At previous Tax Forums sessions in 2021, we speculated as to how the IRS would treat forgiven PPP loan proceeds and, perhaps more importantly, the related PPP-funded expenditures. We know from the Consolidated Appropriations Act that the loan forgiveness is considered tax-exempt income and increases the basis of S corporation stock, but questions remained as to whether the tax-exempt income should be treated as an increase to the Accumulated Adjustments Account (“AAA”) or the Other Adjustments Account (“OAA”), and whether the PPP-funded (and deductible) expenditures should reduce AAA or reduce OAA.

      The IRS has confirmed our prior speculation that the tax-exempt income should not increase AAA and that the PPP-funded expenditures should not reduce AAA. Instead, both items should be reported as adjustments to OAA. In the draft instructions to Form 1120S released on December 22, 2021, the IRS informed taxpayers that column (d) of Schedule M-2 “should include tax-exempt income from the forgiveness of PPP loans and report expenses paid with PPP loans that are forgiven on line 5.” The net effect of all this is that a taxpayer obtains the benefit of the deductions paid for with the PPP loan proceeds without a reduction in AAA (or basis).
 

      Practitioners should verify that their 2020 S corporation tax returns followed such treatment, as some tax preparation software may have defaulted to include the tax-exempt income as an increase to OAA while also reducing AAA by the PPP-funded expenditures. It may be necessary to adjust beginning AAA on the 2021 return to account for the proper treatment, and some taxpayers may need to amend their 2020 returns, if the improper treatment resulted in a distribution of AE&P to the S corporation shareholders.

      This development will be discussed at next week’s final presentation of the Thirty-Fifth Annual Tax Planning Forum held on January 11-13, 2022. Registration is still open.

      And, remember: the live Q&A never ends! We are always happy to address your questions - either about the programs or about any passthrough or closely held business matter that comes up in your practice. Please do not hesitate to call us at 800-286-4760 or email either of us.

             

Chuck Levun                              Michael Cohen 
crlevun@lgclaw.com                  mjcohen@lgclaw.com