Offers In Compromise ("OIC") for Defaulted SBA Non EIDL loans and Section 108 of the Internal Revenue Code ("IRC"), Relief of Indebted Income, a Trap for the Unwary!
Many clients contact Jim Shenwick, Esq regarding assistance with their defaulted SBA Non EIDL loans and ask that we assist them with filing an OIC with the SBA.
BACKGROUND
By way of background, if an individual or a company borrows money from the SBA and is unable to repay their loan, one option is to file an OIC with the SBA, requesting that they be allowed to pay only a portion of the money's due on the defaulted Non EIDL loan as final and full payment for the SBA loan.
For example, let's assume that an individual borrowed $200,000 on an Non EIDL loan and hypothetically offered $25,000 as a lump sum payment to the SBA as a final and full payment on the defaulted SBA loan (OIC offer)
The SBA OIC program is similar to the OIC program for outstanding taxes owed to the IRS.
Historically, to file for an OIC with the SBA, the business had to close. However, recently the SBA has changed their rules, and they are now allowing individuals or businesses with defaulted SBA loans to file an OIC even if the business is still open.
The SBA has an Offer in Compromise form that must be filed, in addition to other forms, that detail the business’s assets, liabilities, revenue, & expenses and why the SBA Non EIDL loan cannot be repaid.
However, filing for an offer in compromise with the SBA may not benefit the borrower because it may result in taxable income resulting from relief of indebtedness income pursuant to Section 108 of the IRC.
LAW
Section 108 of the Internal Revenue Code, provides that if an individual or a business borrows money and does not repay that money, the amount that is not repaid is considered ordinary income. For example, assume an individual borrows $100,000 from a bank and repays $50,000; according to the IRS, the taxpayer has been enriched to the sum of $50,000, and the bank is required to report "relief of indebtedness income" of $50,000 to the IRS on Form 1099-C. If the taxpayer does not report this income to the IRS, they will be audited and assessed interest and penalties on the taxes they did not report and pay.
There are two exceptions to "relief of indebtedness income" The first exception, is the Bankruptcy Exception (see Section 108(a)(1)(A) of the IRC). If an individual or business files for bankruptcy, they do not have to report relief indebtedness income. The second exception is the Insolvency Exception, (see Section 108(d)(3) of the IRC). If an individual's or company's liabilities exceed their assets on the date that the loan is satisfied, partially paid off or discharged, they also do not have to pay relief of indebtedness income.
An example of the Insolvency Exception is as follows: an individual owns real estate and personal property worth $250,000, has liabilities totaling $500,000 (Insolvent). Under this scenario, if the taxpayer had $200,000 of relief of indebtedness income (since their liabilities exceed their assets) they would not have to pay tax on the $200,000 of a relief of indebtedness income.
Accordingly, taxpayers and their advisors make the mistake of filing for an OIC with the SBA, without considering the tax consequences of that decision. If they do that, they will have effectively traded an SBA problem (the defaulted SBA Non EIDL loan) with an Internal Revenue Service relief of indebtedness income problem in the near term.
For example, assume a taxpayer had an LLC which borrowed $200,000 from the SBA in the form of an Non EIDL loan. The LLC was unable to repay the Non EIDL loan, and their plan was to file an offer in compromise with the SBA in the amount of $25,000. Assume that the taxpayer who owned the LLC also had a $1 million pension plan. If this taxpayer were to file for an OIC with the SBA, and if the OIC offer were accepted by the SBA, the taxpayer would have to report $175,000 of ordinary income on their tax return ($200,000-$25,000), provided that the Bankruptcy Exception and the Insolvency Exception do not apply. If the taxpayer was in a 30% tax bracket, they would have to pay $52,500.00 ($175,000 x 30%) in taxes in addition to the $25,000 they paid to the SBA (for the OIC) for a total of $77,500.
In the above scenario, if the LLC had filed for chapter 7 bankruptcy, they could have avoided paying the SBA $25,000 (OIC) and saved $52,500 in taxes—a better result for the borrower.
The bottom line is that prior to filing for an OIC with the SBA, an individual or business considering making an offer must consider the tax consequences of the offer as well!
Clients or advisors with questions about defaulted Non EIDL loans are encouraged to contact Jim Shenwick, Esq. jshenwick@gmail.com 917 363 3391.
Please click the link to schedule a telephone call with me.
https://calendly.com/james-shenwick/15min
Jim is a Bankruptcy and Workout attorney with an LLM in Taxation from NYU Law School and he has SBA Non EIDL default experience.
Jim Shenwick SBA EIDL Blog Posts:
EIDL LOAN WORKOUTS AND BANKRUPTCY https://shenwick.blogspot.com/2022/07/eidl-loan-workouts-and-bankruptcy.html
EIDL Loan Default Questions & Answers
https://shenwick.blogspot.com/2022/10/eidl-loan-default-questions-answers.html
EIDL LOAN DEFAULT DOCUMENT REVIEW, WORKOUT, BANKRUPTCY FILING & OFFER IN COMPROMISE
https://shenwick.blogspot.com/2022/07/eidl-loan-default-document-review.html
EIDL Defaulted Loans
https://shenwick.blogspot.com/2022/07/eidl-defaulted-loans.html
New Relief Program for SBA EIDL Borrowers Who are Having Difficulty Repaying EIDL Loans " Hardship Accommodation Plan"
https://shenwick.blogspot.com/2023/05/new-relief-program-for-sba-eidl.html
EIDL LOANS and SBA OFFER IN COMPROMISE PROGRAM
https://shenwick.blogspot.com/2022/07/eidl-loans-and-sba-offer-in-compromise.html
PPP & EIDL Fraud
https://shenwick.blogspot.com/2022/08/ppp-eidl-fraud.html
Better to connect-What small business owners need to know about repaying loans tied to pandemic relief from the SBA EIDL Loans
https://shenwick.blogspot.com/2022/11/better-to-connect-what-small-business.html
