Loans.org Explains That Interest-Free Personal Loans Are Still Taxable

LOS ANGELES, April 2, 2012 /PRNewswire/ -- As April 15th approaches, consumers need to be aware that their interest-free personal loans will be taxed by the IRS. In a recent article, Loans.org explains the reasoning behind the IRS's decision to tax interest-free personal loans, which often unexpectedly takes a bite out of consumers' year-end reimbursement.

Interest-free personal loans are viewed by the IRS as cancellation-of-debt (COD) income. COD income refers to an indirect source of income that a consumer should not have but is instead acquired through a deal, a gift, or some form of forgiveness. As a result, the IRS expects a cut of this indirect income, which they reap from borrowers come tax season.

In order to determine how much borrowers should be taxed, the IRS will look at the principal borrowed and assign that principal a fair market interest rate. The borrower will then be taxed on that interest rate, despite the fact that the borrower and lender agreed to no interest.

"In effect, the IRS 'attributes' interest even when the parties don't intend—and don't want—it," explained Robert W. Wood, a Forbes contributor and Calif. tax attorney. Due to this, Wood has called COD income one of the biggest tax traps he's come across in his 30 years of practicing law.

The most common forms of interest-free personal loans are those used to finance an automobile. Dealerships who offer zero percent financing often fail to inform their clients that a tax penalty will still come with the interest-free financing.

Another increasingly common source of COD income comes from mortgages that were strategically defaulted on. If homeowners walk away from their house payment, the IRS will still tax them on the remaining principal, which the government considers "forgiven" as soon as the mortgage is foreclosed. Additionally, those who receive a mortgage modification will be considered to have received COD income in the amount forgiven.

Source: http://www.irs.gov/pub/irs-pdf/p4681.pdf

To learn more about interest-free personal borrowing, you can go to http://loans.org/personal to find a frequently updated library of financing information. Prospective loan applicants can also access a free-to-use quote-comparison generator that is designed to help consumers receive the lowest interest rates possible.

To access the full article on taxable interest-free financing, readers can follow the "Questions" link at the top of any page on the site.

SOURCE Loans.org, LLC

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