The new year has come and gone and now tax time is upon us. If you are a newer peer-to-peer lending investor in the United States, 2012 may mark the first time that you have to pay taxes on the money that you earned from Lending Club or Prosper. Fortunately, it’s not terribly complicated to include the interest that you earned from peer-to-peer lending sites on your federal taxes.

How is Peer to Peer Lending Interest Taxed?

Income from peer-to-peer lending is taxed like other interest income—as ordinary income. This means, that if you are in the 25% tax bracket, you will have to pay 25% of the interest that you earned from Lending Club or Prosper to the federal government. Unfortunately, peer-to-peer lending investments do not receive the same favorable tax treatment that mutual funds and stocks do.

What forms should I expect to receive from Lending Club?

Lending Club will issue a 1099-OID form to investors for all Lending Club notes issued after October 24th, 2008. The calculation that Lending Club uses for the form is the interest payments and late fees that you have received as a borrower, minus the service fees that you pay as an investor. You will only get this form if you paid $10.00 or more in interest each year.

According to the book Wall Street Words, The 1099-OID form is used to report “the amount of implied and real income derived from original-issue discount securities such as Treasury bills, zero-coupon bonds, and commercial paper.” Income from a 1099-OID form must be included on Part 1 of Schedule D of your federal income tax return.

There are a few other 1099 forms that Lending Club will send out as well. You may receive a 1099-B form if you had sold notes on the FOLIOfn platform during the previous year. If you participated in any of Lending Club’s bonus offers, you will receive a 1099-MISC form if you received more than $600 in incentives. If you have any loans issued before October 14th, 2008, you will get a 1099-INT form from Lending Club, however, there are very few of those loans that remain outstanding.

Lending Club makes tax documents available by January 31st of each year. You can access your tax statements by going into your “Account Statements” section.

Lending Club also has a set of Frequently Asked Questions regarding tax matters.

What forms should I expect to receive from Prosper?

Investing in loans with Prosper.com has very similar tax implications to that of investing in loans with Lending Club. Prosper will send out a 1099-OID form to investors that have invested in peer-to-peer loans on Prosper in 2009 or later. You will only get a 1099-OID from Prosper if you earn more than $10.00 in interest each year.

Prosper also sends out a few other 1099 forms. If you have notes dating back to before 2009, you will a 1099-INT form on your earnings. If you receive $600 or more a year in late fees and incentive payments from Prosper, you will get a 1099-MISC. There are some states that have reporting exemptions which would trigger a 1099 to be sent at a lesser amount. If you sell Prosper notes by way of FOLIOfn, you will receive a 1099-B form.

Prosper also has a “taxes” section under their Investing FAQ.

Defaults and Charge-Offs

As an investor, peer-to-peer loans that go into default can be considered investment losses. Lending Club simply reports written-off notes via year-end statements. Prosper sells some of its “bad debt” which can make tax matters a bit more complicated.

Prosper’s FAQ says the following about their treatment of charge-offs:

“Charge-offs and gross proceeds from any bad debt sale to a third party will be reported to investors in a year-end investor statement, and debt sales will be filed on tax form 1099-B. Using the loan principal balance before sale and the sale amount, investors can calculate their net amount of loss for the year. Investors are encouraged to consult their tax advisor to determine their tax basis on loans sold to debt buyers.Delinquent (late) loans which have not yet been sold to a debt buyer will have no impact upon taxes until further action on these loans takes place.”

Lending Club’s FAQ says the following about their treatment of charge-offs:

Lending Club notes that are written-off are reported on your year-end investor statement.

Disclaimer: I am not an accountant and do not offer professional tax advice. You should seek the counsel of an experienced accountant to answer specific tax questions.