If the SBA Made Six Loan Payments on Your Behalf, Are You Taxed?Tax Planning
Since the arrival of the COVID-19 pandemic, the Small Business Administration (SBA) Paycheck Protection Program (PPP) loans and Economic Injury Disaster Loans (EIDLs) have gotten the most attention from businesses seeking a quick cash infusion.
But the SBA has several other loan programs that pre-date the pandemic and don’t require a disaster for eligibility.
These include the following:
- 7(a) loans: general small business loans of up to $5 million
- 504 loans: loans of up to $5.5 million to provide financing for major fixed assets such as equipment or real estate
- Microloans: short-term loans of up to $50,000 for small businesses
The $2 trillion Coronavirus Aid, Relief, and Economic Security (CARES) Act appropriated $17 billion to provide a temporary payment subsidy to businesses with these non-disaster SBA loans.
If you have such a loan, you likely have already benefited from this subsidy, or you soon will if your loan is on deferment.
Is this subsidy taxable income to you? There is no definitive answer right now.
CARES Act Six-Month Loan Payment Subsidy
The CARES Act requires the SBA to pay six months of principal, interest, and any associated fees that borrowers owe for all 7(a) and 504 loans and microloans that
- were in regular servicing status as of March 27, 2020, when the CARES Act was enacted, or
- were applied for after March 27, 2020, and fully disbursed before September 27, 2020.
The SBA makes the six months of principal and interest payments automatically. You don’t need to file an application.
For loans not on deferment (see footnote 3 for an explanation), the SBA began making payments with the next payment due and will make six monthly payments.
For loans currently on deferment, the SBA will begin making payments with the next payment due after the
deferment period ends, and will make six monthly payments.4
The SBA pays the lender directly. You won’t find this money in your hands.
The SBA debt relief program does not apply to PPP loans or EIDLs.5 As you likely know, the SBA has a program in
place for you to have your PPP loans forgiven.
Are the Loan Subsidies Taxable Income?
If you receive such SBA loan subsidies, are they taxable income to you?
The CARES Act is silent on that question, and the IRS has yet to issue any guidance on this particular loan subsidy program.
Government Disaster Payments Are Not Tax-Free Gifts
Since you receive these SBA loan payments without even asking for them, you might think they qualify as tax-free gifts from the government.
Not so. Government payments in response to a disaster do not qualify as tax-free gifts because the government’s intent in making them arises from its duty to relieve the hardship caused by the disaster.
A tax-free gift must be motivated by “detached and disinterested generosity.”8 These characteristics are sadly lacking at the SBA.
Prior IRS Guidance on SBA Loan Subsidies
This is not the first time government units have made SBA loan payments for borrowers in the wake of a disaster. The state of North Carolina did so in 1999 after Hurricane Floyd. And the city of Grand Forks, North Dakota, did so in 1997 after a massive local flood. These government units paid the interest on SBA loans for a limited time.
In both cases, the IRS advised that the loan payments were includable in income by the taxpayer-borrower on whose behalf the payments were made.
The IRS reasoned that such payments were a clear accession to wealth and therefore includable in business gross income.
The IRS advised that the lender should treat the payments as having been paid first by the government to the business taxpayer and then by the business to the lender. The business could deduct the interest portion of such loan payments.
The IRS also said that the state and local agencies should file an IRS Form 1099-MISC reporting the payments to the IRS.
Could the IRS Invoke the General Welfare Exclusion?
Hopefully, the IRS will issue new guidance or a revenue ruling on the tax treatment of the CARES Act loan subsidies.
Although the prior guidance that the loan subsidies are a clear accession to wealth makes perfect sense, the IRS could nonetheless conclude that these loan subsidies are not taxable under the general welfare exclusion.
The general welfare exclusion is an IRS administrative exception that allows you to exclude from your taxable income payments made by government units to promote the general welfare.
The exclusion has frequently been used to exempt from taxable income any payments made to taxpayers due to disasters. Indeed, the exclusion was made part of the tax code for government payments made in connection with a qualified disaster.
Ordinarily, the exclusion applies to government-provided, disaster-related payments to “individuals” for food, medical care, housing, transportation, and similar expenses.
For example, payments by the state of North Carolina to help repair homes damaged by Hurricane Floyd fell within the exclusion.
As a rule, payments to businesses do not qualify under the general welfare exclusion because they are not based on individual or family need. And we’ve seen that the IRS did not extend the general welfare exclusion to SBA loan subsidies paid by North Carolina to businesses in the wake of Hurricane Floyd.
But the IRS has made exceptions to this general rule. For example, it found that grants to help establish businesses on Indian reservations were tax-free under the exclusion.
The COVID-19 pandemic is a nationally declared disaster unlike anything seen in over 100 years. If there ever was a time to break general rules, it’s now. Thus, the IRS may make another exception to find that the general welfare exclusion comes into play to make the SBA payments of principal, interest, and fees not taxable to you.
But there are no guarantees. You can only hope.
Will Congress Act?
It’s also possible that Congress will act to make the SBA loan payments tax-free. This could be done in a future stimulus bill. But it’s impossible to predict what Congress will do.
What to Do Now
Right now, the prudent course is to assume that the SBA loan subsidies are taxable income and to plan accordingly.
You should plan on including the payments in your business gross income on your tax return and deducting the interest portion of the payments, as well as any deductible fees the SBA paid on your behalf.
The CARES Act requires the SBA to make six months’ worth of payments for 7(a) loans, 504 loans, and microloans. This article explains whether you must pay income tax on such loans.
Here are five things we know from this article:
- The CARES Act is silent on this issue, and the IRS has yet to provide any guidance.
- Such loan payments do not qualify as gifts.
- The IRS has advised in the past that similar payments from government units are taxable income to the business borrower.
- The IRS could take a different view this time and find that the payments are tax-free under the general welfare exclusion.
- Congress could also act to make the payments tax-free.
If you have such a loan, the prudent course is to assume—until the IRS or Congress says otherwise—that the six payments by the SBA on your loan are taxable income to your business.