Note: The writer is not a CPA or tax professional. This article is for general information purposes, and should not be construed as tax advice. Readers are strongly encouraged to consult their tax professional regarding their personal tax situation.
There’s no doubt about it: negotiating an SBA loan settlement can be taxing. These days, lenders are so overwhelmed with defaulted loans that it can take an act of Congress to get them to even return your phone call. Then, when they do return your call, they ask you to fill out a series of onerous and confusing forms. Once you return that info, it’s likely that your initial attempt as a settlement offer will be summarily dismissed. From there you negotiate, fighting tooth and nail in order to get a deal done. Finally, after weeks or even months of mind-numbing, energy-sapping negotiating, a deal gets done. You send them a check, and finally breathe a sigh of relief. After all, the situation is now over and behind you right? Well, not exactly. At least not according to the folks at the IRS.
Debt forgiveness, you see, is treated as taxable income. Why? In a nutshell, if someone gives you money and you don’t have to pay it back, it’s taxable. Just like you have to pay taxes on wages from a job. Part of the reason that debt forgiveness is taxable is because otherwise, it would create a giant loophole in the tax code. In theory, your boss could “lend” you money every 2 weeks, and at the end of the year they could forgive it and none of it would be taxable.
I’ve had clients ask me to try to negotiate the taxability of debt forgiveness. Unfortunately, no lender (including the SBA) has the ability to do such a thing. Just like your employer is required to send a W-2 to you every year, a lender is required to send 1099 forms to all borrowers who have debt forgiven. That said, just because lenders are required to send 1099s doesn’t mean that you personally automatically will get hit with a huge tax bill. Why? In most cases, the borrower is a corporate entity, and you are just a personal guarantor. I know that some lenders only send 1099s to the borrower. The impact of the 1099 on your personal situation will vary depending on what kind of entity the borrower is (C-Corp, S-Corp, LLC, etc). Most CPAs will be able to explain how a 1099 would manifest itself.
While I can’t tell you the specific impact that SBA debt forgiveness will have on you, the point of my article is really just to recognize that loan forgiveness does potentially have tax consequences that a borrower should look into so they can make the most informed decision possible.
Common Questions About SBA Loan Forgiveness, Part I
Is it possible to settle an SBA Disaster Loan?
It is possible to settle an SBA disaster loan. It should be noted, however, that disaster loans are handled by a different area than “regular” SBA loans. Technically, they have the same SOPs (standard operating procedures), but the rules tend to be interpreted a little differently by the disaster loan folks than they are by the “regular” SBA loan area.
How long will it take to settle my loan?
It depends. There are many factors that can drag out the process. Is there business equipment that needs to be sold? Is there real estate that needs to be sold? Are you dealing directly with the SBA, or is your lender still servicing the loan? Like a construction project, the rule of thumb is that it will always take longer than you expect it to. With that said, don’t despair. It is possible to settle. The SBA is fair (in my opinion), so if you abide by the settlement rules, and understand how the SBA is going to evaluate your offer, your chances of settling are good provided you can raise an acceptable amount of cash.
What can an SBA workout specialist do for me that I can’t do for myself?
A knowledgeable SBA workout expert will have a strong knowledge of the SBA settlement process. They will have a firm grasp of how the SBA will analyze your financial situation in order to determine whether your offer is acceptable. In addition to their ability to determine a fair settlement offer, an SBA workout expert will be able to challenge lenders, who often hide behind the SBA as an excuse not to settle. Some lenders will cite specific SBA guidelines as reason why an offer cannot be acceptable. A seasoned SBA workout pro knows the SBA rules, and can challenge the lender when they know that something is not factually correct. As a business owner who is going through the settlement process for the first time, how could you possible know all the SBA rules and practices? More importantly, how would you know if they lender is accurately interpreting the SBA guidelines?