If the SBA Makes Loan Payments on Your Behalf, Are You Taxed?
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 during the COVID-19 pandemic. 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. On December 27, 2020, Congress appropriated an additional $3.5 billion in its second stimulus law to expand this loan subsidy program. If you have one of these loans, you likely already benefited from this subsidy, or you will soon if your loan is on deferment. If you don’t have such a loan, you can apply for one now and still benefit from the loan subsidy in 2021. Is this subsidy taxable income to you? Read on.
The Original CARES Act Loan Payment Subsidy
The original CARES Act required the SBA to pay six months of principal, interest, and any associated fees that borrowers owed for all 7(a) loans, 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 payments automatically and directly to the lenders. You won’t find this money in your hands. You don’t need to file an application. For loans not on deferment, the SBA begins making payments with the next payment due. For loans currently on deferment, the SBA begins making payments with the next payment due after the deferment period ends. The SBA debt relief program does not apply to PPP loans or EIDLs. As you likely know, the SBA has a program in place for PPP forgiveness.
The New and Improved CARES Act Loan Payment Subsidy
Congress revised the CARES Act subsidy program with enactment of the second stimulus law on December 27, 2020, as follows:
Loans Approved Prior to March 28, 2020
If your 7(a), 504, or microloan was approved by the SBA before March 28, 2020, the SBA will make three additional loan payments on your behalf starting February 2021. Thus, you’ll get a total of nine months of payments of principal, interest, and fees. The three additional payments will be capped at $9,000 per month per borrower. The first six payments are not capped. But wait, there’s more.
Once your three additional payments end, you get five more loan payments of up to $9,000 per borrower per month if your business was assigned one of the following North American Industry Classification System (NAICS) codes when you applied for your loan (as shown in SBA records):
71—Arts, entertainment, and recreation
72—Accommodations and food services
213—Support activities for mining
448—Clothing and accessories stores
451—Sporting goods, hobby, musical instrument, and bookstores
485—Transit and ground passenger transportation
487—Scenic and sightseeing transportation
511—Publishing industry (except internet)
512—Motion picture and sound recording industries
515—Broadcasting (except internet)
532—Rental and leasing services
812—Personal and laundry services
Thus, businesses in these fields that obtained their loans before March 28, 2020, get a total of 14 loan payments from the SBA. The last eight payments are capped at $9,000 per month.
Loans Approved February 1, 2021, Through September 30, 2021
The SBA will make six monthly payments of principal, interest, and associated fees for 7(a), 504, and microloans approved February 1, 2021, through September 30, 2021. All these payments are capped at $9,000 per borrower per month.
A business may receive SBA principal, interest, and fee payments for only one loan approved after March 27, 2020. This means if you already received one of these loans before the deadline, you can get another and qualify for the loan subsidy. The SBA can reduce the number of payments it makes on all of these loans if it starts running out of money.
Are the Loan Subsidies Taxable Income?
Having the SBA make loan payments on your behalf is great. But it’s less great if the payments are taxable income to you. This reduces the value of the payments by up to 37 percent, depending on your top federal income tax rate. Oddly, the CARES Act was silent on whether the payments are taxable. But then the SBA weighed in and said the payments were taxable and should be reported as income to the IRS on Form 1099-MISC. Fortunately, lawmakers have come to the rescue and overruled the SBA. The second stimulus, enacted on December 27, 2020, amended the CARES Act to provide that
the SBA’s payments of principal, interest, and fees on behalf of the borrower on these SBA loans are not taxable income to the borrower, and
expenses paid by the borrower with subsidized SBA loan proceeds are fully deductible.
IRS Adds Clarity
In Notice 2021-06, the IRS states:
Section 278(c)(1) of the COVID Relief Act provides that such a payment is not included in the gross income of the person on whose behalf the payment is being made. Section 278(c)(2) provides that no deduction shall be denied by reason of the exclusion of the loan payments from gross income. Because borrowers may deduct mortgage interest that the Small Business Administration (SBA) paid to lenders under section 1112 of the CARES Act, lenders may include those mortgage interest payments in Box 1 of Form 1098, Mortgage Interest Statement, notwithstanding Section 1.6050H-1(e)(3)(ii) of the Income Tax Regulations.
What to Do
First, smile. You don’t have to do a thing. If you have a qualifying SBA loan, the loan subsidy has been, or will be, paid on your behalf automatically by the SBA. You won’t need to report any of the payments as income on your tax return. Obviously, you should deduct the interest and fees portion of the loan payments the SBA makes on your behalf as noted by the IRS. If you don’t have a 7(a) loan, 504 loan, or microloan, you should think about applying for one. If it’s approved by the SBA by September 30, 2021, the first six payments (up to $9,000 per month) will be paid on your behalf by the SBA (provided the money appropriated for the task holds out).
Here are six things to know from this article:
The CARES Act, as revised by the second stimulus law enacted on December 27, 2020, requires the SBA to make several months’ worth of payments for 7(a) loans, 504 loans, and microloans.
All businesses get at least six subsidized loan payments, but some qualify for 14 if they obtained their loans before March 28, 2020.
Loan subsidy payments made after February 1, 2021, are capped at $9,000 per borrower per month.
You’ll qualify for six subsidized payments up to $9,000 per month if you obtain one of these loans from February 1, 2021, through September 30, 2021.
The SBA loan subsidy is not taxable income to the borrower and need not be reported on your tax return as such. Further, the deductible expenses paid by the subsidy are tax deductible, such as interest and fees.
If you don’t have one of these loans, you should think about applying for one.