How Eidl Funds May Be Used
EIDL loans werent created just for the coronavirus economic crisis. In fact, theyve been part of the SBAs Disaster Loan program for many years. They often make national headlines when a natural disaster hits an area, like when Hurricane Harvey caused flooding and business disruption for many parts of Texas. So before we dive into specific questions, lets look at how these loans were designed to be used. According to the Standard Operating Procedures for Disaster Loans :
Economic Injury is a change in the financial condition of a small business concern, small agricultural cooperative, small aquaculture enterprise, or PNP of any size attributable to the effect of a specific disaster, resulting in the inability of the concern to meet its obligations as they mature, or to pay ordinary and necessary operating expenses.
Economic injury may be reduced working capital, increased expenses, cash shortage due to frozen inventory or receivables, accelerated debt, etc. Economic injury loan proceeds can only be used for working capital necessary to carry the concern until resumption of normal operations and for expenditures necessary to alleviate the specific economic injury .
While there is no comprehensive list of how EIDL funds may be used, if youre trying to err on the side of caution, there are clues in the section of the SOP that describes how to calculate economic injury. The following examples come from the section of the SOP that relates to calculating economic injury:
Risks Of Financing Real Estate Investments Using Credit Cards
There are, of course, some risks associated with using a credit card to purchase real estate. Here are five reasons you should proceed with extreme caution before you decide to finance your real estate purchase with plastic.
What Happens If The Irs Investigates
In many cases, the IRS will audit your return once they notice you have taken out a shareholder loan. They will be looking to see if you are trying to disguise your wages or a dividend. That is why you should always be cognizant of when the IRS may look at your return so you can structure your loan appropriately. The process typically goes like this:
- The IRS will investigate your relationship to the organization. If you are the company’s only shareholder and completely control your earnings, that definitely weakens your argument that the loan is valid. The IRS will be less likely to question your loan if you are one of several shareholders in the company .
- After this, the IRS will investigate the details of the loan. Generally, the more businesslike the loan appears, the less the IRS will poke around. They check to see if:
- You set a maturity date or repayment schedule for the loan.
- You have missed any repayments.
- Your company has tried to collect any overdue funds.
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Borrowing From Your Corporation
If you have a business corporation, your income will normally consist of salary or dividends. However, given the right circumstances, your corporation may be able to lend you money tax-free.
There are some things that you need to be aware of. First, if the company extends you a low or no-interest loan, there will be a taxable benefit added to your income based on the prescribed rate .
Second, the Income Tax Act contains a set of rules that are designed to prevent shareholders from taking a series of back-to-back loans in place of other taxable streams of income.
The Wrong Way How To Buy A Home With A Corporation In Canada
Before I explain how the strategy works, lets look at the wrong way to buy a home, which is a common mistake that many business owners make. The wrong way is to have your corporation pay a bonus or lump-sum salary payment to you. This way is ineffective, because approximately half of the payment must be remitted to the Canada Revenue Agency to pay for payroll taxes, leaving you with only 50% in your hands to purchase a home in Canada.
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Rollover For Business Startups
Rollover for Business Startups has become another viable alternative for those looking to raise funds for a business. When a ROBS transaction is implemented correctly, it provides entrepreneurs with a way to invest their retirement savings into a new business venture without incurring taxes, early withdrawal penalties, or loan costs.
However, executing a ROBS can be extremely complicated, which is why it’s essential to work with a competent provider that has experience with these transactions. While there are plenty of ROBS providers to choose from, most offer a similar product with similar fees and support. In addition to researching potential ROBS partners, it’s important to consider how tapping into your retirement assets will affect your long-term financial plans.
Types Of Business Credit
Businesses can have a credit history and credit scores that are separate from the business owners credit. Building your business credit can make it easier to qualify for a line of credit, loan or credit card. You can then use these accounts when you need to borrow money to help run and grow your business.
Learning how to build and manage your personal credit may also be important. Many small business owners find their personal credit history is also important, because lenders may review the business owners personal credit before approving a new account.
However, before you decide to borrow money, calculate the costs associated with the loan and the impact on your business. Getting approved for a loan doesnt always mean you should accept it.
Remember, youll need to repay the money plus fees and interest.
If youre borrowing money without a clear plan for how it will improve your business, or how youll repay the loan, you might not want to take on the debt. Otherwise, you could wind up using most of your companys revenue to repay debt and you wont have money left over for yourself or to invest in the companys future.
On the other hand, if you think a loan can help your business make or save more money than youll pay in fees and interest, then the loan might be a good idea.
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How Do I Document How I Used Eidl
There is also confusion about documentation required.
Im self employedand it says show receipts, do we just save our receipts and turn them in at some point?
You dont turn in documentation automatically but you should keep careful track of how you spend EIDL proceeds in case the SBA or another governmental agency asks to review that information in the future. Just as there have been audits and inspections of past disasters, there will be scrutiny of some of these loans as well. You might put a note EIDL on those expenditures in your accounting program and keep a file with receipts. If you dont use an accounting program its a good idea to keep a spreadsheet listing how you spent these funds.
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Youll Have To Balance The Personal With The Professional
This final point has been the throughline of much of this article, but it bears repeating: Taking on a loan from a family member means mixing your business and personal lives.
For some people, thats okay: They feel confident they can balance the needs and egos of their family members in exchange for working capital. Others may not enjoy this process and might consider keeping everything professional by sticking with a third-party lender.
If you do take out a loan from a family member, best practices include keeping your lender appraised of how the business is doingso there are no surprisesand, of course, keeping up your end of your formal agreement.
A loan from a family member can be a unique opportunity to grow or scale your business with affordable, flexible financing. It can also be the first step in a long line of financial decisions that hamper not just your small business, but your familial relationships.
As with any loan, do your research and speak to your advisors before taking on such a large financial and personal responsibility. Just because its family doesnt mean it will be easyin fact, in some ways it might be even harder on you than repaying a traditional loan.
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Things The Bank Will Ask When You Need A Business Loan
That bank loan you want for your company? Well, the bank is going to want a lot before they give it to you.
Do you find this daunting? Me too. I was really disappointed when I needed my companys first commercial bank loan to finance receivables of more than $1 millionfrom well-known distributors no lessand we ended up having to sign a lien on our family home to get the loan.
We said, Wait, were a corporation, why do we need personal guarantees?
They said, If you dont believe in your business, then we dont either.
We said Wait, these are good receivables, you already checked the credit ratings of these distributors, why arent they enough?
They said, If you dont believe. And at that point I realized the truth in the old cynical joke that says banks will lend you money only if you dont need it.
One of the first things overly-optimistic entrepreneurs discover as they look for funding is that banks dont fund business plans. In their defense, it would be against banking law if they did. Banks are dealing with depositors money. Would you want your bank to invest your checking account balance in a startup? I wouldnt. And neither would the U.S. banking regulators.
So heres what to expect a bank to ask for when you apply for a commercial loan for your business. There will be occasional exceptions to every rule, of course, but heres the general rule:
Evaluate The Risk Of Using Personal Assets
While most entrepreneurs believe their business concept will succeed with certainty, nearly half of all new businesses cease to exist within five years. If the business fails, the owner could lose any savings, retirement funds, or other personal assets that they have put into the business.
If you havent done so already, we recommend developing a robust business plan that includes details on how much money you need to fund your business and the sources of those funds. If you have sufficient personal assets to fund your business and also have a reserve for emergency expenses that may arise, using personal assets makes sense.
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Borrowing Money From Your Business
If you are a member of a limited liability company , you can borrow money from the company. The manner in which you can do so depends on how you have elected to have the LLC be treated, which would be as either a corporation or as a pass-through entity specifically for tax purposes. If there are other members involved, you must get approval from them before borrowing any money from the business.
If the LLC is being treated as a pass-through entity, there is no need to borrow money from the company. With this business structure, cash can be taken out as a draw, which you will pay or will have already paid income taxes on. Although borrowing is permitted, it is recommended that you speak with an accountant or with corporate legal counsel before proceeding.
It is worth noting that while owners often borrow from their businesses, the Internal Revenue has the authority to re-characterize the loan and make it a dividend or a distribution, which makes it taxable to the recipient. It may also not be deductible to the corporation.
An audit by the IRS brought to light that the shareholder advances were not actual loans and undertook to treat the advances as taxable transactions. The findings by the IRS were backed up when it was taken to court.
Making An Investment In Your Business
The other option for putting money in your business is to invest the money. In this case, the funds go into your owner’s equity account or into shareholders’ equity .
If you withdraw your contribution, you may have capital gains tax to pay if there is an increase in the price of the shares. If you withdraw additional money in the form of bonuses, dividends, or draw, you will be taxed on these amounts. There is no tax consequence to the business on this investment.
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Do You Make Enough Money
Many lenders require a minimum annual revenue, which can range anywhere from $50,000 to $250,000. Calculate your revenue and find out the minimum a given lender requires before you apply.
You lack time in business.
You need funding quickly.
Online lenders provide small-business loans and lines of credit from about $1,000 to $5 million. The average annual percentage rate on these loans ranges from 6% to 99%, depending on the lender, the type and size of the loan, the length of the repayment term, the borrowers credit history and whether collateral is required.
These lenders rarely have APRs as low as those at traditional banks, but approval rates are higher and funding is faster than with banks as fast as 12 hours.
What Happens If Your Company Writes Off A Loan
New rules introduced in 2013 affect how loans are treated if they are repaid and replaced with new loans.
If the loan is written off and never repaid to the company then the amount of the loan will be treated according to your relationship with the company.
If you are a shareholder and a director the written-off amount is treated as a distribution and no tax relief is gained by the company. However, although the written-off amount is treated as a distribution for income tax that is not the case for NI. The NI cost would be a deduction from profits for the company.
If you are only a director then the written-off amount is treated as the net of tax pay and grossed up to calculate PAYE and NI. The company would then be entitled to deduct the gross amount and employers NI from its profits and receive tax relief.
We recommend that you speak to your accountant before writing off any loans to decide the best way forward.
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All Of Your Personal Financial Details
This includes social security numbers, net worth, details on assets and liabilities such as your home, vehicles, investment accounts, credit card accounts, auto loans, mortgages, the whole thing.
For businesses with multiple owners, or partnerships, the bank will want financial statements from all of the owners who have significant shares.
And yes, as I implied in the introduction to this article, thats leading to the personal guarantee. Expect to sign a personal guarantee as part of the loan process.
How To Get A Loan To Buy A Business
Its not always necessary to start a company from scratch these days. If you see a promising business for sale, it may be a good investment to buy it. Youll likely need a business acquisition loan to finance the endeavor, however. Use the steps above for this type of loan, as well. Instead of providing all the documentation for your own business, however, youll need to include the same type of information for the company youll be buying.
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