The Small Business Administration has issued information on tax reporting for payments made under §1112 of the CARES Act.[1] That provision provided that the government, via the SBA, would pay principal and interest for loans covered by §7(a) of the Small Business Act for a period of six months.[2]

Although the Act did not provide any explicit guidance governing whether such payments were to be treated as income by the recipient, Congress did not specifically provide that the amounts were not to be treated as taxable income, unlike the explicit provision treating forgiveness of PPP debt as not being subject to tax.[3]

IRC §61 broadly defines gross income as “all income from whatever source derived, including (but not limited to)” a long list of items, including “[i]ncome from the discharge of indebtedness…”[4] Thus, from the very beginning, it appeared that these payments would represent taxable income to the businesses who had a portion of their debts paid.

SBA Notice

The notice effectively confirms the amounts represent a form of income, outlining Form 1099 and Form 1098 reporting responsibilities. The notice begins:

In April 2020, SBA began making payments under Section 1112 of the CARES Act to cover, for a 6-month period, the principal, interest, and any associated fees that small businesses owe on 7(a), 504, and Microloans (“Section 1112 payments”). These Section 1112 payments relieve the small businesses of the obligation to pay that amount. SBA is providing the following information to 7(a) Lenders, Microloan Intermediaries, and Certified Development Companies with respect to information reporting issues arising from the Section 1112 payments…[5]

The notice provides the following guidance to the lenders regarding the involved parties’ responsibilities for filing a Form 1099MISC reporting this income to the borrower:

In accordance with section 6041 of the Internal Revenue Code (“Code”) and the regulations thereunder, the following are responsible for issuing the Form 1099- MISC with respect to the Section 1112 payments:

7(a) Lenders are responsible for issuing the Form 1099-MISC for: (1) loans that have not been purchased by SBA, and (2) loans that have been purchased by SBA and are serviced by the 7(a) Lender. SBA is responsible for issuing the Form 1099-MISC for 7(a) loans that have been purchased, and are serviced, by SBA.
Microloan Intermediaries are responsible for issuing the Form 1099-MISC for the Microloans serviced by the Intermediaries. SBA is responsible for issuing the Form 1099-MISC for the Microloans that are serviced by SBA.
SBA is responsible for issuing the Form 1099-MISC for all 504 loans. Lenders and Microloan Intermediaries should refer to the Instructions for Form 1099- MISC and the General Instructions for Certain Information Returns for more information about filing and furnishing the forms, including requirements to file electronically. Microloan Intermediaries and 7(a) Lenders should contact IRS’s Stakeholder Liaison Local Contacts at https://www.irs.gov/businesses/smallbusinesses-self-Employed/stakeholder-liaison-local-contacts (link provided to SBA by the U.S. Department of the Treasury) with any questions concerning the information reporting of the Section 1112 payments.[6]

The notice provides that the following amounts are to be reported as income on the Form 1099MISC:

The total amount of the Section 1112 payments must be reported as income to the Borrower, including the principal, interest and any fees that were included in the Section 1112 payments. (emphasis added) This total amount should be included in Box 3 of Form 1099-MISC.[7]

The notice continues, outlining who is to be shown as the payor and recipient on the Form 1099MISC related to CARES Act §1112 payments:

The 7(a) Lender and Microloan Intermediary should be identified as the PAYER in the “Payer” box in Form 1099-MISC, with its name, street address, city or town, state or province, country, ZIP code, and telephone number. The Borrower of the 7(a) loan or the Microloan should be listed as the “RECIPIENT” in Form 1099-MISC.[8]

The notice concludes by noting that even though interest may have been paid with CARES Act §1112 payments, if a Form 1098 is required to be issued on the obligation that interest should be reported on the Form 1098:

In accordance with section 6050H of the Code and the regulations thereunder, the amount of interest paid on the loan by the Section 1112 payments should be reported to the IRS, and furnished to small businesses, on Form 1098, Mortgage Interest Statement.[9]

Tax Treatment on the Recipient’s Return

Note that the SBA is not indicating that the payments should be treated as cancellation of debt, with a Form 1099C being issued. Rather this is being viewed as some other form of income.

While it might seem that there’s little difference—the amounts represent ordinary income—if a borrower is insolvent while some or all of the payments are paid, it becomes important whether this is a cancellation of indebtedness or some other form of income. The issue is that IRC §108 provides relief in certain cases from having to report some or all cancellation of debt income if certain requirements are met. A key one that could apply to some borrowers is the exclusion under §108(a)(1)(B) if the taxpayer is insolvent at the time the debt is cancelled.

In this case it does seem the most supportable view is that the payments do not represent cancellation of indebtedness. The debt in this case is not payable to the SBA in most cases, but rather the federal government has stepped in to make such payments on behalf of the businesses. Thus the lender did not cancel the debt in question.

Note that there are cases, as the notice points out, where the SBA will have purchased the loan and may even be servicing the loan. The notice does not treat such loans differently from those held by another lender, most likely to provide a consistent result. But there may be some room to argue that in this case, the lender is truly forgiving a portion of the debt.

The borrower should be able to claim a deduction for the interest paid on the business’s behalf, as the business is reporting such a payment as income. Thus, for most practical purposes, the payment of the principal and any otherwise nondeductible amounts would be the net amount taxable under this program.

[1] SBA Information Notice, Control No. 5000-20067, Tax Issues Relating to the Payments Made on Behalf of Borrowers under Section 1112 of the CARES Act, December 8, 2020 (https://www.sba.gov/sites/default/files/articles/5000-20067.pdf?utm_medium=email&utm_source=govdelivery retrieved December 12, 2020)

[2] CARES Act, §1112

[3] CARES Act, §1106(i)

[4] IRC §61(a)(11)

[5] SBA Information Notice, Control No. 5000-20067, Tax Issues Relating to the Payments Made on Behalf of Borrowers under Section 1112 of the CARES Act, p. 1

[6] SBA Information Notice, Control No. 5000-20067, Tax Issues Relating to the Payments Made on Behalf of Borrowers under Section 1112 of the CARES Act, pp. 1-2

[7] SBA Information Notice, Control No. 5000-20067, Tax Issues Relating to the Payments Made on Behalf of Borrowers under Section 1112 of the CARES Act, p. 2

[8] SBA Information Notice, Control No. 5000-20067, Tax Issues Relating to the Payments Made on Behalf of Borrowers under Section 1112 of the CARES Act, p. 2

[9] SBA Information Notice, Control No. 5000-20067, Tax Issues Relating to the Payments Made on Behalf of Borrowers under Section 1112 of the CARES Act, p. 2