Does Defaulting on an SBA EIDL Loan Result in Taxable Income?
Bottom line: Defaulting on an SBA EIDL loan can create a federal income tax bill on top of the collection problem, and many borrowers and their advisors never ask about it.
Background
After the PPP loans, the SBA made Economic Injury Disaster Loans (EIDL) to small businesses. The loans ranged from $20,000 to $2 million. Unlike PPP loans, EIDL loans are not forgivable. If a loan exceeded $200,000, the business principal was required to guarantee it.
A significant number of borrowers have defaulted. They now face collection efforts by the SBA, the Treasury Offset Program, or collection agencies retained by the Treasury Offset Program.
The Question Most Borrowers Forget to Ask
Clients and their advisors usually call us about liability: what happens to the business, and what happens to the guarantor personally. They rarely ask about the tax consequences of the default, including cancellation of debt (COD) income under section 108 of the Internal Revenue Code.
The general principle is that a borrower who receives loan proceeds and does not repay them has received an economic benefit. The unpaid amount is taxed as ordinary income, not capital gain. A default can therefore leave a borrower owing tax on money that has already been spent.
See our prior posts, Increased SBA and Treasury Collection Actions on Defaulted SBA Loans https://shenwick.blogspot.com/2026/01/increased-sba-and-treasury-collection.html
and
Treasury Offset Program (TOP) and SBA EIDL Loans
https://shenwick.blogspot.com/2024/04/treasury-offset-program-top-and-sba.html
Ways to Avoid Recognizing COD Income
The Internal Revenue Code provides exceptions under Section 108:
Bankruptcy. If the individual facing COD income files a personal bankruptcy case, the discharged debt does not generate COD income.
Insolvency (balance sheet test). If the borrower's liabilities exceed the borrower's assets, and the borrower files the appropriate form with the Form 1040, the borrower does not have to recognize COD income.
Other tax strategies may also be available, depending on the borrower's circumstances.
Talk to Us Before the Tax Return Is Filed
If you or your client has defaulted on an SBA EIDL loan, contact Jim Shenwick to discuss the consequences of the default and the ordinary income that may have to be recognized. Addressing COD income before the return is filed keeps more options open.
Jim Shenwick, Esq 917 363 3391 jshenwick@gmail.com
Please click the link to schedule a telephone call with me.
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