PPP Forgiveness and Basis

As discussed in our December 22, 2020 post, the Consolidated Appropriations Act of 2021 clarified that expenses paid with funds from the Paycheck Protection Program (PPP) are fully deductible, even though the loans were or will be forgiven.  The law also clarifies that the adjusted basis of owners of entities with PPP loans will be increased by the tax-free income resulting from the forgiveness of PPP loans.  Such entities include S corporations, partnerships and limited liability companies (LLCs) that are taxed as partnerships.

Many entities did not receive forgiveness of their PPP loans as of the end of their 2020 tax year.  The timing of the increase in the adjusted basis of the owner due to the forgiveness of the PPP loan can be important.  Some entity owners may have a zero or low adjusted basis.  If the entity reports a loss, the increase in basis from the PPP loan forgiveness will result in the owner being able to deduct losses that would otherwise be suspended due to the adjusted basis limit and carried forward to the next tax year.  (If an entity reports income or if its owners already have sufficient basis to deduct a loss, the timing issue of the PPP loan forgiveness will have no tax effect for its owners.)

The IRS has not yet issued guidance on the timing of the increase in the adjusted basis due to the forgiveness of PPP loans.  (The IRS has rescinded prior guidance that it had issued before the Consolidated Appropriations Act of 2021 was enacted.) 

Unless/until new guidance is issued, it appears that PPP loans need to be reported in a way that matches their legal form.  If the PPP loan has not yet been forgiven as of the end of an entity’s tax year, then the legal form of the PPP remains a liability, which the entity would report as such.  In this case, the tax-free income from the forgiveness of the PPP loan would not occur until the subsequent tax year.  Therefore, it appears that the resulting increase in the adjusted basis of the owner(s) would also not occur until the subsequent tax year.

Unless/until new guidance is issued, to the extent that a taxpayer wishes to make an argument that the tax-free income should increase the owner(s) adjusted basis prior to the year in which the forgiveness occurs, practitioners should be aware that the IRS could challenge such a position.