Taxation Of Loan Payments Made For You

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 realestate

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.

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 Florida to help repair homes damaged by a hurricane may fall 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.

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.

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.

If you have additional questions regarding this information, or other tax and accounting related matters, give us a call.


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