Your suggested approach would be fine if I were filing as an S Corp rather than as a Sole Proprietor.
Or, if your sole proprietorship had other W-2 employees. Since the PPP money was specifically designated for paying employees, I'm a bit perplexed about it being forgiven. To the best of my knowledge, the loan is only forgiven if used to pay employee wages with. But that aside:
Borrowed money where payback of the loan is forgiven is "usually" reported to the borrower on IRS Form 1099-C - Cancellation of Debt form. Then the forgiven amount becomes taxable (or at least reportable) income to the person or entity that payback of the borrowed money is no longer required from.
As for the PPP, while I did see and am well aware of the "forgiveness of debt" rules, I have never seen nor even heard rumor about any "forgiveness of taxes" on that PPP money that does not have to be paid back. This is true to the best of my knowledge not just at the federal level, but at the state level too for all states that tax personal income.
So if this is a state tax issue for you on state taxes, you might want to actually call the HI dept of Taxation at 1-800-222-3229 to get clarification. If you're on maui it's 808-984-8500. For molokai it's 808-553-5541. Kauai is 808-274-3456 and the big island is 808-974-6321.
But again, as I've not seen anything, anywhere that states the forgiven PPP debt is tax free at the federal or state level, I fully expect the forgiven amount to be reportable and taxable by both, with taxability offset only by those business expenses that are deductible from the business income.
