diff --git a/app/controllers/projects/autocomplete_sources_controller.rb b/app/controllers/projects/autocomplete_sources_controller.rb
index 992c8ea6992..07627ffb69f 100644
--- a/app/controllers/projects/autocomplete_sources_controller.rb
+++ b/app/controllers/projects/autocomplete_sources_controller.rb
@@ -14,7 +14,7 @@ class Projects::AutocompleteSourcesController < Projects::ApplicationController
   end
 
   def labels
-    render json: @autocomplete_service.labels(target)
+    render json: @autocomplete_service.labels_as_hash(target)
   end
 
   def milestones
diff --git a/app/services/projects/autocomplete_service.rb b/app/services/projects/autocomplete_service.rb
index aa60661f7f2..9d0eaaf3152 100644
--- a/app/services/projects/autocomplete_service.rb
+++ b/app/services/projects/autocomplete_service.rb
@@ -20,24 +20,28 @@ module Projects
       MergeRequestsFinder.new(current_user, project_id: project.id, state: 'opened').execute.select([:iid, :title])
     end
 
-    def labels(target = nil)
-      labels = LabelsFinder.new(current_user, project_id: project.id, include_ancestor_groups: true)
-        .execute.select([:color, :title])
+    def labels_as_hash(target = nil)
+      available_labels = LabelsFinder.new(
+        current_user,
+        project_id: project.id,
+        include_ancestor_groups: true
+      ).execute
 
-      return labels unless target&.respond_to?(:labels)
+      label_hashes = available_labels.as_json(only: [:title, :color])
 
-      issuable_label_titles = target.labels.pluck(:title)
-
-      if issuable_label_titles
-        labels = labels.as_json(only: [:title, :color])
-
-        issuable_label_titles.each do |issuable_label_title|
-          found_label = labels.find { |label| label['title'] == issuable_label_title }
-          found_label[:set] = true if found_label
+      if target&.respond_to?(:labels)
+        already_set_labels = available_labels & target.labels
+        if already_set_labels.present?
+          titles = already_set_labels.map(&:title)
+          label_hashes.each do |hash|
+            if titles.include?(hash['title'])
+              hash[:set] = true
+            end
+          end
         end
       end
 
-      labels
+      label_hashes
     end
 
     def commands(noteable, type)
diff --git a/spec/services/projects/autocomplete_service_spec.rb b/spec/services/projects/autocomplete_service_spec.rb
index 6fd73a50511..e98df375d48 100644
--- a/spec/services/projects/autocomplete_service_spec.rb
+++ b/spec/services/projects/autocomplete_service_spec.rb
@@ -131,4 +131,58 @@ describe Projects::AutocompleteService do
       end
     end
   end
+
+  describe '#labels_as_hash' do
+    def expect_labels_to_equal(labels, expected_labels)
+      expect(labels.size).to eq(expected_labels.size)
+      extract_title = lambda { |label| label['title'] }
+      expect(labels.map(&extract_title)).to eq(expected_labels.map(&extract_title))
+    end
+
+    let(:user) { create(:user) }
+    let(:group) { create(:group, :nested) }
+    let!(:sub_group) { create(:group, parent: group) }
+    let(:project) { create(:project, :public, group: group) }
+    let(:issue) { create(:issue, project: project) }
+
+    let!(:label1) { create(:label, project: project) }
+    let!(:label2) { create(:label, project: project) }
+    let!(:sub_group_label) { create(:group_label, group: sub_group) }
+    let!(:parent_group_label) { create(:group_label, group: group.parent) }
+
+    before do
+      create(:group_member, group: group, user: user)
+    end
+
+    it 'returns labels from project and ancestor groups' do
+      service = described_class.new(project, user)
+      results = service.labels_as_hash
+      expected_labels = [label1, label2, parent_group_label]
+
+      expect_labels_to_equal(results, expected_labels)
+    end
+
+    context 'some labels are already assigned' do
+      before do
+        issue.labels << label1
+      end
+
+      it 'marks already assigned as set' do
+        service = described_class.new(project, user)
+        results = service.labels_as_hash(issue)
+        expected_labels = [label1, label2, parent_group_label]
+
+        expect_labels_to_equal(results, expected_labels)
+
+        assigned_label_titles = issue.labels.map(&:title)
+        results.each do |hash|
+          if assigned_label_titles.include?(hash['title'])
+            expect(hash[:set]).to eq(true)
+          else
+            expect(hash.key?(:set)).to eq(false)
+          end
+        end
+      end
+    end
+  end
 end