Can You Settle an SBA Loan? 6 Steps in an SBA Offer in Compromise

Falling behind on an SBA loan can make it feel like you will never get back on track financially. You may be able to settle an SBA loan for less than you owe, but you will have to go through an “Offer in Compromise” process with the SBA and pay what you can, the SBA forgives what you can’t. Usually this is only an option after you have defaulted, closed the business and sold any collateral you gave to secure the loan.

For a typical SBA-backed loan, the government guarantees the lender 75% to 85% of the loan value, and the lender usually has to collect what it can first if you default, and then file a claim with the SBA. You are considered in default after 120 days. Finally, the SBA pursues you for what you owe. Ignore it, and the government can take your tax refunds, garnish your Social Security, deny you certain federal loans, revoke licenses, and even place a lien on your property.

Offer in Compromise

Step one, the demand letter: If you default on your SBA loan, the SBA may send you a “60-Day Demand Letter.” You get 60 days to pay the entire amount in full, come up with an “Offer in Compromise” (a partial settlement), or file for bankruptcy. Miss that deadline and the debt is turned over to the Treasury Offset Program, meaning you will have fewer options. Need more time? Ask the SBA in writing before the deadline passes.

Step two, closing down: You have to have gone out of business and sold everything you used as collateral for the SBA to even review an offer. Yes, that includes a home.

If you’re only slightly behind, call your lender first. It may be easier to defer or restructure payments or settle the loan for less than you owe. You may not have to close down and sell everything first. The lender has to get the SBA’s prior written consent to cut the principal on the loan. Send them a hardship letter, offer a particular amount, and include updated financial statements.

Step three, the paperwork: Gather your profit and loss reports, balance sheet, bank statements, current receivables and payables, and property appraisals and/or valuations. You’ll also need to write a hardship letter explaining why you stopped making payments, plus cash flow statements demonstrating that your income is not enough to pay a higher loan payment. You may have years of balance sheets and sales reports stashed away, but they may not be in agreement. Go back and see if you can make everything match. The SBA will check to see if the property is worth what you claim it is. Find an accountant or attorney to help prepare the forms.

The fourth step is to submit a Form 1150 explaining your offer and the reasons you can’t pay the entire amount. Also send a Form 770 detailing your personal finances, household expenses and dependents.

You and the other guarantors may want to offer different amounts to settle the loan for less. Each guarantor must file their own forms, stating how much they are personally offering to settle for and why. Because most SBA loans require all owners of 20% or more of the business to personally guarantee the loan, that means you and those who own that much or more of the business are each liable for the entire balance. The SBA wants the offer and attached documents organized in an OIC 8-Tab Kit format. Send it to the Commercial Loan Service Center and that “should” speed processing, according to the SBA. The SBA says it wants no fraud, full disclosure of your finances, accurate collateral values, and a clear source of funds to make payment. There is no guarantee, however, that it will take your deal.

Step five is determining the amount you can offer. The SBA says it will not generally consider an Offer in Compromise under $5,000, unless a hardship case is demonstrated. The amount you offer must also reflect what the SBA believes it could collect if it took legal action to collect the balance, such as garnishing your wages or seizing your assets. A lowball offer from someone with real assets or substantial income is unlikely to pass.

Lump sums paid within 90 days of acceptance are generally approved more often because it’s a more definite payoff. Payments over time, for up to 36 months, are harder to get approved. Plus, miss one installment and you owe the original balance, minus payments made, as if the settlement never happened.

Step six, the wait: Once your offer is submitted, all you can do is wait. The review can take several months. Complete offers can be rejected. Denied requests go to the Treasury Department.

If the SBA Won’t Settle

At this stage, the U.S. Treasury Department can withhold your tax refund or federal benefit payments, garnish up to 15% of your disposable pay or seize what’s in your bank account, all without a court order. You’ll usually have 30 days’ notice and a chance to contest it. There is no time limit on Treasury offset. The collection can continue until the entire balance of what you owe and any penalties are repaid.

You still have another option. If your loan is not tied to collateral and you can’t pay it, you may be able to use Chapter 7 bankruptcy and not owe the rest, though it will hurt your credit for years. A Chapter 13 payment plan can allow you to work down the balance over three to five years.

The IRS Usually Taxes the Forgiven Part as Income

If your settlement offer is accepted, the IRS usually taxes the forgiven part as income unless you are insolvent or bankrupt. Tax form 982 will guide you. Also, the settled loan will probably appear on your personal credit and also those of any other guarantors. It is typically less damaging than a collections account or bankruptcy, but may make qualifying for new credit more difficult.

COVID EIDLs are not forgivable as with PPP loans, but COVID-stricken businesses do have a hardship option on them. Borrowers can lower payments to 50% for six months using the Loan Portal.

Bottom line: settling an SBA loan for less than you owe is possible but it may take a long time. Act early, answer every notice and consider an SBA attorney. Disclose everything and make your best case.