Resources / Uncategorized

How Do Personal Loans and Credit Cards Affect Your Taxes

By: David Halverson April 11, 2023

Personal loans and certain credit cards can be great tools when it comes to providing you with financial flexibility. In a matter of seconds, you can get approved for either of these options online, and in the case of personal loans, you may even have money in your bank account in less than 24 hours. In most cases, borrowers don’t really think about how taking out various types of loans can affect their taxes. But there are certain things you should fully understand about the relationship between personal loans and taxes before you borrow any money. Here are the most important.

Can I Deduct Personal Loan Interest?

Although some loan interest can be deducted on your taxes, personal loan interest usually doesn’t qualify. 

The general rule from the IRS is that any type of consumer interest is non-deductible, but business-related interest can be deducted. So, if you run your own small business out of your home and you take out a personal loan specifically for business purposes, you may indeed be able to deduct some or all of that interest. 

But for general personal loans, the answer is no. If you do own a small business and have a personal loan, you should likely consult with a tax professional or CPA to determine whether or not your interest is deductible.

What About Credit Card Interest?

The same rules that apply to personal loan interest also apply to credit card interest, as both are considered consumer loans. If you’re just using your credit card for your everyday expenses, you can’t deduct that interest on your tax return. 

However, if you have a specific, dedicated business credit card and run a qualifying small business, you may very well be able to deduct that interest. If there’s any gray area in your mind – particularly if you mix business and personal expenses on the same credit card – speak with an expert.

What if My Debt Is Canceled?

In some cases, you may be able to negotiate with a lender to reduce the amount that you have to pay back to satisfy a debt in full. This is referred to as canceled debt. 

Canceled debt can seem like a windfall, as you may save hundreds or even thousands of dollars in payments and still keep your account in good standing. However, there’s a price to pay for this shortcut. 

First of all, your credit score will likely suffer, as any time you settle a debt for less than the full balance it’s a major negative mark. Second – and this is the part that trips many people up – any debt that is forgiven becomes taxable income. 

For example, if you owe $10,000 on your credit card and your card issuer agrees to settle the debt for just $4,000, the $6,000 that was forgiven becomes taxable income. That could result in thousands of extra dollars that you’ll owe at tax time.

Is a Personal Loan Considered Income?

When you get approved for a personal loan and the money appears in your bank account, it’s not considered income. At that point, your loan is simply a liability. For this reason, loan proceeds are not considered taxable income.

How About Credit Card Rewards?

For the most part, credit card rewards are not considered taxable income. For example, if you receive a sign-up bonus of points, miles, or even cash in exchange for spending a certain amount on the card, those benefits are not generally taxable. 

However, direct cash payments often can be considered taxable income. For example, if you get a $200 bonus simply for opening a checking or savings account, the bank will generally issue you a 1099 and report that payout as income. But if you get cash-back from spending on a credit card, those rewards are generally not taxable, as the IRS simply considers that money a rebate from your own spending.

Can I Deduct the Annual Fee I Pay for a Credit Card?

As with interest payments, the deductibility of a credit card annual fee comes down to whether it is used for personal or business purposes. If you use your credit card for everyday personal expenses, you cannot deduct the annual fee. But if you use your card exclusively for your own business purposes, that fee will likely be tax-deductible.

Can I Pay My Taxes With a Credit Card?

You are allowed to pay your taxes with a credit card, but it’s not generally advisable. If you’re using your credit card to pay your taxes because you cannot afford them, you’ll be slapping an interest rate of 15% to 20% or even more on your unpaid taxes. Before you know it, the $1,000 you owed in taxes could double, simply due to interest charges.

The IRS will also charge you a fee to pay your taxes with a credit card. Depending on the processor you choose, you’ll pay between 1.85% and 1.98%. While much better than using a credit card with a double-digit interest rate, there’s no reason to pay that fee if you have the money to pay your taxes. Any credit card rewards you gain from putting your taxes on your card will likely be negated by the fee that you have to pay.

Ready to get started?

How much money do you need?