When things get tight financially, you may be able to count on your family and friends to help you out. However, you may not realize that, according to the IRS, there could be potential tax implications for both of you.
In this post, we’ll go through what taxes you might have to pay if you borrow money from someone under certain circumstances and why applying for an emergency loan from a licensed lender may be the easier choice.
When Interest is Involved
For the borrower, taking out a personal loan is not considered taxable income. People borrow money all the time for needs like mortgages, auto loans, student loans, etc. Even using a credit card is essentially a form of a loan. In all these situations, the money the borrower receives is not considered taxable income by the IRS because this money must eventually be paid back.
However, for the lender who is a family member or friend, the situation may be different if interest is involved. In such cases, the interest portion of repayments made by the borrower may be considered taxable income for the lender. Therefore, under the right circumstances, it should technically be reported on their federal income tax return.
If you’re unsure whether or not you owe taxes, it’s always recommended to consult a tax professional or the IRS.
What If Interest Isn’t Charged?
Intuitively, you’d think you could avoid reporting interest to the IRS by simply borrowing the money without it. However, against expectation, this may make the situation more complicated.
Anytime a loan is made that’s below the current “applicable federal rate” (including when you forgo interest altogether), the IRS will treat it as if the borrower effectively paid this interest and the lender “gifted” it back to the borrower. This is referred to as “imputed interest” and results in two taxable transactions:
- Income to the lender
- A gift to the borrower
Keep in mind that these imputed interest rules only apply if the loan is for more than $10,000, according to IRS rules for tax year 2023, and not used to buy income-producing assets. If the exchange is below this limit, it will be exempt from these interest rules.
Apply for an Emergency Loan Instead
If these rules seem daunting, and especially if you’re planning on borrowing more than $10,000, then it may be best to seek out other sources of financing. To do this, shop around for lenders who specialize in giving emergency loans to those in need.
Emergency loans are typically unsecured personal loans that don’t require collateral (something of value like a vehicle that can be used to secure the loan). These loans rely on criteria like your credit score, financial situation, and job status.
Emergency loans are fairly flexible with reasonable interest rates and repayment terms that can last up to seven years. If, for any reason, you believe that you may not be eligible for an unsecured loan, you can always apply for a secured loan using collateral.
The Bottom Line
While borrowing money from a friend or family member may not be taxable for the one receiving the money, it could be for the lender if they’re paid interest. To avoid the whole situation, an alternative form of financing, such as an emergency loan from a licensed lender, may better suit your financial needs.
Notice: Information provided in this article is for information purposes only and does not necessarily reflect the views of europeanraptors.org or its employees. Please be sure to consult your financial advisor about your financial circumstances and options. This site may receive compensation from advertisers for links to third-party websites.
