Forgivable Loans

The federal government passed several emergency aid bills during the COVID-19 pandemic that were meant to help people survive during what was one of the most challenging times in U.S. history.

The first of these aid bills was called the CARES Act. Passed in March 2020, there were many aspects to the multi-trillion-dollar package. Multiple forgivable loans were created specifically for use by small businesses, while other forgivable programs were created for individuals.

While these are some of the most well-known forgivable loans, they are not the only type. In this article, we’ll discuss what forgivable loans are and what eligibility and tax issues result from them.

Economic Injury Disaster Loan (EIDL)

The Economic Injury Disaster Loan (EIDL) program expanded considerably during the pandemic. The federal government declared the entire country to be in a disaster zone as a result of the pandemic, effectively making every small business eligible for these loans. 

The first type of EIDL loan was the most common one. They provided small businesses with funds to pay for working capital and other normal operating expenses. These loans had favorable terms but were forgivable and had to be repaid.

There were different requirements for this EIDL loan, depending on how large the loan amount was. Loan increases were also available until all the funds were exhausted.

The second type were the EIDL Advance funds. They were awarded to existing EIDL applicants who met additional criteria. The Advances are treated like grants without the typical requirements the federal government places on such programs.

Because of their grant-like nature, EIDL Advance funds were forgivable and didn’t need to be repaid.

Public Service Loan Forgiveness (PSLF)

The Public Service Loan Forgiveness program, or PSLF, applied to borrowers who had federal direct loans. These borrowers could qualify for loan forgiveness after they made 12 monthly payments while they were working for an eligible employer on a full-time basis. 

Payments made as part of an income-driven repayment plan also qualified as payments toward the PSLF. 

Paycheck Protection Program (PPP)

Perhaps the most popular forgivable loan program was the Paycheck Protection Program, or PPP. It was a new loan backed by the Small Business Administration aimed at helping small businesses continue employing their workers during the pandemic.

The money handed out under the program was a loan that could turn into a forgivable grant if the recipient met certain qualifications. 

Loans of as much as $10 million were available to small businesses to use for as much as six months of their average monthly payroll costs from the previous year. Businesses that received the loans could use as much as 40% of the total on non-payroll costs, including utilities, rent and mortgage interest.

All loans were for five years with a fixed interest rate of 1%. If the loans were used for the purposes described above, they could qualify for full forgiveness. The amount to be forgiven would be reduced, though, depending on how the funds were allocated.

Eligibility

To be eligible for a PPP loan, a small business had to have 500 employees or less. Each business could apply for a loan worth as much as 250% of its average monthly payroll costs — with a maximum of $10 million — and it was meant to cover up to eight weeks of payroll, and help with the other expenses mentioned above.

Those who are self-employed, an independent contractor or sole proprietor were also eligible to apply for a PPP loan. Any portion of the PPP loan that wasn’t forgiven was subject to a loan term of 10 years, with a maximum rate of 4%. 

Conditions for Loan Forgiveness

In order for small businesses to receive loan forgiveness under the PPP program, there were a number of requirements they had to meet. Only 40% of the funds could be used for non-payroll expenses, while the rest had to be used to maintain payroll.

Businesses that received these loans had to compile proper documentation, fill out a forgiveness form and submit the documentation to the lender. Those files would all be reviewed, with a decision sent back to the small business.

Small businesses that received a PPP loan before June 5, 2020, had to repay their loans fully in two years, or within five years if they were approved after that time. Payments could also be deferred for as much as 10 months after the disbursement date of the loan. 

Other Types of Forgivable Loans

There are other types of forgivable loans that weren’t related to the pandemic and weren’t targeted to small businesses. 

Here are some examples. 

Teacher Loan Forgiveness (TLF)

Many different states have Teacher Loan Forgiveness (TLF) programs available for teachers. Typically speaking, teachers must work for at least five years in a row at a low-income school district or educational service agency.

After this period of time, they may qualify to have part or all of their school loans forgiven. How much of the loan is forgivable depends on a number of factors, including the state they teach in, their specialization and location.

Down Payment Assistance (DPA)

Some borrowers may qualify for a second mortgage that will help them cover closing costs and a down payment when they are buying a new home. There are various factors that determine whether a borrower might qualify for a DPA as well as how much the loan could be worth.

In most cases, the borrower can qualify for full forgiveness of the DPA if they lived in the home for at least five years. The length of time they must live in the home varies from case to case, though. 

Some of the DPA programs that are available are targeted specifically to types of buyers such as military personnel, teachers and first-time homebuyers.

Tax Implications of Forgivable Loans

While forgivable loans are certainly great, they aren’t without implications. Depending on the type of loan that was forgiven, you may take a tax hit as a result.

That’s because the Internal Revenue Service (IRS) typically treats forgivable loans as taxable income. This means that you must claim the amount of the loan that was forgiven on your tax returns at the end of the year, just like other sources of income.

There are, of course, exceptions to this rule. The most popular ones are the pandemic-related loan programs. For instance, forgivable PPP loans were not considered to be taxable income, which provides small business owners with more financial relief. 

It’s important that you consult with an experienced tax professional and attorney to determine how loan forgiveness might affect you from a tax perspective.

Weigh Your Options with an Experienced Attorney

Forgivable loans became very popular during the COVID-19 pandemic. While most of these programs have since ended, there are still some forgivable loans available. 

That being said, some people still experience financial difficulties even after they receive forgivable loans. If that’s the case, it’s important to weigh your options with an experienced attorney.

At Babi Legal Group, we have more than 20 years of experience in real estate law and more than 10 years experience in business, bankruptcy, debt collection and debt settlement law. We can help advise you on the implications of forgivable loans and help you explore your options if you’re still experiencing financial difficulties.

For more information, please contact us today.