Lending Club Profits and Your Taxes

Whew.. Mrs. MM and I finally signed, sealed and delivered both our income and property taxes earlier this week. Since I hadn’t made enough estimated tax payments on self employment income through the year*, it ended up being a pretty big bill. But it is done for another year, which is a fine feeling.

This was the first year that I had to report earnings on profits earned through Lending Club. I had been nervously looking forward to this step, since the topic remains shrouded in secrecy. Internet rumors of uncertain rules and 20-page documents of confusing numbers detailing every one of your $25 notes were circulating. Doing some research on other forums and blogs, I learned that the company’s reporting method started out quite primitive, requiring major manual effort on the part of investors. But for tax year 2012, things have improved considerably.

I had an extended conversation with a contact within the company, and could not get them to send me a statement of how to report loan income to the IRS – even when pressured with the prospect of public embarrassment on this blog. “Our lawyers won’t let us say anything, since we’re not legally allowed to give tax advice”, they said.

Luckily, I don’t have any lawyers myself, so I’m happy to give any tax advice I can.  So with no further delay, here’s how I handled my own Lending Club income tax reporting:

The company automatically generates the right reporting form for you. It’s called the 1099-OID, which stands for Original Issue Discount. The actual term itself is a bit of an obscure financial one, but for our purposes it is very similar to just the 1099-INT, which is how your bank reports interest paid on your savings account.

If you have a few hundred notes or more in your Lending Club account, this will be a long statement – the interest you received on every note throughout the year is detailed here. But luckily, they add it up at the end for you. Here’s an image from the last page of my own 1099-OID (with a few numbers changed for security), just so you can get the general idea:

Figure 1: Last page of Lending Club 1099-OID (click for larger)

So all you care about in this case is the total for “Box 1”, which is summed nicely at the bottom. For me, it was $301 in 2012. This number already factors in any service fees you paid, late fees collected on your behalf, etc.

Once you have that number, you simply plug it into Schedule B on your tax form (which in turn goes into box 8a), or in Turbo Tax under “Personal Income->Interest and Dividends->1099. Here you’ll see my little $301 again.

That covers the happy case of income received, but it does not handle the necessary evil of “charge-offs” – loans that have gone bad and been written off from your portfolio. I didn’t have any of these in my first year of Lending Club (and still haven’t had any as of mid-April in the second year), but a certain number are sure to come. The currently fashionable way to handle these is on IRS form 8949 (Sales and other Dispositions of Capital Assets). Turbo Tax handles that form automatically for you as part of the regular interview process as well.

In future years, it is possible that Lending Club may further optimize their 1099-OID to automatically factor in charge-offs as well, but for now, this is the deal as far as I can tell.

So it’s not exciting, but it’s not scary either.

In related news, I recently started a new headquarters page for the Lending Club Experiment, so I can post monthly updates to the progress of the investment, without having to spam you with monthly articles on the topic. That page can be found here:

The Lending Club Experiment

*A few readers wrote in warning me of my crazy tax irresponsibility and the accompanying dire consequences.. to be clear on this, we didn’t deliberately underpay the taxes, we just paid the same amount as last year (which resulted in a refund at the time) but earned a bunch of extra money near the end of the year while incurring smaller business expenses than forecast. Hopefully I don’t get in trouble from the IRS, but if I do, it’ll make yet another good story.