Loan Modification in 2026 Rather than Going for Debt Settlement
A small business in the US might prefer to apply for a loan modification in 2026 rather than going for debt settlement if it can afford to repay the loan in full over a longer period. It is more likely to be in the business’s best interest to go with a loan modification if the debt is secured with collateral or it is owed to the SBA. It is better to go with debt settlement if a business realistically cannot repay the principal amount. The debt should be unsecured and the business owner should be able to raise the lump sum or short-term payments. A loan modification means that the debt is the same but the loan terms are different.
A settlement means that the amount of debt is reduced, but the reduction is generally taxable income, and it can only be achieved if the creditor agrees. A business owner must consider whether the debt is secured, the identity of the creditor, if the owner guaranteed the debt, and the solvency of the business before it decides which option is best.
Loan modification is an agreement made between a creditor and debtor in which the creditor modifies the terms of the loan. The amount borrowed will usually not be reduced. Monthly payments will be reduced but the total interest paid on the loan will typically be increased. Lenders generally require three to six months of bank statements and two to three years of tax returns before agreeing to a loan modification. Loan modification is useful if the cash flow problem is temporary (e.g. seasonal or loss of one major customer) and the business can demonstrate that it has enough cash flow to service the modified payment. Loan modification does not help if the debt is permanently out of proportion to the business’s earnings.
The most significant potential liability of the settlement is the tax. Under the federal income tax code, a debtor generally is required to treat a forgiven debt as ordinary income. If the creditor is an applicable financial entity, it’s required to file a Form 1099-C with the IRS if it cancels a debt of $600 or more. The debtor must report the income even if it does not receive the Form 1099-C. Section 108 of the Internal Revenue Code provides two basic exceptions. Income from cancellation of debt during a bankruptcy proceeding is completely excluded. Income from cancellation of debt during an insolvency is excluded up to the amount of the taxpayer’s insolvency. Insolvency means a taxpayer’s total liabilities exceed the fair market value of all of its assets, determined immediately before the cancellation. A taxpayer that claims an exclusion files Form 982. The taxpayer also must reduce its tax attributes beginning with net operating losses and then business credit carryovers.
A sole proprietor is indebted to a lender for $200,000. The sole proprietor and the lender negotiate a settlement for the debt of $90,000. The sole proprietor has a $110,000 discharge of debt. The sole proprietor had liabilities in excess of the fair market value of all of the sole proprietor’s assets by $60,000 prior to the settlement. The sole proprietor may exclude $60,000 based on the insolvency rules. The remaining $50,000 of taxable income will be reported on the Schedule C of the sole proprietor’s income tax return. All of the sole proprietor’s assets, including assets in retirement accounts and other assets not subject to claims of creditors, must be included in the insolvency calculation. This will tend to reduce the amount available for exclusion. An exclusion that applies to businesses that use the cash method of accounting will not create income if a debt is forgiven where the debt, if paid, would be deductible.
Economic Injury Disaster Loans
Identity of the Creditor Can Be Critical with SBA Loans. For Economic Injury Disaster Loans issued in connection with the COVID-19 pandemic, the SBA announced March 19, 2025, that its Hardship Accommodation Plan is closed. The remaining “modification-type” option allows an eligible borrower to cut the payment in half for six months, but it may be exercised only once every five years. To qualify, the loan must be current and less than 90 days past due, the business must be open, no owner can be in active bankruptcy, and the hardship must be short-term. Interest will continue to accrue during the six months, so that the “balloon payment” when the loan comes due will be bigger. For loans that have been delinquent for 120 days, EIDLs may be referred to the Treasury Offset Program. Once a loan is in Treasury’s Cross-Servicing Program, the SBA states, it can no longer help the borrower.
Offer in Compromise Process
Settling an SBA EIDL is much harder. Lawyers who handle these loans say the SBA’s offer in compromise process has in practice been limited to businesses that have closed, liquidated their assets, and documented that they cannot repay on SBA Forms 1150 and 770. They also report no confirmed compromise approvals on COVID EIDLs in recent years. For a business that is still operating and cannot afford its EIDL, the realistic options are usually the 50 percent payment reduction, a negotiated workout, or bankruptcy. A company that charges a fee to settle an operating business’s EIDL is selling an outcome the SBA is not currently granting.
Merchant Cash Advance Contract Negotiations
Merchant cash advances are the opposite case. Funders set them up as purchases of future receivables rather than loans, so there is often no loan to modify, and a negotiated settlement is the usual route. How the advance is legally classified can change the owner’s leverage. In Fleetwood Services v. Richmond Capital Group, decided in 2023, the federal Second Circuit affirmed that an advance was really a loan charging illegally high interest. It also upheld damages under the federal racketeering statute. Courts applying New York law look at three things. They check whether the contract really lowers payments when sales fall, whether it has a fixed end date, and whether the funder can still collect if the merchant files for bankruptcy.
Enforcement has also impacted merchant cash advance contract negotiations. In January 2025, the New York Attorney General announced a $1.065 billion settlement and judgment against Yellowstone Capital. The settlement released over 18,000 businesses from across the nation from $534 million in debt. The New York Attorney General alleged that funders were charging effective interest rates of up to 820%. In February 2024, a federal judge forced merchant cash advance operator Jonathan Braun to pay $20.3 million in a case filed by the Federal Trade Commission, the FTC’s first jury trial. An amendment to the CPLR 3218 has prohibited creditors from filing confessions of judgment in the state of New York against residents of other states since August 2019. Funders had filed these to get judgments against debtors without filing lawsuits.
Advance Fees
The Telemarketing Sales Rule of the FTC, amended in 2010, does not allow debt relief telemarketers to charge a fee until a debt is actually settled, the customer has agreed to a deal offered by the creditor in writing, and the customer has made at least one payment to the creditor. The FTC’s FAQ on the rule, which concerns an individual’s unsecured debts, does not address business debt. The amendment to the rule, which became effective on May 16, 2024, extends the rule’s ban on misrepresentation in business-to-business calls, but does not extend the rule’s ban on advance fees. This means that an owner may be required to pay advance fees which would not be allowed in a consumer program. The terms of the fee schedule and refunds are important elements in a written agreement.
Collateral and personal guarantees limit both options. Settlement mostly works for unsecured debt such as vendor balances, business credit cards, and merchant cash advances. A secured lender that goes unpaid can take its collateral, so it has less reason to accept a discount. A personal guarantee lets the lender pursue the owner personally after the business defaults. A settlement that ends the company’s liability but leaves the guarantee in force solves only part of the problem, which is why the written terms need to say whether guarantors are released.
Subchapter V of Chapter 11
If neither of those are appropriate the last resort is the Subchapter V of Chapter 11, where a small business can continue operating and reorganize its debts (shortened deadlines for plans, no U.S. Trustee quarterly fees, appointed trustee helps to negotiate a consensual plan). In a case commenced on or after June 21, 2024, the inflation adjusted Subchapter V debt limit is $3,424,000. The Bankruptcy Threshold Adjustment Act of 2026 was passed by the House of Representatives on September 16 and the Senate on September 28, 2026. As of early October 2026, the Bill was awaiting the signature of the President of the United States. It would adjust the debt limit to $7.5 million for a case commenced on or after the date it is enacted. A debt that is discharged in a bankruptcy case is completely excluded from taxable income, while an out-of-court settlement only qualifies for a partial exclusion, based on insolvency.
