With the implementation of a significant IT upgrade two weeks ago, the Small Business Administration (SBA) has suddenly gone from processing just 900 disaster loan applications per day, to over 10,000 per day. Given the fact that millions of small businesses have applied for these loans and are desperately in need of these funds in order to simply stay in existence during the COVID-19 recession, this will be welcome news for these small businesses.
However, these loans come with a LOT of strings attached. As their professional advisor, it behooves you to have an understanding of these loan conditions, some of which are quite draconian. This will help you to help your clients make a wise decision about accepting this loan or not, and if they do, how to properly utilize the funds.
This should probably be a CPE webinar, but due to other projects I’m working on this week, this blog post will need to suffice.
There are three main things that I want you, as a tax professional, to be aware of on behalf of your clients in relation to the Economic Injury Disaster Loans:
- The terms of the loan agreement.
- Restrictions on use of proceeds.
- The realization that this may be a once in a lifetime opportunity to “refinance” IRS tax debt into a 30 year, fixed rate loan at 3.75%.
Let’s briefly address each of these items.
EIDL Loan Terms and Conditions
SBA Form 1391 is the loan agreement for an Economic Injury Disaster Loan, and spells out the terms and conditions of the loan. Their are two very important things to understand about this loan agreement.
First, on loans in excess of $25,000, the SBA will secure their loan position with a general lien against all the business’ assets. This collateral for the loan is secured by use of a UCC-1, which will be filed in the county in which the business is located. The SBA deducts a $100 fee from the loan proceeds in order to cover the preparation and filing of the UCC-1. When I say that this lien covers all assets, I do mean all. It operates very similarly to a federal tax lien, and covers all property, rights to property, and property that may be acquired in the future. Heck, it even includes intangible intellectual property that the business may create in the future. It’s a very broad lien.
This may make it very difficult to obtain access to other credit facilities in the future. In addition, just like with the IRS requirement for obtaining a discharge certificate in order to sell property covered by a federal tax lien, the borrower will need to obtain SBA permission to sell assets (except for inventory turned in the normal course of business).
The second really big consideration in the EIDL agreement has to do with SBA access to books, records, and financial statements. All businesses should maintain proper books anyway, of course, and that’s part of why they hire you. But the loan terms require the borrower to furnish audited financial statements at the SBA’s request, and the SBA will require that this review-level audit be conducted at the expense of the business by a CPA — and it can’t be you if you’re already doing their accounting. This means the business may incur thousands of dollars in expenses to appease the SBA.
At a minimum, the SBA requires that the business provide un-reviewed financial statements within three months of the close of the borrower’s fiscal year. You can prepare these, so be ready to do so for your clients that are taking out these EIDL loans.
There are additional terms and conditions of course, and I encourage you to review them all.
Restrictions on Use of EIDL Proceeds
Remember, an EIDL is a working capital loan. That is the basic guiding principle for use of the loan funds. Working capital is money used to fund day-to-day operations. This means there is a short list of eligible expenses that can be paid with the loan monies, and a much longer list that the SBA doesn’t want these funds being used for.
The SBA handbook on the origination of EIDL loans is contained in SBA SOP 50 30 Rev 9. Make sure that you are reading the most recent revision, dated May 2018. To jump straight to the punchline, see pages 75 and 76 of the document, which states:
E. Ineligible Uses of Loan Proceeds: EIDL proceeds may not be used for:
- Payment of any dividends or bonuses;
- Disbursements to owners, partners, officers, directors, or stockholders, except when
directly related to performance of services for the benefit of the applicant;
- Repayment of stockholder/principal loans, except when the funds were injected on an
interim basis as a result of the disaster and non-repayment would cause undue hardship
to the stockholder/principal;
- Expansion of facilities or acquisition of fixed assets;
- Repair or replacement of physical damages;
- Refinancing long term debt;
- Paying down (including regular installment payments) or paying off loans provided, or
owned by another Federal agency (including SBA) or a Small Business Investment
Company licensed under the Small Business Investment Act. Federal Deposit
Insurance Corporation (FDIC) is not considered a Federal agency for this purpose;
- Payment of any part of a direct Federal debt, (including SBA loans) except IRS
- Pay any penalty resulting from noncompliance with a law, regulation or order of a
Federal, state, regional, or local agency.
- Contractor malfeasance; and
This list repeats much of what is contained in the loan agreement, but it’s worth reading and understanding from the SOP, also. The most important element to communicate to your clients, in my opinion, is that these loans cannot be used to pay down or pay off other long-term debt. In other words, an EIDL should not be used to effectively “refinance” other long-term liabilities. Also, the money cannot be used to move the business to a new location or used to fund physical expansion.
Lastly, about that part I highlighted in red…
Using EIDL To Pay Off Federal Tax Debts
This is probably my favorite potential use of these funds for your clients. You are, after all, reading this on a tax resolution blog.
Under SBA regulations, EIDL proceeds are explicitly allowed for use in paying off IRS tax debts. This is a huge opportunity for business tax debtors to “refinance” their IRS debt into a 30 year fixed rate loan at 3.75% interest rate. This is less than the IRS interest rate, so that alone makes it a good deal. But that 30 year term just won’t be found anywhere else.
For your existing business clients, even those without tax debt, evaluate their potential for incurring near-term 941 liabilities due to the pandemic recession. Many businesses have not yet experienced serious financial impact from this declared natural disaster, but they very well could. When business finances turn sour, payroll taxes are often one of the first things that don’t get paid. Your client may want to prepare for the potential for this now, and secure EIDL funds in preparation.
The EIDL can be a valuable resource for your clients impacted by a natural disaster. When I first started worked in taxpayer representation, I worked with many business clients that were still feeling the economic impact from Hurricane Katrina. At the time , I had no idea that the SBA offered these loans (they’ve been around for decades), and I consider that to be a major failure on my part, because my clients at the time could have definitely been helped by these disaster loans.
Do better for your clients than I did a decade ago, and make sure they are aware of the resources available to them to weather this viral storm, or any other natural disaster that may impact them in the future. But at the same time, be aware of the downsides to these loans, and know that an EIDL can potentially end up creating more problems than it solves for some business clients.