaus. If you receive any windfalls or increase your income, feel free to pay more than the minimum amount due or make extra payments each month. That may also help improve your credit.
Using a Personal Loan to Generate Extra Income
Since we’re talking about the IRS, let’s review scenarios where personal loans can be used to generate additional income. This will create a tax liability, but the upside of making extra money may outweigh the additional tax burden. Here are a few ways you may be able to use a loan to generate income:
- Go to flea markets and buy items to resell on eBay
- Buy yard care equipment and open a landscape service
- Invest in some tools and become a handyman
- Use the money to have someone build you a business website
- Invest the money into someone else’s business to earn a return
You could also use a loan to pay a month’s bills and try freelancing. It takes time to build a business this way, so having the extra financial cushion from the loan may help.
The Bottom Line
Taking out a personal loan will not incur a tax liability with the IRS, but certain ways you use it might. Understand what your options are, don’t apply for a loan if you can’t afford to repay it, and manage it properly if you do get it. To make extra money, use your loan to start a business. That could incur a tax liability, but only if you make a profit.
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