We wanted to share important information regarding S-Corporations and Economic Injury Disaster Loans (EIDL) administered by the Small Business Administration (SBA).
EIDL loans provide businesses with access to capital during times of hardship. During the COVID-19 pandemic, these loans helped businesses manage slower periods, maintain operations, and navigate the financial uncertainty caused by the crisis. Some potential benefits of SBA loans include:
- Help businesses qualify for financing they may not otherwise obtain
- Provide working capital to support ongoing operations
- Offer repayment terms of up to 30 years, which can help reduce monthly payments and preserve cash flow.
However, S-Corporations with an EIDL loan should pay close attention to the loan’s requirements as it pertains to shareholder distributions.
S-Corporation owners can extract money from the business through two primary channels:
- Payroll: Owners who actively work in the business are required to receive reasonable compensation through payroll.
- Shareholder distributions: Additional profits may be distributed to shareholders tax free to the extent of the company’s equity.
If your S-Corporation currently has an EIDL loan, shareholder distributions may be restricted under the terms of the loan agreement. Taking distributions when they are not permitted could violate the loan covenants and potentially result in the outstanding loan balance becoming due or a large down payment needed to regain compliance. Loan proceeds may still be used for eligible business expenses, including payroll paid to the S-Corporation owners.
It’s critical to review your EIDL loan agreement before taking any shareholder distributions. Loan requirements may vary, and a decision that appears routine could create an unexpected issue if it conflicts with the loan covenants. If you have questions about how your EIDL loan affects payroll, shareholder distributions, or business cash flow, now is the time to review the details with your advisor. We’re here to help!