Unless you are investing through a tax-advantageous investment account, you have to pay taxes on your earnings either in the form of ordinary income or in the form of capital gains. This is also true for peer-to-peer lenders that are providing loans to borrowers through Lending Club and Prosper.
The income that lenders earn in the form of interest that borrowers pay on their loans is taxable as regular income for lenders. Both Lending Club and Prosper Marketplace send out 1099 forms to their investors and to the IRS each January for the interest that investors earned on their funds for the previous year. This means that any money that you earn on your Lending Club or Prosper Marketplace will be taxed at your marginal tax rate, which could be anywhere between 15% and 33% depending on your income.
You will have to report any income that you receive in interest on your tax return as miscellaneous income along with any other 1099 forms that you receive, such as from interest on a savings account.
Lending Club offers an IRA option for investors so that investors can invest their funds tax free. Just like any Individual Retirement Arrangement (IRA) option, you can invest money tax tax-deferred into the account however you can’t take the money out until retirement. The interest itself won’t be taxed as you earn it, but you will pay taxes on the amount when you take the money out in retirement. If you’re not already investing in a Roth IRA or a Traditional IRA, this might be a great way for you to save for retirement.
The taxes that you will pay on your Lending Club or Prosper Marketplace are a consideration when making the investment, just like you would when comparing a tax-free municipal bond versus a taxable bond. Know that the earnings that you make will be reduced by the amount of taxes that you have to pay on the earnings that you bring in.