Month: September 2020

Seven Things to Know Before You Take Out an EIDL

Small Business Administration (SBA) Economic Injury Disaster Loans (EIDLs) can be a great source of low-interest funding for businesses struggling with the economic impact of the COVID-19 pandemic. 

Unlike Payroll Protection Program (PPP) loans, EIDLs are not forgivable—borrowers have to pay them back. But they have a low 3.75 percent interest rate and a long 30-year repayment period. Borrowers can repay them at any time without penalty.

To obtain an EIDL, borrowers must sign a loan authorization and agreement, a note, and a security agreement filled with fine print. Many of these provisions could have a significant impact on the borrower’s business for the life of the loan—up to 30 years.

It is vital to understand the terms and conditions before taking out any loan, including an EIDL. Here are seven key provisions borrowers should be aware of.

1. No Changes to the Business

Without SBA approval, EIDL borrowers may not sell the business or change its ownership structure. This includes removing or adding a business partner.

2. No Distributions Outside the Usual Course of Business

The owners may not make distributions outside the usual course of business without SBA approval. This includes loans, advances, bonuses, or asset transfers to owners, employees, or other companies.

Distributions within the usual course of business are permitted. SBA officials have said this includes distributions of net income to owners of a pass-through business, such as an S corporation or a limited liability company.

3. Strict Record-Keeping Requirements

The SBA imposes strict record-keeping requirements on EIDL borrowers. They must keep itemized receipts showing how they spend the loan funds. Also required is a full set of financial and operating statements, which must be furnished to the SBA each year. The SBA also has the option of requiring an expensive review of the borrower’s records by an independent CPA.

4. Using Other COVID-19 Payments to Pay the SBA

EIDLs are intended to cover disaster losses not compensated by other sources. If an EIDL borrower obtains grants, loans, insurance proceeds, or lawsuit recoveries to help defray COVID-19-related losses, the borrower is required to notify the SBA. The SBA may require that such money be used to repay the EIDL. 

But a business may obtain both a PPP loan and an EIDL so long as it doesn’t use them for the same expenses.

5. Strict Collateral Requirements

Businesses that borrow more than $25,000 are required to pledge all their business’s personal property as collateral. Such collateral includes present and future inventory, equipment, deposit accounts, promissory notes, negotiable instruments, and receivables. 

The SBA obtains a security interest in all such collateral the borrower has at the time of the loan, or collateral it acquires or creates in the future. The borrower must

• obtain hazard insurance for its collateral, and
• ask the SBA for permission before selling or otherwise disposing of its collateral, other than selling inventory in the ordinary course of business.

6. Buy American

EIDL borrowers must promise to buy American-made equipment and products with the loan proceeds, to the extent feasible.

7. Penalties for Violations

Penalties for violations of the EIDL terms can be severe. The SBA can demand immediate repayment of the entire loan if the borrower breaches any of its terms. The SBA also reports defaults to credit reporting agencies. 

Borrowers who misapply EIDL funds—for example, using them to pay personal expenses—are liable to the SBA for an amount equal to one-and-a-half times the original loan.

If you need my assistance or would simply like to discuss EIDLs, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• September 28, 2020

No PPP Loans Today, But You Can Still Get $150,000 from the SBA

Can your business use an infusion of cash to deal with losses caused by the COVID-19 epidemic? 

The hugely popular federal Payroll Protection Program (PPP) loan program that paid forgivable loans to millions of businesses ended on August 8 (although it could come back in revised form). But you can still obtain a low-interest Emergency Income Disaster Loan (EIDL) of up to $150,000 from the Small Business Administration (SBA).

Do You Qualify for an EIDL?

You can qualify for an EIDL if your business has fewer than 500 employees and has suffered “substantial economic injury” due to the COVID-19 pandemic. You have suffered economic injury if you’re unable to pay your normal business operating expenses and other bills, or to sell or produce your goods or services because of the pandemic.

You can obtain an EIDL even if you already received a PPP loan. However, you may not use the EIDL to pay the same payroll costs or other expenses you pay with a PPP loan.

How Much Can You Borrow?

The SBA is currently capping EIDLs at $150,000. The amount you receive is intended to cover six months of your business operational expenses. For most small businesses, the loan amount is based on gross revenues minus cost of goods sold during the period from February 1, 2019, through January 31, 2020, divided by two.

What Are the Loan Terms?

These are 30-year loans at a 3.75 percent interest rate. You don’t have to make any payments until one year after you receive the loan (interest continues to accrue during the one-year delay). There is no prepayment penalty.

How Do You Apply?

You apply for an EIDL with the SBA, and the loan is funded directly from the U.S. Treasury. Unlike with PPP loans, banks are not involved. You can apply online, and the SBA has created a streamlined application.

Do You Need to Have Collateral or Make Guarantees?

The SBA does not require a personal guarantee for an EIDL of less than $200,000.

Collateral is required only if the loan is over $25,000. 

For loans over $25,000, the SBA obtains a security interest in all tangible and intangible property your business owns or acquires, including inventory, equipment, and receivables. The SBA files a UCC-1 lien against your business. 

How You Can Use the Money

The money is supposed to be used to help you carry on your business until life gets back to normal. You can use the money to pay normal operating expenses, such as employee salaries and benefits, rent, utilities, and fixed debt payments. You can continue to take your owner’s draw for work you actually perform for the business.

But EIDLs are not supposed to be used to replace lost sales, fund business expansion, start a new business, or refinance long-term debt. Nor can you use them to pay yourself dividends or bonuses. 

As you can see, EIDLs can be a useful source of low-interest financing during these troubled times. If you need my assistance or would simply like to discuss EIDLs, please call me on my direct line at 408-778-9651.

• By Leon Clinton
• September 23, 2020

Don’t Let Section 179 Recapture Hurt You

Okay, so you took the big Section 179 expensing deduction on your vehicle.

How do you keep it?

You might wonder: What do we mean by “keep it”?

In tax law, there’s no free lunch. The Section 179 deduction comes with “recapture strings” attached. 

When you claim your Section 179 deduction, you make a deal with the government to keep your business use above 50 percent during the “designated” depreciation periods (five years for vehicles).

One Sad Story 

In 2018, Jerry Jackson claimed a $53,000 Section 179 deduction on a qualifying pickup truck. In 2020, Jerry’s wife drives the truck and Jerry’s business use drops to zero.

Jerry violated his 50 percent business-use agreement with the government. Now he has phantom income to report (called “recapture”), and he’s going to pay the price for breaking his tax promise on the Section 179 deal.

The pickup truck is listed property. This means that Jerry must recompute his allowable deductions using the ADS straight-line depreciation tables, which will result in the following:

• $5,300 deduction (10 percent of $53,000) in 2018
• $10,600 deduction (20 percent of $53,000) in 2019

In 2018, Jerry deducted his 90 percent business cost ($53,000) using Section 179. But now, with recapture, his ADS straight-line depreciation for 2018 and 2019 totals only $15,900 ($5,300 + $10,600). 

So in 2020, the year of violation, tax law recaptures $37,100 ($53,000 – $15,900). Jerry must report the 2020 recapture income on the same form or line on which he (or his corporation) claimed the original $53,000 deduction in 2018.

For example, say Jerry operates as a proprietor who claimed his 2018 Section 179 deduction on Schedule C. In 2020, he reports the recapture income as other income on Schedule C. 

Holy smokes! On Schedule C, that means the Section 179 recapture is going to create self-employment taxes. Correct! The original Section 179 deduction reduced self-employment taxes.

On his recapture income, Jerry gets the double whammy: increased income and self-employment taxes.

Traps to Consider

Retirement. Are you going to retire? Will retirement bring your business use to zero?

Children. Do your children drive your business vehicle(s)? Will their driving bring your business use to 50 percent or less? 

Spouse. Does your spouse drive your business vehicle for personal purposes? Will your spouse’s mileage drop your business use to 50 percent or less?

Personal use. Are you converting Section 179 assets, such as a vehicle, to personal use? Does the conversion to personal use occur during the recapture period? 

You need to consider recapture when doing your tax planning. If you would like my help with this, please don’t hesitate to call me on my direct line at 408-778-9651.

• By Leon Clinton
• September 23, 2020