Tax Consequences Related to COVID-19 EIDL Loan

Published: Dec 5, 2022
Topics: Tax

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Tax Consequences of an EIDL Loan Default

The Coronavirus Aid, Relief, and Economic Security (“CARES”) Act authorized the U.S. Small Business Administration (“SBA”) to issue Economic Injury Disaster Loans (“EIDL”) to certain COVID-19 affected businesses and eligible small business ^owners.[1] The payment deferral period, totaling a period of up to 30 months from the date of the promissory note,^[2] has begun to sunset, and payment is becoming due for borrowers who took loans out early in the pandemic.

Small loans, under $200,000, did not require personal guarantees by the small business owners; the loans could be secured by business assets alone. Large loans, exceeding $500,000, required collateral consisting of real estate owned by the business. Borrowers with loan amounts in excess of $200,000 were required to sign a general unsecured personal guarantee.^[3] What happens to borrowers who personally guaranteed their loans if the business shuts down; and, after winding up (i.e., shutting down on the books), the business assets are insufficient to pay back the full amount of the EIDL note?

Unless and until Congress or an executive order tells us otherwise, these business owners, now without their business, are left holding the debt, and if not paid per the note, will become delinquent and eventually default on the loan. Under the Debt Collection Improvement Act,^[4] any debt that reaches 120 days delinquent must be sent to the Treasury Offset Program^[5] (“TOP” or “TOPs”) for collection.

TOPs collects delinquent federal and state debts and will offset monies, such as tax refunds, belonging to a debtor being held by federal agencies like the IRS or a state agency such as a department of revenue through the State Reciprocal Program (“SRP”) .^[6] Meaning, a defaulted EIDL loan can result in a borrower’s federal or state tax refund being confiscated by the IRS or state department of revenue and turned over to the SBA to pay the delinquent debt.

Other sources of income, such as a portion of a borrower’s federal pensions or social security income,^[7] can also be offset and sent to the SBA for payment of the delinquent loan. Keep in mind, despite the appropriation of these monies, this income will retain its original character and income tax may still be owed, and withheld, on this offset income despite the fact it was never actually received by the borrower.

Temporary Mitigation

The best way to avoid having a tax refund offset is to avoid having a refund at all:

Review/update Form W-4, or state equivalent, with your employer; the Form changed substantially in 2020 and a careful review of the instructions is strongly recommended.^[8]
Self-employed individuals, or those who must otherwise make estimated tax payments, should retain/consult with their tax advisors early and often and explain the situation so each quarter’s estimate can be carefully calculated based upon the prior quarter’s income.
Year-end extension payments should not be rounded up to include the next year’s first quarterly payment, a common defensive practice against late payment penalties.

Borrowers may also be able to protect a non-debtor spouse’s portion of the tax refund.

Consult with your tax advisor whether married filing separately would be a good option in your specific circumstances to protect a spouse’s refund.
File Form 8379, Injured Spouse Allocation, either simultaneously with a married filing joint return or alone after a tax refund is offset, to protect or have returned the non-debtor spouse’s portion of the tax refund^[9].

Hardship waivers to reduce or eliminate the offset are also a possibility but can only be issued by the agency to which the debt is owed,^[10] in this case the SBA^[11].

[1] The declaration of Covid-19 as a disaster in the Coronavirus Preparedness and Response Supplemental Appropriations Act of 2020, Public Law-116-123, allowed the SBA to issue EIDL loans to certain small business owners under 15 U.S.C. 636(b)(2), which was further expanded by the CARES Act.

[2] SBA Procedural Notice, Control No. 5000-830558, March 15, 2022.

[3] 86 FR 50214.

[4] 31 CFR Part 285, as amended by the Data Act, Public Law No: 113-101, in 2014.

[5] Unless the debt is exempted due to reasons such as pending litigation, foreclosure of collateral, bankruptcy, etc. Audit of SBA’s Compliance with the Debt Collection Improvement Act, as Amended, Report Number 20-20, September 30, 2020.

[6] Treasury Offset Program - How the Treasury Offset Program (TOP) Collects Money for State Agencies

[7] Limited to 15% of Social Security Income, or less if a hardship is shown, per the Debt Collection Improvement Act of 1996 (DCIA), passed as part of the Omnibus Consolidated Rescissions and Appropriations Act of 1996, Public Law 104-134.

[8] 2022 Form W-4 (irs.gov)

[9] See Internal Revenue Manual, I.R.M., 25.18.5 Injured Spouse, Community Property, Injured Spouse for details on states subject to special allocation rules due to state community property laws.

[10] Internal Revenue Manual, I.R.M., 21.4.6.5.11.1(2) (09-06-2022), Offset Bypass Refund (OBR).

[11] Options for Borrowers facing financial hardship

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