Tax Corner: Tax Questions on Peer to Peer Loans Answered by CPA

If you have wondered what part of your investment in Peer to Peer loans may be taxable, then this post is for you. I am happy to introduce the tax corner.

The information in this post is provided by my friend and outstanding CPA and tax whiz, Ian Schechter.  Here are some common tax questions related to peer to peer lending as an investment. Like with all my posts from other experts, my comments will be in parentheses but is otherwise all in the expert's words. Like with all things involving taxes, each person's situation and amount taxable to them varies. Please consult your own tax advisor, and if you need one then use Ian, he's a pro's pro. Let me know and I will get his contact information to you or you can call Decosimo and ask for him. Tell him I sent you.

by Ian Schechter, Senior Tax Accountant at Decosimo CPA and Business Advisors

What Is Interest?

 

“Interest” is defined as the charge for borrowed money, generally a percentage of the amount borrowed.  The most common example of interest is if you put your money into a bank account, the bank will pay you interest on that money.  But, like anything else, the government wants its piece of the pie, and the interest income that is generated by that account is taxable by the government.  This does not end at interest income from bank accounts.  Most types of interest income are taxed by the government.  Those that are not are usually designated as “tax-exempt”. [Municipal bonds are an example of a tax exempt investment but most interest generated, including that of peer to peer loans is not exempt]

Why Is My Interest Being Taxed?

 

As stated above, the government wants its piece of the pie and interest on principal is no different.  Most income, in general, is taxed, including the principal on the money that the interest is derived from.  For the interest on the bank account example from above, the principal can be wages from your job or profits from other investments. [Since p2p loans are fully amortizing, we are getting some interest and some principal repaid every month but only the interest part is taxable. Note that our statements each month from the lending platforms show us how much interest is received and how much principal is repaid with each payment]

 

How does the government know how much interest I made?

 

All companies (and individuals) are required to file Form 1099-INT with the IRS, to tell them how much interest was paid to the investor if the amount of interest income is greater than $10.  The investor must furnish their SSN or EIN to the reporting company (bank, brokerage house, peer lending platform etc.) so that the IRS can match the investor’s SSN or EIN with the investor’s tax return.  If the investor does not, the reporting company must withhold 31% of the earnings (called backup withholding).  A copy of the 1099-INT is sent to the IRS and the investor, so that the investor knows how much to report. [It is the responsibility of the lending platforms to send us this 1099 form at the end of each year so we know how much to declare as income.]

 

Where is the interest income reported on my tax return?

 For individuals, interest income is reported on the front of Form 1040, line 8a (line 8b is for tax-exempt interest, which must also be reported, but not taxed).  If the total interest income is greater than $1,500, an itemized list of interest income from different sources is shown on Schedule B of Form 1040.  For C Corporations, interest income is reported on line 5 of Form 1120.  For S Corporations and Partnerships, interest income flows through to the shareholders/partners for them to pick up on their individual Form 1040s.

How much of my interest income is taxed?

 Interest income is taxed at ordinary income tax rates, so if you are in the 25% tax bracket, interest income will be taxed at 25%. [Ordinary income is like saying marginal income or additional income. If your marginal tax rate (the  tax rate on the last dollar you earn is 25% then interest income will be added to that and taxed at the same rate unless the interest income moves you into a higher tax bracket.]

More on Interest and Taxes to come.....

 

About the author

Stu Stu Lustman, the author of this post, is a Credit Analyst by trade trying to bring Commercial Credit Analysis techniques to the world of Peer to Peer Lending. Check me out on Twitter, LinkedIn and Google+

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