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Are SBA loans Dischargeable in Bankruptcy?

Are SBA loans dischargeable in bankruptcy? Generally speaking, yes, they are. But first some background.

Certain obligations of an individual to the government are nondischargeable. The most common examples of such obligations are taxes and school loans. The nondischargeability of school loans is almost absolute. The debtor may obtain a hardship discharge of school loans, but doing so is extremely difficult. Income taxes, however, are treated more leniently than school loans. Income taxes are generally dischargeable after three years, so long as the tax return was timely filed and certain other conditions are met.

So-called “trust-fund” taxes, such as an employer’s Social Security contribution for an employee, are also nondischargeable. The theory with respect to such taxes is that the employer has taken the funds out of the employee’s pay, and is therefore holding the funds in trust for the government. The employer violates that trust if the funds are not paid to the government.

Owners of failing businesses sometimes make the mistake of not paying the trust fund taxes, or income taxes for that matter, because they need to use the cash to keep the business afloat. It is all too easy to do so, because the Internal Revenue Service doesn’t immediately come knocking on the door like a credit card company would, looking for its payment. If the business totally fails, the owner may find out months or even years later that he or she is liable for the trust-fund taxes (plus significant penalties and interest) virtually forever, even they if he or she files Chapter 7 bankruptcy.

There are many other types of obligations which a debtor may owe to state or governmental agencies. One type of obligation is that of loans obtained on the basis of a guarantee from Small Business Administration. The question commonly arises as to whether such loans, like student loans, are nondischargeable.

The short answer to that question is yes, the obligation to the SBA is generally dischargeable. Sometimes the SBA loan will actually be taken out by a closely-held corporation, with the debtor guaranteeing the corporation’s obligation to the SBA. The debtor normally would be required to guarantee the obligation of Corporation. Under such circumstances, the debtor may discharge the guarantee of the corporation’s obligation to the SBA. The Corporation would remain liable for the debt. However, the however, if the Corporation has asked has assets and if it defaults on the loan, the SBA can try to collect on the debt from those assets.

As with much of the bankruptcy code, dischargeability rules are complex and have quite a few exceptions. If you have an SBA loan and are considering filing bankruptcy, it is best to obtain the advice of a lawyer as to whether your particular obligation is dischargeable.

Dennis Shea