SBA (Small Business Administration) loans can, quite literally, be lifesavers for small business owners.
On paper, an SBA loan seems like a dream come true. A versatile financing program for small businesses with low interest rates, minimal collateral, and borrower-friendly repayment terms? Sounds amazing!
And it is amazing, in many respects. However, the interaction between SBA loans and taxes can sometimes restrict your access to an SBA loan or complicate the process of acquiring one.
In order to prepare for taking out an SBA loan, you will need to fully understand what an SBA loan will mean for your tax returns and vice versa.
Today, we will be discussing whether or not SBA loans are counted as tax-deductible income, whether you can get an SBA loan without having filed your taxes, and whether tax payments are required on SBA disaster loans.
Do SBA Loans Count as Income?
First and foremost, it’s important to understand how SBA loans are classified with regard to income.
The finances that you receive as part of your SBA loan are not generally considered taxable income, and therefore, you don’t usually need to declare your SBA loan on your tax returns.
However, there are some exceptions to this rule.
The main exception concerns loan forgiveness. Loan or debt forgiveness constitutes a reduction or cancellation of your loan repayments.
For example, SBA sometimes offers PPP (Payment Protection Program) loans to small businesses, which are eligible for forgiveness under certain conditions.
If at least 60% of your business proceeds go towards the payroll, with the rest being spent on other acceptable expenses, and if you are continuing to appropriately compensate your employees during the weeks following disbursement, you would be eligible for a PPP loan which would qualify you for full forgiveness.
The idea of having your loan repayments canceled or reduced is obviously very tempting for small business owners who may be struggling financially.
However, it’s important to note that, in some cases, the forgiven amount of debt may be taxable, which means that you will have to declare it as income on your tax returns.
So, with some forgiven SBA loans, the tradeoff for canceling or reducing your repayments is having to pay income tax on the reduced or canceled amount.
While a forgiven amount of a personal loan would typically need to be declared as ‘other income’ on your tax return form, a forgiven business loan (such as a forgiveness-eligible SBA loan) can be classified as ‘ordinary income.’
Again, however, there may be some exceptions which would mean that you don’t have to pay any tax on your forgiven SBA loan.
In December 2020, a CRRSAA (Coronavirus Response and Relief Supplemental Appropriations Act) law was passed by Congress.
This law states that forgiven loans obtained through the Payment Protection Program will be exempt from tax payments.
This means that any PPP SBA loans that are forgiven from the end of 2020 onwards will not be taxable and do not need to be declared as income on your tax return forms.
Are SBA Loans Tax Deductible?
One thing that often draws small business owners towards the prospect of an SBA loan is the suggestion that SBA loan payments may be tax-deductible.
However, the tax-deductibility of your SBA loan will be limited and dependent on circumstances, so you should never take out an SBA loan on the premise that the payments will be fully tax-deductible.
To clarify, tax deduction refers to the lowering of a person or business’s taxable income or tax liability.
These deductions can be standardized or, if expenses incurred over the year total more than the standardized deduction rate, itemized.
In most cases, only the interest payments on your SBA loan will be tax-deductible.
For anyone who isn’t familiar with loan terminology, loan interest payments are additional payments on top of the amount of the loan.
These payments are calculated as a percentage of the overall sum that you have borrowed, and they are implemented over time until the original amount is paid in full.
The national average interest rate for an SBA 7(a) loan is 5.5%, so let’s use that as an example.
Say you borrowed $350,000 for your small business at an annual interest rate of 5.5%.
This would mean that you are liable to repay the $350,000 over a certain period of time, and with each passing year, the total amount to pay will increase by 5.5%, which would be $1,925 per year.
Now, while the original $350,000 will not be tax-deductible, the annual $1,925 generated by the interest rate can be tax-deductible.
So, in short, while SBA loans, in general, are not tax-deductible, the interest payments incurred by these loans usually are.
Can I Get an SBA Loan if I Didn’t File Taxes?
Getting an SBA loan can be much more difficult if you haven’t filed your taxes for the past two years.
This doesn’t mean that it’s strictly impossible to get an SBA loan in the case of unfiled taxes, as there are some exceptions, and some lenders may be willing to make alternative arrangements.
However, it does mean that you will be more unlikely to receive a loan.
If your lender agrees to continue with the loan in the absence of previously filed taxes, some extra steps will be added to your loan application process.
In normal circumstances, loan officers will ask to see your filed tax returns from the previous two years. This is required so that your lender has proof of your business’s recent income situation as well as your history of tax payments.
Unfiled taxes not only prevent your loan officer from being able to accurately and legally assess your income, but it’s also an indication of unreliability on your end.
Obviously, loan officers need to be able to trust you to repay your loan in a timely manner, so unfiled taxes definitely don’t look good on your application.
We should clarify, however, that you don’t necessarily have to have filed your taxes for the current year in order to apply for an SBA loan.
Depending on when in the year you’re applying for your loan, the deadline for filing tax returns may not yet have rolled around, in any case.
When applying for the loan, your lender will ask you to complete the 4506T IRS form with details of your historically filed tax returns.
With that being said, it’s always best practice to file your tax returns for the current year on time, whether you’re planning on taking out an SBA loan or not.
If you haven’t filed your tax returns for the previous two years, this is where things can get a little complicated.
Unfortunately, many SBA lenders will automatically decline, or at the very least, hold off your application in the absence of up-to-date tax filing.
However, some lenders may be lenient and ask you to complete something called an income statement as opposed to a standard tax return.
While a business tax return is a declaration of the amount of taxable income generated by your business, an income statement is simply a declaration of your business’s total revenue as well as expenses.
While acceptance of an income statement in lieu of filed taxes is rare for SBA lenders, it’s still worth making inquiries on this front if you are seeking financial support and haven’t filed the previous two years of tax returns for your business.
Do You Have to Pay Taxes on SBA Disaster Loans?
SBA disaster loans are slightly different from standard SBA loans in the sense that disaster loans are specifically awarded to businesses that need help financially recovering from a disaster.
SBA disaster loans cover physical or economic damages caused to businesses as a result of a recorded disaster.
In order to qualify for an SBA disaster loan, you will need to prove that your business is based in a disaster zone.
You’ll also need to pass a routine credit check. If the loan that you require is significantly larger than average (in excess of $25,000), you will more than likely also need to provide collateral.
Collateral, in terms of SBA loans, refers to an asset (that you legally own). In the event that you are unable to repay your loan within the specified time frame, a lender has the legal right to seize and sell the collateral to make up for the unpaid amount.
The most common form of SBA disaster loan is an Economic Injury Disaster Loan (EIDL). This type of disaster loan does not need to be reported in your tax returns.
You can also claim tax reduction on any business expenses that the loan covers.
Please note that any sources dated prior to the introduction of the Consolidated Appropriations Act (2021) may not be accurate since the passing of this act was instrumental in making EIDL SBA loans untaxable.
In short, SBA loans and taxes are inextricably intertwined in the world of finance.
SBA loans, in and of themselves, including SBA disaster loans, are not usually classified as taxable income.
Up until very recently, it was standard for tax payments to be required for forgiven SBA loans. However, at the end of 2020, the IRS confirmed that SBA loans acquired through the Payment Protection Program are no longer taxable.
Moreover, the Consolidated Appropriations Act of 2021 ended the taxability of Economic Injury Disaster Loans.
You can claim tax reduction on your SBA loan’s interest payments, as well as expenses covered by the loan, although the original amount of the loan will not be tax-deductible.
In order to apply for an SBA loan, you will usually need to have your tax returns for the past two years filed in order to prove your taxable income and financial responsibility.