Not sure this solution works. The expenses related to PPP forgiveness are tax deductible. Unlike usual, while these are deductible they are also expenses related to tax-exempt income (see IRS guidance below) so they offset the tax-exempt PPP income in OAA on M-2. If the expenses are tax deductible they should not be a permanent difference unless there is an offset on the M-1, correct? To compensate for this, I did the following instead of step 5 described in the solution:
1. added another line on M-2 worksheet additions for "Expenses from forgiven PPP" and overrode the amount to put it in the AAA column instead of OAA
2. Also put the expenses on the M-1 worksheet on the "Other expenses related to tax-exempt income line"
This way the expenses are appropriately reported as deductible and as a reduction of OAA rather than AAA. IRS guidance follows:
Per the M-2 instructions in the 2021 IRS 1120-S instructions, "If column (a) on line 2 or line 4 of the
Schedule M-2 includes expenses paid with proceeds from forgiven PPP loans, an
S corporation should report that amount in column (a) on line 3 and in column (d) on line 5 of the Schedule M-2. " This same guidance applies to prior year expenses included in M-2, column (a), line 1.
