SBA EIDL Loans and Change of Entity Structure

It is hard to believe, but year 2022 seems to have just flown by. As many of you, I really enjoy the fall season, and not only for its beauty, much anticipated rain, and great holidays, but also because it is when I reconnect with my clients before the year end and plan for the next year.

As part of tax planning, I may review their current business entity form and depending on their level of revenues and net income, determine whether an alternative entity choice may produce more tax benefits. However, year 2022 may be a bit different as many small businesses carry SBA Economic Injury Disaster Loans (EIDL) they obtained during the pandemic. One of the requirements for carrying the loan to its full term of 30 years is to maintain its entity structure used initially to obtain the loan.

It means that the entity formed, for example, as a single member LLC which can save taxes by switching to an S corporation status may trigger a premature repayment of the EIDL loan upon changing its entity form. The business is no longer at liberty to change its business structure when it sees fit, but instead should seek SBA’s formal approval of a strategic transaction because the EIDL loan documents dictate so. Specifically, the EIDL promissory note states that the borrower is in default if it “reorganizes, merges, consolidates, or otherwise changes ownership or business structure without SBA’s prior written consent.”

If anticipated tax savings from changing the existing business structure are material enough to pursue the change, requesting a formal approval from the SBA’s loan officer who initially closed the loan should be priority #1.

As we continue navigating post-pandemic economic realities, extra diligence is required to avoid costly mistakes.