How to Report PPP Loan Forgiveness on Form 1120-S
Gain clarity on accurately integrating Paycheck Protection Program loan forgiveness into S corporation financial records and tax filings.
The Paycheck Protection Program (PPP) offered a lifeline to many small businesses, including those structured as S corporations. These forgivable loans helped businesses maintain payroll and cover other operating costs. The unique tax treatment of PPP loan forgiveness for S corporations filing Form 1120-S introduced specific considerations for tax compliance and financial planning.
Federal Tax Treatment of Forgiven PPP Loans
The federal tax treatment of forgiven PPP loans provides a significant benefit to businesses. The amount of a covered loan forgiven is excluded from gross income, meaning it is not considered taxable income. This exclusion was clarified by the Consolidated Appropriations Act, 2021, which explicitly stated that forgiven PPP loan amounts are tax-exempt.
In addition to the income exclusion, expenses paid with forgiven PPP funds remain deductible for federal income tax purposes. The Consolidated Appropriations Act, 2021, clarified that no deduction should be denied, nor any tax attribute reduced, solely because the loan used to pay them was forgiven and excluded from income.
Impact on S Corporation Shareholder Basis
For S corporation shareholders, the non-taxable income from PPP loan forgiveness has a direct impact on their stock and debt basis. An S corporation operates as a pass-through entity, meaning its income, losses, deductions, and credits are passed through to its shareholders for tax purposes. The shareholder’s basis is a measure of their investment in the S corporation and determines the limit on deductible losses and the taxability of distributions.
Non-taxable income, such as forgiven PPP loans, increases a shareholder’s basis. A higher basis allows shareholders to deduct more losses and receive tax-free distributions up to that basis. The forgiven PPP loan proceeds specifically increase a shareholder’s basis in their S corporation stock and also increase the Other Adjustments Account (OAA) on the corporate books.
Reporting on Form 1120-S
Reporting PPP loan forgiveness on Form 1120-S and its accompanying schedules requires specific entries. The non-taxable income from PPP loan forgiveness is reported on Schedule K (Form 1120-S), specifically on Line 16b, as “other tax-exempt income.”
This tax-exempt income then flows through to each shareholder’s Schedule K-1 (Form 1120-S) on Line 16, typically with code B for “Other Tax-Exempt Income,” increasing their individual basis. Expenses paid with PPP funds, despite being covered by the forgiven loan, are generally deductible and are reported as ordinary business expenses on page 1 of Form 1120-S. These expenses should not reduce the Accumulated Adjustments Account (AAA) but rather reduce the Other Adjustments Account (OAA) for S corporations.
To reconcile book income with tax income, adjustments are made on Schedule M-1 (Reconciliation of Income (Loss) per Books With Income (Loss) per Return) and Schedule M-2 (Analysis of Accumulated Adjustments Account, Other Adjustments Account, and Shareholder’s Undistributed Taxable Income Previously Taxed). The tax-exempt PPP loan forgiveness amount is typically added back on Schedule M-1, Line 5, as income on books not on Schedule K. On Schedule M-2, the forgiven PPP loan amount is reported on Line 3, column (d) for Other Additions. Expenses paid with forgiven PPP proceeds are reported on Line 5, column (d) of Schedule M-2, as a reduction. An S corporation must also attach a statement to its return, as required by Revenue Procedure 2021-48, providing details such as the company’s name, address, EIN, the amount of tax-exempt income, and confirmation of whether forgiveness has been granted.
State Tax Implications and Other Considerations
The state tax treatment of forgiven PPP loans and related expenses varies significantly across jurisdictions. While the federal government clarified the exclusion of forgiveness from income and the deductibility of expenses, states have adopted different approaches. Some states conform to the federal treatment, excluding the forgiven amount from income and allowing the deduction of associated expenses.
Other states may treat the forgiven loan amount as taxable income, or they might exclude the income but disallow the deduction for expenses paid with the forgiven funds. Businesses should consult their state’s specific tax laws and guidance to ensure compliance. Maintaining detailed records related to the PPP loan, the forgiveness application, and all expenditures funded by the loan supports the reported tax treatment and is important for potential audits or inquiries.