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  5. How to Get a Small Business Loan and Navigate the Tax Implications

How to Get a Small Business Loan and Navigate the Tax Implications

Updated for Tax Year 2021 / October 16, 2021 11:45 AM


OVERVIEW

Small business loans like the SBA 7(a) loan can be a crucial lifeline for your company. But how do these loans affect your taxes?


If you're hoping to understand how to get a small business loan, loans obtained through the federal government's Small Business Administration (SBA) are a great option. But how can you qualify for these loans and how will they affect your taxes?

About SBA 7(a) loans

The SBA is a federal agency that advocates for the needs and interests of small businesses and counsels business owners as they navigate their organizations through new ventures. The agency's primary assistance program is called the 7(a) loan program. This program offers a variety of loan packages, including:

  • Standard
  • Small Loans
  • SBA Express
  • Export Express
  • Export Working Capital
  • International Trade

If you've wondered how to get a small business loan, you'll most likely start with the Standard Loan or the Small Loan. Even though the most common iteration is the Standard 7(a) Loan, most loans provided under the program operate wherein the SBA:

  • Establishes a maximum loan amount
  • Guarantees a percentage of the loan
  • Sets maximum interest rates
  • Works with approved lenders to administer the loans

The Standard 7(a) Loan's maximum assistance is $5 million and is guaranteed by the SBA up to 75%. Most loans mature in 10 years but may extend to 25 years for real estate purchases. Businesses can use this program for a variety of business needs, but a few common ones are:

  • Renovating or expanding a business
  • Purchasing real estate
  • Financing startup costs
  • Boosting working capital
  • Purchasing inventory
  • Establishing a seasonal line of credit
  • Refinancing existing debt

The key thing for business owners to remember is that each loan is unique. Even though the SBA supports and backs these loans, many of the details are ironed out during negotiations with the lender. Businesses should only seek these loans if they are ready to advocate for their needs and compromise when needed.

Qualifying and applying for SBA 7(a) loans

Many businesses can qualify for an SBA 7(a) loan. Sole proprietorships, corporations, partnerships, limited liability companies, and cooperatives are all eligible. At a minimum, they must:

  • Operate for profit
  • Do business (or plan to do business) in the United States or its territories
  • Have owners with equity to invest in the business
  • Obtain financial assistance through other sources, including personal assets, before applying for an SBA loan

The goal of the SBA is to support business growth and promote a business's stability in the marketplace. Its goal is not to help individuals finance business purchases. Loan requests will be denied for individual applicants hoping to use SBA loan proceeds to purchase ownership of a company that they aren't currently affiliated with. The one exception includes individuals operating sole proprietorships. Sole proprietors may be eligible for SBA loans, but only if they are seeking support for their business.

This does not mean the SBA will immediately deny all loan requests to purchase equity. The SBA would likely approve an application where:

  • A partial business owner fully buys out their co-owners, resulting in a complete change in ownership, or
  • A small business acquires 100% interest in another business, either through stock or asset purchases

The SBA outlines other specific exclusions and limitations on their website.

All SBA 7(a) loans are administered by preapproved lenders. Business owners seeking SBA support can contact their local lender and inquire about the application process, or they can find an approved lender using the SBA's Lender Match tool. Like most loan applications, the lender will request historical financial data, ownership information, business licenses, prior tax returns, legal documents like leases and mortgages, and other relevant information.

Tax consequences of an SBA 7(a) loan

SBA 7(a) loans will be taxed like any other term loan the business has. The tax laws for reporting term loans are simpler than you might think.

The IRS doesn't view loan proceeds as revenue. Because SBA 7(a) loans must be repaid within a certain term, the loan proceeds have no impact on the borrower's tax return.

The loan's associated interest payments are a little different. The IRS sees financing costs as ordinary and necessary expenses and allows businesses to take deductions for interest payments. Most loan payments are structured in such a way that monthly payments go toward both principal and interest. Only the portion of the payment that represents interest is deductible.

Only in rare circumstances would interest payments on an SBA 7(a) loan be nondeductible. Typical requirements for deductibility include:

  • The business is legally liable for the debt
  • Both the business and the lender intend for that debt to be repaid
  • The loan was made at arm's-length

In these cases, the interest should be deductible for both federal and state tax purposes.

PPP and EIDL

SBA 7(a) loans are different from Paycheck Protection Program (PPP) Loans and Economic Injury Disaster Loans (EIDL). While these loans are also backed by the SBA, they have their own rules for eligibility, and the tax consequences may differ. For example, when PPP loans are forgiven, businesses need not include that cancellation of debt in income for federal tax purposes. There is no similar blanket exception for SBA 7(a) loans that are forgiven or discharged.

Alternatives to small business loans

SBA 7(a) loans — and small business loans in general — aren't the right path for every business. There are other ways business owners can infuse capital into their business.

Sell equity

Sole proprietors can't sell equity in their business, but most other entities can sell an equity stake in their business. This task will be simplest for corporations who can easily sell shares of stock, but even partnerships can take on additional partners if their partnership agreement allows it.

Establish a line of credit

Lines of credit don't typically offer as much assistance as an SBA 7(a) loan might but having a line of credit with a bank can be just the right amount of support a small business needs. And bonus: Interest payments on lines of credit are deductible provided the loan proceeds are used for business purposes.

Apply for tax credits

There are hosts of business tax credits that can help boost a business's access to cash. Businesses can rely on their tax software to help them identify tax credits that are new for the current tax year or simply new to them and their circumstances, but a few to be aware of for the 2021 tax year are:

  • Work Opportunity Tax Credit
  • Credit for Employer-Provided Childcare Facilities and Services
  • Small Business Health Care Tax Credit
  • Research and Development Tax Credit
  • Retirement Plan Startup Costs Tax Credit
  • Plug-In Electric Drive Vehicle Credit

Look to the state for assistance

Some jurisdictions provide financial assistance to small businesses through state-specific tax credits, incentive programs, and grants.

Businesses asking how to get a small business loan have many options available to them, and SBA 7(a) loans may be the perfect solution. If you are considering getting a small business loan — SBA 7(a) loans or otherwise — you may want to talk to a trusted lender and think about the tax consequences of that loan before moving forward.

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