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Frequently Asked Questions (FAQs) for Form 1120 Schedule M-3

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NOTE:  The following table may be searched using "Key Words" in the Edit/Find function.

General Instructions

  • Purpose of Schedule

Q-012. Does Treasury and IRS intend to update Schedule M-3 annually?

A. There is no specific timeframe for updating Schedule M-3. Schedule M-3 will be updated as necessary to ensure that Schedule M-3 obtains information on emerging issues and evolving business trends. There is no intention to materially change the schedule each year as this would cause burden on the taxpayers and the tax software developers.

Schedule M-3 Update for 2013 
Subject always to a possible need to reflect changes in law, there are no planned changes to Schedule M-3 forms for tax year 2013.

Q-028. What is the future of the M-3 with respect to reporting of deferred income taxes and the provisions of FAS 109?

A. Schedule M-3 will be updated as necessary to ensure that the schedule elicits information on emerging issues, evolving tax and business trends and book-tax differences caused by new or changed FASB accounting rules and/or tax law.

  • Who Must File

Q-001. When is Schedule M-3 effective?

A. Schedule M-3 is effective for taxable years ending on or after December 31, 2004.

Q-002. Who is required to file Schedule M-3?

A. Any corporation (or U.S. consolidated tax group) required to file Form 1120, U.S. Corporation Income Tax Return, that reports on Schedule L of Form 1120 total assets at the end of the corporation’s (or U.S. consolidated tax group’s) taxable year that equal or exceed $10 million. (This is the same criterion used to determine whether a corporation is within the jurisdiction of the IRS’ Large and Mid-Size Business Division (LB&I)).

Q-008. If a corporation was required to complete Schedule M-3 in the preceding taxable year and the corporation reports on Schedule L of Form 1120 total assets at the end of the current taxable year of less than $10 million, is the corporation required to file Schedule M-3 for the current taxable year?

A. No. The corporation may either (i) continue to complete Schedule M-3; or (ii) file Schedule M-1. However, if the corporation chooses to file Schedule M-1 and, in a subsequent taxable year, the corporation is required to complete Schedule M-3, the corporation will be required to complete Schedule M-3 in its entirety in that subsequent taxable year (including Columns (a) and (d) of Parts II and III). Treasury and IRS currently are evaluating whether a corporation should be required to continue to file Schedule M-3 once it has filed Schedule M-3 for the first time.

Q-009. If a corporation prepares financial statements on an accrual basis and the corporation uses an overall cash method of accounting for federal income tax purposes, must the corporation's total assets at the end of the corporation's taxable year be determined on an accrual basis or on a cash basis for purposes of determining whether the corporation has total assets at the end of the current taxable year of $10 million or more?

A. The corporation's total assets must be determined on an accrual basis, i.e., the same basis as the corporation's financial statements, for purposes of determining whether the corporation has total assets at the end of the current taxable year of $10 million or more.

Q-010. Is an insurance company that files Form 1120PC or Form 1120L required to complete Schedule M-3?

A. Schedule M-3 is not required for any member of a U.S. consolidated tax group if the parent company of the U.S. consolidated tax group is an insurer that files Form 1120PC (U.S. Property and Casualty Insurance Company) or Form 1120L (U.S. Life Insurance Company Income Tax Return), regardless of whether any members of the group file Form 1120. If the parent company of a U.S. consolidated tax group files Form 1120, all members of the group must file Schedule M-3. However, if any member of that group files Form 1120PC or Form 1120L, that member may either (i) fully complete Schedule M-3 as if the member filed Form 1120; or (ii) complete Schedule M-3 by including the sum of all differences between the member's net income (or loss) per the income statement and taxable income ("differences") (regardless of whether the difference would otherwise be reported elsewhere on Part II or on Part III) on Part II, Line 26, Other income (loss) items with differences, and separately state and adequately disclose each difference in a supporting schedule. Any member of the U.S. consolidated tax group that files Form 1120PC or Form 1120L and is required to file Schedule M-3 (in accordance with the preceding sentence) may classify all differences as permanent in Column C or identify differences as temporary or permanent, as appropriate.

Q-037. May a corporation that attaches Schedule M-3 to its Form 1120 also complete Schedule M-1?

A. No. The Schedule M-3 instructions provide that a "corporation filing Schedule M-3 must not file Schedule M-1". This applies regardless of whether the taxpayer is required to file Schedule M-3 or is voluntarily filing Schedule M-3. It should be noted that if Schedule M-1 is completed when Schedule M-3 is attached, it could lead to inconsistencies that may raise the perceived level of compliance risk contained in the return, especially when returns are electronically filed.

Q-065. If an LLC elects to be treated as a partnership for U.S. federal income tax purposes, is it required to file Schedule M-3 for its December 31, 2004 year end? 

A. For purposes of Schedule M-3, references to the classification of an entity are references to the treatment of the entity for U.S. federal income tax purposes. Schedule M-3 is not required for any taxpayer other than those identified in the 2004 Schedule M-3 Instructions. For example, taxpayers required to file Form 1065, U.S. Return of Partnership Income are not required to file Schedule M-3 with the 2004 tax return.

  • Other Form 1120 Schedules Affected by Schedule M-3 Requirements
  • Schedule L

Q-061. A calendar year-end corporation prepares accrual basis financial statements under GAAP. However, they have reported on their 2003 Form 1120, Schedule L the tax-basis balance sheet amounts of the corporation. The corporation is required to file Schedule M-3 with their 2004 Form 1120 and, according to the instructions for Schedule M-3, must report on Schedule L, line 15, column (d), the total assets of the corporation as reported in the financial statements. Should this corporation restate the 2004 beginning balance sheet amounts reported on Schedule L or have a reconciling item in Schedule M-2?

A. The corporation should not restate the 2004 beginning balance sheet amounts. Any difference between beginning tax basis retained earnings and beginning GAAP basis retained earnings as reported on their financial statements should be reported on Schedule M-2 as a reconciling item and an explanation provided.

Q-062. A calendar year-end corporation prepares accrual basis financial statements under GAAP. However, the total assets reported on their 2003 Form 1120, Schedule L do not equal the total assets reported for financial statement purposes. The corporation is required to file Schedule M-3 with their 2004 Form 1120 and, according to the instructions for Schedule M-3, show on Schedule L, line 15, column (d), the total assets of the corporation as reported in the financial statements. Should this corporation restate the 2004 beginning balance sheet amounts reported on Schedule L?

A. The corporation should not restate the 2004 beginning balance sheet amounts. However, if for any reason there is a difference between the beginning retained earnings as reported and beginning GAAP basis retained earnings as reported on their financial statements, a reconciling amount should be reported on Schedule M-2 and an explanation provided.

Q-068. A U.S. consolidated tax group required to file Schedule M-3 includes both non-insurance companies and insurance companies. On what basis is the consolidated Form 1120, Schedule L to be presented? Should Schedule L tie to the consolidated balance sheet in Form 10-K, which is entirely GAAP basis or should the consolidated Schedule L be presented on a combination GAAP/STAT basis for the non-insurance and insurance companies?

A. The U.S. consolidated tax group may choose to report the Schedule L on either a GAAP basis or a GAAP/STAT basis. However, Schedule M-3, Part I, line 11, should reflect statutory basis income (loss) with respect to insurance companies included in the consolidated tax group. The amount reported on Schedule M-3, Part I, line 11, must also be reported on Schedule M-2, line 2, Net income (loss) per books. In addition, the Unappropriated Retained Earnings balance per Schedule M-2 must be the amount reported on Schedule L. Therefore, if Schedule L is presented on a GAAP basis rather than a GAAP/STAT basis, some adjustment will likely be needed in Schedule M-2 in order for (a) the amount of net income reported on Schedule M-2, line 2 to equal the amount on Part I, line 11 on Schedule M-3, and (b) the amount of Unappropriated Retained Earnings to agree both in Schedule M-2 and in Schedule L.

  • Schedule M-2
  • Consolidated Return (Form 1120, Page 1)
  • Entity considerations for Schedule M-3
  • Consolidated Schedule M-3 vs. Consolidating Schedule M-3

Q-005. Is each member of a U.S. consolidated tax group required to file its own Schedule M-3?

A. Part I of Schedule M-3 must be completed once to report the consolidated information and activity for the entire U.S. consolidated tax group. However, Parts II and III of Schedule M-3 must be completed separately by each member of the U.S. consolidated tax group to reflect each member's own activity. The parent company must complete all parts of Schedule M-3 by including: (i) the consolidated information for the U.S. consolidated tax group in Part I; and (ii) its own separate (i.e., non-consolidated) company information in Parts II and III. Each subsidiary corporation in the U.S. consolidated tax group must complete Parts II and III on its own separate Schedule M-3 to reflect its own activity. Additionally, Parts II and III must be completed on a consolidating Schedule M-3 in order to consolidate all the Schedule M-3 information of the entire U.S. consolidated tax group. For example, if a U.S consolidated tax group consists of a parent and three subsidiaries, it is anticipated that six Schedule M-3s must be completed and attached to the tax return of the group as follows:

Parts I, II, and III of a Schedule M-3 by the parent reflecting Part I information for the entire consolidated group and its own activity in Parts II and III; Parts II and III of Schedule M-3 by each of the three subsidiaries reflecting their respective activity; Parts II and III of a consolidating Schedule M-3 to account for items such as differences between financial statement net income and taxable income related to intercompany transactions and adjustments made at the consolidated group level that are not attributable to any specific member of the U.S. consolidated tax group (e.g., disallowance of net capital losses, contribution deduction carryovers, and limitation of contribution deductions); and One consolidated Schedule M-3 with Parts I, II, and III resulting from consolidating those Schedule M-3s described above.

Q-036. Expense XYZ exists in the books and records of both Subsidiary A and Subsidiary B. Both subsidiaries are in a consolidated return. XYZ expense is not an item listed specifically on Schedule M-3. Subsidiary A has a book-tax difference (BTD) in regard to its XYZ expense but Subsidiary B's book and tax amount for XYZ expense is the same. Do both subsidiaries have to report this item on Part III, line 35 Other expense/deduction items with differences, because one of them has a BTD, or would A report the item on Part III line 35 while B would report the item on Part II, line 29 Other income(loss) and expense/deduction items with no differences?

A. The characterization of an item is determined at the entity level. Therefore, in the above example Subsidiary A would report the item on Part III line 35 Other expense/deduction items with differences while B includes the item on Part II, line 29 Other income (loss) and expense/deduction items with no differences.

Q-038. If all required line item detailed schedules for Part II and Part III of Schedule M-3 are attached for each separate entity included in the Consolidated Part II and Part III, including those for the parent company and the eliminations entity, is it also required that the same supporting detailed information be presented on a separate consolidated supporting schedule for Part II and Part III of the consolidated Schedule M-3?

A. No. Provided that all line item detailed information required by Schedule M-3 and the instructions for Schedule M-3 is included on the attached schedules for Part II and Part III for each separate entity’s Schedule M-3, including that of the parent company and the eliminations entity, then a separate consolidated (roll-up) schedule for the Consolidated Schedule M-3 is not necessary.

Q-048. When filing a consolidated return, is a separate Schedule M-3 required for each entity including the parent and consolidation eliminations entity, or can a spreadsheet be attached to the consolidated Schedule M-3 that details the separate Schedule M-3 amounts of all entities? 

A. A separate Schedule M-3 must be completed for each includible corporation, including the parent corporation and consolidating eliminations entity.

Q-069. Q-036 on the FAQ website requires that the characterization of an item is determined at the entity level. However, the software used by some taxpayers to prepare the federal income tax return requires (1) a common chart of accounts for the general ledger (i.e., chart of accounts) for all subsidiaries and (2) for purposes of Schedule M-3, each profit and loss general ledger account must be commonly mapped to a line item on the Schedule M-3. How can the characterization then be determined at the entity level?

A. Q-036 clearly states the rule for the characterization of an item. The 2005 Schedule M-3 draft Instructions clarify this rule. Some or all of the software vendor groups are aware of this requirement and are changing their software products to accommodate this rule. Taxpayers should work with their vendors and software user groups to make sure the software they are using conforms to the requirements for completing the Schedule M-3.

  • Completion of Schedule M-3

Q-024. Are there penalties for not filing a complete and accurate Schedule M3? 

A. There are currently no penalties specific to the Schedule M-3. However, all penalties applicable to Form 1120 are applicable to Schedule M-3 which is filed as part of Form 1120.

Specific Instructions for Part I

  • Part I. Financial Information and Net Income (Loss) Reconciliation
  • When to Complete Part I
  • Line 1. Questions Regarding the Type of Income Statement Prepared

Q-016. If the parent company of a U.S. consolidated tax group is not a publicly traded company but prepares financial statements for the U.S. consolidated tax group, and a member of the U.S. consolidated tax group is a publicly traded company that prepares its own separate financial statements, what are the appropriate financial statements for purposes of completing Part I?

A. The financial statements of the parent company of the U.S. consolidated tax group are the appropriate financial statements for purposes of completing Part I.

Q-022. If a consolidated financial statement group, parented by a US corporation, does not elect to file a US consolidated income tax return, from which balance sheet is the Schedule M-3 $10 million total asset requirement threshold tested: (a) the consolidated financial statement, (b) the separate financial statement of each of the corporations included in the consolidated financial statement, or (c) the Schedule L of each separately filed US income tax return for the corporations included in the consolidated financial statement group? A. (c). Therefore, if US parent A owns US subsidiary B; A and B file separate US income tax returns; the AB accrual basis financial statements report total assets of $12 million after intercompany eliminations; A's accrual basis Schedule L reports total assets of $7 million; and B's accrual basis Schedule L reports total assets of $6 million, then Schedule M-3 is not required for either A's separate US income tax return or B's separate US income tax return. This answer assumes that the Schedule L of both A and B are prepared in accordance with the Schedule M-3 Instructions pertaining to Schedule L that are found on page 2 of the instructions, at the bottom of column 1. It is also important to recognize and employ other pertinent "Who Must File" requirements of the Schedule M-3 Instructions.

Q-023. Assume the following. Non-US parent A owns US company B and US group CD (C owns all of D). A prepares a consolidated worldwide financial statement for the ABCD group under US GAAP in order to meet US bank lending restrictions, and the consolidated total assets reflected there is $25 million. A is not required to file a US income tax return. B files a separate US income tax return, and its Schedule L reports total assets on an accrual basis in the amount of $12 million. The CD group files a consolidated US income tax return and, after eliminating intercompany transactions between C and D, the CD Schedule L reports total assets on an accrual basis in the amount of $8 million. Which balance sheet(s) are used to make the Schedule M-3 $10 million total asset requirement test: (a) the ABCD worldwide consolidated financial statement, (b) the separate financial statement of each of the corporations included in the ABCD worldwide consolidated financial statement, or (c) the Schedule L (on an accrual basis) of each of the US income tax returns respectively for B and the CD consolidated US income tax return group?

A. (c). Therefore B is required to file Schedule M-3 (Schedule L total assets on an accrual basis of $12 million), but the CD group is not (Schedule L total assets on an accrual basis of only $8 million). This answer assumes that the Schedule L of both B and CD are prepared in accordance with the Schedule M-3 Instructions pertaining to Schedule L that are found on page 2 of the instructions, at the bottom of column 1. It is also important to recognize and employ other pertinent "Who Must File" requirements of the Schedule M-3 Instructions.

Q-026. How should Schedule M-3, Part I, line 1 be answered if the foreign parent company files a 10K with the SEC, but the US subsidiary company or US consolidated tax group has no financial statements because financial information reported to the foreign parent company is not the equivalent of a recognizable financial statement? 

A. See the Instructions for Schedule M-3, Part I, Line 1 at page 3, column 2. Answers to Part I, line 1 should refer only to the corporation or the consolidated US income tax return group that files the return. The instructions are very clear about how to answer Part I, line 1 of Schedule M-3. If there is not a financial statement for the corporation filing the return, or for the US consolidated group filing the return, then the "No" box at Line 1c should be checked and the amount entered at Part I, line 11 should be the net income from the books and records of the corporation or US consolidated group filing the return.

Q-071. The draft instructions for the 2005 version of Schedule M-3 have been made public. May taxpayers use those draft instructions in completing a 2004 Schedule M-3?

A: Taxpayers may use the draft instructions for the 2005 version of Schedule M-3 in completing a 2004 Schedule M-3 for the following items only:

  • Part I, line 1, Questions Regarding the Type of Income Statement Prepared – The draft 2005 Instructions state that if the corporation does not prepare financial statements, check Part I, line 1c “No” and report the net income (loss) per the books and records of the U.S. corporation or the U.S. consolidated tax group on Part I, line 4, Worldwide consolidated net income (loss) from income statement source identified in Part I, line 1. Instructions for 2004 Schedule M-3 required that such amount be reported on Part I, line 11. If the corporation does not prepare financial statements, the taxpayer may choose to report the net income (loss) per the books and records according to either the 2004 Instructions or the draft 2005 Instructions in completing the 2004 Schedule M-3.

  • Part I, line 2, Question regarding income statement period and restatements – The draft 2005 Instructions clarify the information required to be included on the statement for Part I, line 2. The requirements in either the 2004 Instructions or the draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part I, line 8, Adjustments to Eliminations of Transactions Between Includible Corporations and Nonincludible Entities – The 2005 Instructions clarify the reporting of adjustments to consolidation and eliminations entries that are contained on Part I, line 4, required as a result of removing amounts on Part I, lines 5 or 6, and amounts of any additional consolidation and elimination entries that are required either as a result of including amounts on Part I, line 7, or to otherwise arrive at the correct amount required to be reported on Part I, line 11. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part I, line 10, Other Adjustments Required To Reconcile to Amount on Line 11 - The draft 2005 Instructions clarify that intercompany dividends received by includible insurance companies, to the extent required by law to be included in statutory accounting net income, should be included on Part I, line 10. In addition, the information required to be included on the schedule required to be attached for amounts on this line has been changed. The taxpayer may choose to configure the attached schedule as described in the 2004 Instructions or the draft 2005 Instructions in completing the 2004 Schedule M-3.

  • Completion of Schedule M-3, Part II and Part III – The 2004 Instructions were not clear as to whether the required line item detail for Part II and Part III of Schedule M-3 had to be attached only for the Consolidated Part II and Part III, only for each separate entity included in the Consolidated Part II and Part III, or both. The draft 2005 Instructions clarify that all required line item detailed schedules for Part II and Part III of Schedule M-3 must be attached for each separate entity included in the Consolidated Part II and Part III, and do not require that the same supporting detailed information be presented on the Consolidated Part II and Part III. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part II, line 20 Unearned/Deferred Revenue – The draft 2005 Instructions clarify what amounts are to be included on Part II, line 20. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part III, line 18, Deferred Compensation - The draft 2005 Instructions clarify what amounts are to be included on Part III, line 18. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Line 2. Questions Regarding Income Statement Period and Restatements

Q-030. Is any explanation required for restatement of the corporation's income statement for any year if such restatement involves only movement between categories of income/expense if total bottom-line income has not been restated from that originally reported? 

A. Yes. The instructions do not limit the restatements that must be disclosed on M-3 to only those restatements that modify net income.

Q-056. Assume the following: Corporation A has a fiscal year end of June 30 and files with SEC. Their financial statements for year ended 6/30/05 reflect that the 6/30/04 balance sheet has been restated, and the related statements of income, stockholders’ equity, comprehensive income, and cash flows for each of the 2-years ended 6/30/04 have also been restated. Corporation A will be required to file Schedule M-3 with its tax year ending 6/30/05 and 6/30/06. Since the restatement is reported with their 6/30/05 financial statements, would Corporation A need to report these restatements on Schedule M-3, Part I, line 2c filed with their 6/30/06 Form 1120?

A. Yes. Part I, line 2c asks “Has the corporation’s income statement been restated for any of the five income statement periods preceding the period on line 2a?” Given the above facts, Corporation A’s restatement of income was for a financial period within the five year period ending 6/30/06. Therefore, Corporation A would answer “yes” on Part I, line 2c and attach an explanation and the amount of each item restated. Note: The restatements would also be reported on Corporation A’s Schedule M-3 attached to their 6/30/05 Form 1120.

Q-057. Are we required to report on Part I, line 2 restatements of the corporation's income statement if the restatement is only between quarters of the same year and not a restatement of the annual 10-K?

A. Only restatements of the corporation’s year-end net income statements, or annual 10-K filing, if applicable, are required to be reported on Part I, line 2.

Q-071. The draft instructions for the 2005 version of Schedule M-3 have been made public. May taxpayers use those draft instructions in completing a 2004 Schedule M-3?

A. Taxpayers may use the draft instructions for the 2005 version of Schedule M-3 in completing a 2004 Schedule M-3 for the following items only:

  • Part I, line 1, Questions Regarding the Type of Income Statement Prepared – The draft 2005 Instructions state that if the corporation does not prepare financial statements, check Part I, line 1c “No” and report the net income (loss) per the books and records of the U.S. corporation or the U.S. consolidated tax group on Part I, line 4, Worldwide consolidated net income (loss) from income statement source identified in Part I, line 1. Instructions for 2004 Schedule M-3 required that such amount be reported on Part I, line 11. If the corporation does not prepare financial statements, the taxpayer may choose to report the net income (loss) per the books and records according to either the 2004 Instructions or the draft 2005 Instructions in completing the 2004 Schedule M-3.

  • Part I, line 2, Question regarding income statement period and restatements – The draft 2005 Instructions clarify the information required to be included on the statement for Part I, line 2. The requirements in either the 2004 Instructions or the draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part I, line 8, Adjustments to Eliminations of Transactions Between Includible Corporations and Nonincludible Entities – The 2005 Instructions clarify the reporting of adjustments to consolidation and eliminations entries that are contained on Part I, line 4, required as a result of removing amounts on Part I, lines 5 or 6, and amounts of any additional consolidation and elimination entries that are required either as a result of including amounts on Part I, line 7, or to otherwise arrive at the correct amount required to be reported on Part I, line 11. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part I, line 10, Other Adjustments Required To Reconcile to Amount on Line 11 - The draft 2005 Instructions clarify that intercompany dividends received by includible insurance companies, to the extent required by law to be included in statutory accounting net income, should be included on Part I, line 10. In addition, the information required to be included on the schedule required to be attached for amounts on this line has been changed. The taxpayer may choose to configure the attached schedule as described in the 2004 Instructions or the draft 2005 Instructions in completing the 2004 Schedule M-3.

  • Completion of Schedule M-3, Part II and Part III – The 2004 Instructions were not clear as to whether the required line item detail for Part II and Part III of Schedule M-3 had to be attached only for the Consolidated Part II and Part III, only for each separate entity included in the Consolidated Part II and Part III, or both. The draft 2005 Instructions clarify that all required line item detailed schedules for Part II and Part III of Schedule M-3 must be attached for each separate entity included in the Consolidated Part II and Part III, and do not require that the same supporting detailed information be presented on the Consolidated Part II and Part III. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part II, line 20 Unearned/Deferred Revenue – The draft 2005 Instructions clarify what amounts are to be included on Part II, line 20. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part III, line 18, Deferred Compensation - The draft 2005 Instructions clarify what amounts are to be included on Part III, line 18. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Line 3. Questions Regarding Publicly Traded Voting Common Stock
  • Line 4. Worldwide Consolidated Net Income (Loss) per Income Statement

Q-016. If the parent company of a U.S. consolidated tax group is not a publicly traded company but prepares financial statements for the U.S. consolidated tax group, and a member of the U.S. consolidated tax group is a publicly traded company that prepares its own separate financial statements, what are the appropriate financial statements for purposes of completing Part I?

A. The financial statements of the parent company of the U.S. consolidated tax group are the appropriate financial statements for purposes of completing Part I.

Q-063. The amounts reported on SEC filings and Audited Financial Statements are usually rounded to the nearest 1000’s. Should a corporation report on Schedule M-3, Part I, line 4, the rounded amount reported on these filings and plug the difference to arrive at actual amounts on Part I, line 10 or should they report the actual amount on Part I, line 4?

A. The corporation may report either the actual amount on Part I, line 4, or report the rounded amount on Part I, line 4, with an adjustment to the actual amount on Part I, line 10, and the attached schedule indicating that amount. For example, if Corporation X reports on its Form 10-K net income of $10,000,000, but the actual amount is 10,000,453, X may report on Part I, line 4, either $10,000,453 or $10,000,000. However, if X reports on Part I, line 4, $10,000,000 then X must report on Part I, line 10, $453 to adjust the rounded amount reported on Part I, line 4, to the actual amount of X’s net income.

Note: Part I, line 11 and all of Parts II and III must be stated in whole dollars.

  • Line 5. Net Income (Loss) of Nonincludible Foreign Entities

Q-042. Are the amounts reported on Part I, line 5a or line 5b with respect to nonincludible foreign entities required to equal the amounts reported on Form 5471 Schedule C, line 21, Current year net income or (loss) per books for each corresponding entity?

A. There is no requirement that these amounts be the same. However, taxpayers should be prepared to provide a reconciliation of differences if the issue arises during an examination.

  • Line 6. Net Income (Loss) of nonincludible U.S. Entities
  • Line7. Net Income (Loss) of Other Includible Corporations
  • Line 8. Adjustments to Eliminations of Transactions Between Includible Corporations and Nonincludible Entities

Q-071. The draft instructions for the 2005 version of Schedule M-3 have been made public. May taxpayers use those draft instructions in completing a 2004 Schedule M-3?

 A: Taxpayers may use the draft instructions for the 2005 version of Schedule M-3 in completing a 2004 Schedule M-3 for the following items only:

  • Part I, line 1, Questions Regarding the Type of Income Statement Prepared – The draft 2005 Instructions state that if the corporation does not prepare financial statements, check Part I, line 1c “No” and report the net income (loss) per the books and records of the U.S. corporation or the U.S. consolidated tax group on Part I, line 4, Worldwide consolidated net income (loss) from income statement source identified in Part I, line 1. Instructions for 2004 Schedule M-3 required that such amount be reported on Part I, line 11. If the corporation does not prepare financial statements, the taxpayer may choose to report the net income (loss) per the books and records according to either the 2004 Instructions or the draft 2005 Instructions in completing the 2004 Schedule M-3.

  • Part I, line 2, Question regarding income statement period and restatements – The draft 2005 Instructions clarify the information required to be included on the statement for Part I, line 2. The requirements in either the 2004 Instructions or the draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part I, line 8, Adjustments to Eliminations of Transactions Between Includible Corporations and Nonincludible Entities – The 2005 Instructions clarify the reporting of adjustments to consolidation and eliminations entries that are contained on Part I, line 4, required as a result of removing amounts on Part I, lines 5 or 6, and amounts of any additional consolidation and elimination entries that are required either as a result of including amounts on Part I, line 7, or to otherwise arrive at the correct amount required to be reported on Part I, line 11. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part I, line 10, Other Adjustments Required To Reconcile to Amount on Line 11 - The draft 2005 Instructions clarify that intercompany dividends received by includible insurance companies, to the extent required by law to be included in statutory accounting net income, should be included on Part I, line 10. In addition, the information required to be included on the schedule required to be attached for amounts on this line has been changed. The taxpayer may choose to configure the attached schedule as described in the 2004 Instructions or the draft 2005 Instructions in completing the 2004 Schedule M-3.

  • Completion of Schedule M-3, Part II and Part III – The 2004 Instructions were not clear as to whether the required line item detail for Part II and Part III of Schedule M-3 had to be attached only for the Consolidated Part II and Part III, only for each separate entity included in the Consolidated Part II and Part III, or both. The draft 2005 Instructions clarify that all required line item detailed schedules for Part II and Part III of Schedule M-3 must be attached for each separate entity included in the Consolidated Part II and Part III, and do not require that the same supporting detailed information be presented on the Consolidated Part II and Part III. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part II, line 20 Unearned/Deferred Revenue – The draft 2005 Instructions clarify what amounts are to be included on Part II, line 20. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part III, line 18, Deferred Compensation - The draft 2005 Instructions clarify what amounts are to be included on Part III, line 18. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Line 9. Adjustment to Reconcile Income Statement Period to Tax Year
  • Line 10. Other Adjustments Required to Reconcile to Amount on Line 11

Q-049. A consolidated tax group required to file Schedule M-3 includes both non-insurance companies and insurance companies. In order to arrive at Part I, line 11, Net Income (loss) per income statement of includible corporations, adjustments for the insurance companies income(loss) from the GAAP financial statements indicated in Part I to statutory-basis income(loss) are reported on Part I, line 10, Other adjustments to reconcile to amount on line 11. Is it sufficient to report the net differences between GAAP income and statutory income by entity on the attached schedule or is each component of the differences required to be reported? 

A. It is sufficient to report by entity the entity name and EIN, GAAP income, statutory income, and the net difference between GAAP income and statutory income on the attached schedule for line 10 of Part I.

Q-060. Normally, in a consolidated return, all intercompany dividends will have been eliminated in financial accounting consolidation eliminations included on Schedule M-3, Part I, line 4. However, insurance companies included in a consolidated Form 1120 may be required to include these dividends on Schedule M-3, Part I, line 11, so that the amount reported there agrees with statutory net income as reported on insurance companies’ Annual Statements. How are these intercompany dividends to be reported on Schedule M-3 for Form 1120?

A. All corporations included in the consolidated U.S. federal income tax return, including insurance companies, should report on Part I, line 8, the reversal of eliminations of intercompany dividends received from nonincludible corporations included on Part I, line 4. In addition, insurance companies included in the consolidated U.S. federal income tax return, should include on Part I, line 10, the adjustments necessary such that Part I, line 11 includes intercompany dividends from any includible corporation to the extent required by statutory accounting principles. Insurance companies fully completing Parts II an III (see instructions for alternative reporting), should include such intercompany dividends on Part II, line 7, column (a), U.S. dividends not eliminated in tax consolidation and include the amount of those dividends in column (d) that is includible in taxable income before the special dividends received deduction. Insurance companies completing Schedule M-3 by including the sum of all differences between the member’s financial statement net income (loss) and its taxable income (loss) on Part II, line 26, Other income (loss) items with differences, should include such intercompany dividends on Part II, line 26, column (a), and the amount of those dividends that is includible in taxable income before the special dividends received deduction in column (d).

Q-063. The amounts reported on SEC filings and Audited Financial Statements are usually rounded to the nearest 1000’s. Should a corporation report on Schedule M-3, Part I, line 4, the rounded amount reported on these filings and plug the difference to arrive at actual amounts on Part I, line 10 or should they report the actual amount on Part I, line 4?

A. The corporation may report either the actual amount on Part I, line 4, or report the rounded amount on Part I, line 4, with an adjustment to the actual amount on Part I, line 10, and the attached schedule indicating that amount. For example, if Corporation X reports on its Form 10-K net income of $10,000,000, but the actual amount is 10,000,453, X may report on Part I, line 4, either $10,000,453 or $10,000,000. However, if X reports on Part I, line 4, $10,000,000 then X must report on Part I, line 10, $453 to adjust the rounded amount reported on Part I, line 4, to the actual amount of X’s net income.

Q-071. The draft instructions for the 2005 version of Schedule M-3 have been made public. May taxpayers use those draft instructions in completing a 2004 Schedule M-3?

A. Taxpayers may use the draft instructions for the 2005 version of Schedule M-3 in completing a 2004 Schedule M-3 for the following items only:

  • Part I, line 1, Questions Regarding the Type of Income Statement Prepared – The draft 2005 Instructions state that if the corporation does not prepare financial statements, check Part I, line 1c “No” and report the net income (loss) per the books and records of the U.S. corporation or the U.S. consolidated tax group on Part I, line 4, Worldwide consolidated net income (loss) from income statement source identified in Part I, line 1. Instructions for 2004 Schedule M-3 required that such amount be reported on Part I, line 11. If the corporation does not prepare financial statements, the taxpayer may choose to report the net income (loss) per the books and records according to either the 2004 Instructions or the draft 2005 Instructions in completing the 2004 Schedule M-3.

  • Part I, line 2, Question regarding income statement period and restatements – The draft 2005 Instructions clarify the information required to be included on the statement for Part I, line 2. The requirements in either the 2004 Instructions or the draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part I, line 8, Adjustments to Eliminations of Transactions Between Includible Corporations and Nonincludible Entities – The 2005 Instructions clarify the reporting of adjustments to consolidation and eliminations entries that are contained on Part I, line 4, required as a result of removing amounts on Part I, lines 5 or 6, and amounts of any additional consolidation and elimination entries that are required either as a result of including amounts on Part I, line 7, or to otherwise arrive at the correct amount required to be reported on Part I, line 11. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part I, line 10, Other Adjustments Required To Reconcile to Amount on Line 11 - The draft 2005 Instructions clarify that intercompany dividends received by includible insurance companies, to the extent required by law to be included in statutory accounting net income, should be included on Part I, line 10. In addition, the information required to be included on the schedule required to be attached for amounts on this line has been changed. The taxpayer may choose to configure the attached schedule as described in the 2004 Instructions or the draft 2005 Instructions in completing the 2004 Schedule M-3.

  • Completion of Schedule M-3, Part II and Part III – The 2004 Instructions were not clear as to whether the required line item detail for Part II and Part III of Schedule M-3 had to be attached only for the Consolidated Part II and Part III, only for each separate entity included in the Consolidated Part II and Part III, or both. The draft 2005 Instructions clarify that all required line item detailed schedules for Part II and Part III of Schedule M-3 must be attached for each separate entity included in the Consolidated Part II and Part III, and do not require that the same supporting detailed information be presented on the Consolidated Part II and Part III. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part II, line 20 Unearned/Deferred Revenue – The draft 2005 Instructions clarify what amounts are to be included on Part II, line 20. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part III, line 18, Deferred Compensation - The draft 2005 Instructions clarify what amounts are to be included on Part III, line 18. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Line 11. Net Income (Loss) per Income Statement of Includible Corporations

Q-053. If a corporation has neither a 10-K nor financial statements and is required to use the Net Income (loss) per books and records in completing Part I of Schedule M-3, should the amount reported on Part I, line 11, Net Income (loss) per income statement of includible corporations, include adjustments to the books and records which were not recorded but should have been to reflect actual book income (e.g. intercompany dividends recorded directly to the parent's general ledger retained earnings account instead of an income account)?

A. Whether or not the corporation prepares financial statements, Part I, line 11, must include all items that impact the net income (loss) of the corporation even if the items are not recorded in the profit and loss accounts in the corporation's general ledger, including, for example, all post-closing adjusting entries (including workpaper adjustments) and dividend income or other income received from non-includible corporations that were recorded directly to the corporation's retained earnings account rather than an income account. For 2004, no schedule is required to be attached to the Schedule M-3 that reflects these adjustments. However, documentation should be available upon request.

Q-060. Normally, in a consolidated return, all intercompany dividends will have been eliminated in financial accounting consolidation eliminations included on Schedule M-3, Part I, line 4. However, insurance companies included in a consolidated Form 1120 may be required to include these dividends on Schedule M-3, Part I, line 11, so that the amount reported there agrees with statutory net income as reported on insurance companies’ Annual Statements. How are these intercompany dividends to be reported on Schedule M-3 for Form 1120?

A. All corporations included in the consolidated U.S. federal income tax return, including insurance companies, should report on Part I, line 8, the reversal of eliminations of intercompany dividends received from nonincludible corporations included on Part I, line 4. In addition, insurance companies included in the consolidated U.S. federal income tax return, should include on Part I, line 10, the adjustments necessary such that Part I, line 11 includes intercompany dividends from any includible corporation to the extent required by statutory accounting principles. Insurance companies fully completing Parts II an III (see instructions for alternative reporting), should include such intercompany dividends on Part II, line 7, column (a), U.S. dividends not eliminated in tax consolidation and include the amount of those dividends in column (d) that is includible in taxable income before the special dividends received deduction. Insurance companies completing Schedule M-3 by including the sum of all differences between the member’s financial statement net income (loss) and its taxable income (loss) on Part II, line 26, Other income (loss) items with differences, should include such intercompany dividends on Part II, line 26, column (a), and the amount of those dividends that is includible in taxable income before the special dividends received deduction in column (d).

Q-070. Example 4 in the 2004 Schedule M-3 Instructions indicates that a U.S. Corporation (“C”) owning a 60% interest in a U.S. LLC (“N”), which is treated as a fully-consolidated corporation for financial statement purposes but as a partnership for U.S. federal income tax purposes, would remove the net income of N on Part I, line 6 and also eliminate the corresponding minority interest on line 8. The example further states that N makes no distribution in the tax year. The example concludes that C would include no net income of N on Part I, line 11. If C has accounted for N on the equity method on its separate general ledger, would the equity earnings picked up on C’s separate general ledger and eliminated in the process of creating consolidated financial statements be reversed on Part I, line 8, so that the amount on Part I, line 11, includes the equity earnings from N and equals the amount included in the general ledger of C?

A. Yes. If a corporate owner of an interest in another entity (1) accounts for that other entity in the owner corporation’s separate general ledger on the equity method, and (2) fully consolidates the other entity in the owner corporation’s consolidated financial statements, but the other entity is not includible in the owner corporation’s consolidated U.S. federal income tax return, then, as part of reversing all consolidation and elimination entries for the nonincludible other entity, the corporate owner would reverse on Schedule M-3, Part I, line 8, the elimination of the equity income pickup from the other entity. If the owner corporation does not account for the other entity on the equity method on its own general ledger, it would not have eliminated the equity income for consolidated financial statement purposes, and therefore would have no elimination of equity income to reverse. Note that Example 4A and 4B in the 2005 draft Instructions are similar to Example 4 in the 2004 Instructions. The substance of this FAQ will be incorporated in the final 2005 Instructions for purposes of clarification.

  • Line 12. Total Assets and Liabilities

Q-081. What is the purpose of Schedule M-3 Part I lines 12a-12d (new in 2008) listing certain financial accounting total asset and total liability amounts ? 

A. The purpose of Schedule M-3 Part I lines 12a through 12d listing certain financial accounting total asset and total liability amounts is to provide two measures (in addition to financial accounting income) of the relative size of the entities with income removed or added on lines 5 through 7.

Q-082. Are Schedule M-3 Part I lines 12a-12d a reconciliation of assets and liabilities between the financial statement and Schedule L?

A. Schedule M-3 Part I lines 12a-12d are not a reconciliation of assets and liabilities between the financial statement and Schedule L because there is no elimination line. Granted, if Schedule L is properly prepared, the difference between line 12a minus line 12b minus line 12c plus line 12d and Schedule L will be the elimination line.

Specific Instructions for Parts II and III

  • General Format of Parts II and III
  • When to Complete Columns (a) and (d)

Q-003. Must a corporation complete all parts of Schedule M-3 for any taxable year the corporation is required to file Schedule M-3?

A. Yes. However, a corporation is required to complete only Part I and Columns (b) and (c) of Parts II and III for the corporation's transition year (the first taxable year the corporation is required to file Schedule M-3). Columns (a) and (d) of Parts II and III are optional for the corporation's transition year. The corporation must complete Schedule M-3 in its entirety for all other taxable years the corporation is required to file Schedule M-3.

Q-004. If a corporation chooses not to complete Columns (a) and (d) of Parts II and III in the corporation's transition year, how is Part II, Line 30, reconciled for the U.S. consolidated tax group in the transition year?

A. Part II, Line 30, for the U.S. consolidated tax group is reconciled in the following manner in the transition year: (i) the amount reported on Part I, Line 11, must be reported in Part II, Line 30, Column A; (ii) Part II, Lines 1 through 29, Columns A and D, must be left blank; (iii) Part III, Columns A and D, must be left blank; and (iv) Part II, Line 30, Column D, must equal the sum of Part II, Line 30, Columns A, B, and C.

Q-043. The Specific Instructions for Parts II and III require that if a taxpayer chooses not to complete columns (a) and (d) of Parts II and III in the first tax year the corporation is required to file Schedule M-3, then column (a) and column (d) of Part II, line 30 Reconciliation totals must still be completed. Is this requirement for the Consolidated M-3 only or are columns (a) and (d) of Part II, line 30 required to be completed on each of the separate Schedules M-3 reported by each includible corporation?

A. Part II, line 30 should be completed in its entirety for the consolidated Schedule M-3 and each separate Schedule M-3 included in the return.

Q-050. Subsidiary A is part of B’s U.S. consolidated tax group B is a calendar year taxpayer and is required to file Schedule M-3 for its 2004 tax return. Since this is the first tax year B is required to file Schedule M-3 it is not required to complete columns (a) and (d) of Parts II and III. Subsidiary A is spun off on 6/30/05 and completes a short period tax return for the tax year 1/1/05 – 6/30/05 which is included in B’s 2005 U.S. consolidated federal income tax return. Is this short period return considered a tax year for Schedule M-3 purposes?

A. Yes. This short period return is considered a tax year for Schedule M-3 purposes. If B is required to file Schedule M-3 for 2005 then A is also required to file Schedule M-3. Since this is the second tax year A is required to file Schedule M-3 it must complete the entire Schedule M-3 including columns (a) and (d) of Parts II and III.

Q-051. Subsidiary A is part of B’s U.S consolidated tax group. B is a calendar year taxpayer and is required to file Schedule M-3 for its 2004 tax return. Since this is the first tax year B is required to file Schedule M-3 it is not required to complete columns (a) and (d) of Parts II and III. Subsidiary A is spun off on 6/30/05 and completes a separate Form 1120 for the tax year 7/1/05 – 12/31/05. A meets the requirements for filing Schedule M-3 on its separate return for this tax year. Is the Schedule M-3 included in A’s separate return considered A’s first Schedule M-3 for purposes of completing columns (a) and (d) of Parts II and III?

A. No. A corporation only gets one pass on completing columns (a) and (d) of Parts II and III. Because A has filed a prior tax return that was required to include Schedule M-3, the tax year 7/1/05-12/31/05 is considered A’s second tax year subject to Schedule M-3 and A must complete Schedule M-3 in its entirety.

Q-052. Subsidiary A is part of B’s U.S. consolidated tax group. B is a calendar year taxpayer and is required to file Schedule M-3 for its 2004 tax return. Since this is the first tax year B is required to file Schedule M-3 it is not required to complete columns (a) and (d) of Parts II and III. Subsidiary A is spun off on 6/30/05 in a reorganization that results in A being a newly formed entity. This newly formed entity files a separate tax return for the tax year 7/1/05 – 12/31/05. This newly formed entity meets the requirements for filing Schedule M-3 for this tax year. Is the tax year 7/1/05-12/31/05 considered the first tax year this entity is required to file Schedule M-3 for purposes of completing columns (a) and (d) of Parts II and III? 

A. Yes. Since this is a newly formed entity for tax purposes it is the first tax year the entity is required to file Schedule M-3. Therefore, the entity is not required to complete columns (a) and (d) of Parts II and III in its first tax year.

  • When to Complete Columns (b) and (c)
  • General Reporting Requirements for Parts II and III

Q-013. If a portion of an item of income, gain, loss, expense, or deduction is treated the same for income statement and federal income tax purposes and a portion of the item gives rise to a difference, does the corporation report all amounts attributable to the item on one line of Parts II or III, as applicable, or is the portion of the item without a difference reported on Part II, Line 29, Other income (loss) and expense/deduction items with no differences and the portion of the item with a difference reported on the applicable line of Parts II or III?

A. All amounts attributable to the item must be reported on the applicable line of Parts II or III and not segregated between that line and Part II, Line 29. For example, if a corporation incurs $200 of meals and entertainment expenses that were deducted in computing net income per the income statement, and $50 of the $200 is subject to the 50% limitation under §274(n), the corporation must report all of its meals and entertainment expenses on Part III, Line 11, Meals and entertainment. Specifically, the corporation reports $200 in Column (a), $25 in Column (b) and/or (c), as applicable, and $175 in Column (d). The corporation should not report the $150 of meals and entertainment expenses that were deducted in computing net income per the income statement and are fully deductible for U.S. federal income tax purposes on Part II, Line 29, Other income(loss) and expense/deduction items with no differences, and the $50 subject to the limitation under §274(n) on Part III, Line 11, Meals and entertainment.

Q-014. Can differences below a certain dollar amount be combined together on Schedule M-3?

A. The Schedule M-3 instructions do not provide a specific dollar or ratio threshold for materiality. Every item of difference should be separately stated and adequately disclosed on Schedule M-3.

Q-025. If a corporate investor in a partnership is required to report a pass-through Reportable Transaction from the investee partnership, is it required to reflect the reportable transaction on Schedule M-3, Part II, line 12? In other words, should the book-tax difference associated with the partnership Reportable Transaction be carved out from amounts otherwise reportable on Schedule M-3, Part II, Lines 9, 10, or 11 - whichever is applicable?

A. Yes. Generally, all amounts of the corporation's distributive share of income or loss from a partnership or other pass-through entity (other than a disregarded entity) should be reported on Schedule M-3, Part II, lines 9, 10, or 11, whichever is applicable, regardless of whether the amount would be reported elsewhere in Schedule M-3, Part II or Part III if the transaction had been entered into directly by the corporate investor.

However, amounts associated with Reportable Transactions which pass through from pass-through entities to the corporation filing Schedule M-3, should be reported at Part II, line 12. Thus, reporting on Part II, line 12 takes precedence over reporting pass-through amounts on Part II, lines 9, 10, and 11 whenever the book-tax difference relates to transactions reportable under Regulations section 1.6011-4(b) (other than a transaction described in Regulations section 1.6011-4(b)(6)).

See instructions for Schedule M-3, page 6, column 2, first full paragraph. Note: this will not satisfy the disclosure requirements of Treasury Regulation section 1.6011-4 for the partnership.

Q-041. Certain line items in Part II and Part III, column (d) will not equal corresponding line items elsewhere reported on Form 1120 and other Schedules and Forms included in the return. Is this a concern?

A. The IRS is aware that certain line items on Schedule M-3 will not correspond to similar line items elsewhere reported on Form 1120 and other Schedules and Forms included in the return. This will not increase the risk associated with an item.

Q-071. The draft instructions for the 2005 version of Schedule M-3 have been made public. May taxpayers use those draft instructions in completing a 2004 Schedule M-3?

A. Taxpayers may use the draft instructions for the 2005 version of Schedule M-3 in completing a 2004 Schedule M-3 for the following items only:

  • Part I, line 1, Questions Regarding the Type of Income Statement Prepared – The draft 2005 Instructions state that if the corporation does not prepare financial statements, check Part I, line 1c “No” and report the net income (loss) per the books and records of the U.S. corporation or the U.S. consolidated tax group on Part I, line 4, Worldwide consolidated net income (loss) from income statement source identified in Part I, line 1. Instructions for 2004 Schedule M-3 required that such amount be reported on Part I, line 11. If the corporation does not prepare financial statements, the taxpayer may choose to report the net income (loss) per the books and records according to either the 2004 Instructions or the draft 2005 Instructions in completing the 2004 Schedule M-3.

  • Part I, line 2, Question regarding income statement period and restatements – The draft 2005 Instructions clarify the information required to be included on the statement for Part I, line 2. The requirements in either the 2004 Instructions or the draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part I, line 8, Adjustments to Eliminations of Transactions Between Includible Corporations and Nonincludible Entities – The 2005 Instructions clarify the reporting of adjustments to consolidation and eliminations entries that are contained on Part I, line 4, required as a result of removing amounts on Part I, lines 5 or 6, and amounts of any additional consolidation and elimination entries that are required either as a result of including amounts on Part I, line 7, or to otherwise arrive at the correct amount required to be reported on Part I, line 11. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part I, line 10, Other Adjustments Required To Reconcile to Amount on Line 11 - The draft 2005 Instructions clarify that intercompany dividends received by includible insurance companies, to the extent required by law to be included in statutory accounting net income, should be included on Part I, line 10. In addition, the information required to be included on the schedule required to be attached for amounts on this line has been changed. The taxpayer may choose to configure the attached schedule as described in the 2004 Instructions or the draft 2005 Instructions in completing the 2004 Schedule M-3.

  • Completion of Schedule M-3, Part II and Part III – The 2004 Instructions were not clear as to whether the required line item detail for Part II and Part III of Schedule M-3 had to be attached only for the Consolidated Part II and Part III, only for each separate entity included in the Consolidated Part II and Part III, or both. The draft 2005 Instructions clarify that all required line item detailed schedules for Part II and Part III of Schedule M-3 must be attached for each separate entity included in the Consolidated Part II and Part III, and do not require that the same supporting detailed information be presented on the Consolidated Part II and Part III. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part II, line 20 Unearned/Deferred Revenue – The draft 2005 Instructions clarify what amounts are to be included on Part II, line 20. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part III, line 18, Deferred Compensation - The draft 2005 Instructions clarify what amounts are to be included on Part III, line 18. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Separately Stated and Adequately Disclosed

Q-027. What happens if there is a transaction with a significant book-tax difference (and thus a reportable transaction for purposes of Section 6011)? I understand from Rev. Rul. 2004-45 that a Form 8886 would not be necessary if the information is properly disclosed on the M-3. How would such information be properly disclosed, and if such information is deemed by the IRS to not have been properly disclosed, may the IRS impose a penalty under new Section 6707A if a Form 8886 is not filed?

A. For a taxable year ending on or after December 31, 2004, a corporation required to file Schedule M-3 that completes and files Schedule M-3 (in accordance with the instructions to the form) with the corporation's timely-filed original tax return (including extensions) for the taxable year is deemed to satisfy the disclosure requirements of §1.6011-4 with respect to transactions described in §1.6011-4(b)(6) (relating to significant book-tax differences) for that taxable year.

Each difference reported must be separately stated and adequately disclosed. In general, a difference is adequately disclosed if the difference is labeled in a manner that clearly identifies the item or transaction from which it arises. If a specific line item of income, gain, loss, expense, or deduction is described on Part II or Part III of Schedule M-3, and the line does not indicate to "attach schedule" or "attach details", and the specific instructions for the line do not call for an attachment of a schedule or statement, then the item is considered separately stated and adequately disclosed if the item is reported on the applicable line and the amounts are reported in the applicable columns. For items that are not specifically listed in Parts II and III of Schedule M-3, those that must be identified on schedules attached for Part II, line 26 or Part III, line 35, care should be taken to make the substance of each item of difference understandable.

For guidance, use as examples the items that are listed in Parts II and III. These items are described in few words, yet are sufficiently descriptive for tax professionals to understand the nature of the item. In addition, it is generally recommended that taxpayers take the opportunity to be as clear and thorough as possible in preparing attached schedules, since there is more likelihood of compliance risk being assumed to exist if clarity and understandability is lacking.

For further guidance see Rev. Proc. 2004-45.

Q-040. What level of detail is required for the attached schedules for Schedule M-3, Part II, line 26, Other income (loss) items with differences, and Part III, line 35, Other expense/deduction items with differences? Is the general ledger account description “adequate disclosure” for these schedules?

A. With respect to differences specifically identified on Schedule M-3, the Schedule M-3 instructions state that an item is considered as separately stated and adequately disclosed if the item is reported on the applicable line and the amount(s) of the item(s) are reported on the applicable line.

For items not specifically listed on Schedule M-3 (i.e., items required to be reported on Part II, Line 26, or Part III, line 35), or those line items requiring a statement or schedule to be attached, an item is adequately disclosed if the difference is labeled in a manner that clearly identifies the item or transaction from which the amount arises. The instructions provide examples such as “Foreign currency translation adjustment” and “Gains and losses on available-for-sale securities” as descriptions meeting such a standard. See instructions for Part II, line 26. It is likely that many general ledger account titles would not meet the “separately stated and adequately disclose” requirement. For example, an “Other Income” account title does not clearly identify the item or transaction from which the amount arose. Similarly, a “Prepaid Expenses” account title that includes prepaid insurance, prepaid advertising, and prepaid postage does not clearly identify the prepaid items and each prepaid item is required to be separately stated and adequately disclosed.

  • Part II. Reconciliation of Net Income (Loss) per Income Statement of Includible Corporations with Taxable Income per Return
  • Line 1. Income (Loss) from Equity Method Foreign Corporations
  • Line 2. Gross Foreign Dividends not Previously Taxed
  • Line 3. Subpart F, QEF, and Similar Income Inclusions
  • Line 4. Section 78 Gross-Up
  • Line 5. Gross Foreign Distributions Previously Taxed
  • Line 6. Income (Loss) from Equity Method U.S. Corporations
  • Line 7. U.S. Dividends not Eliminated in Tax Consolidation

Q-046. A parent corporation files a consolidated return with its 80% owned subsidiary. For financial statement purposes the parent accounts for the subsidiary on the equity method. The subsidiary pays a dividend during the year to its parent. Is the dividend reported on Schedule M-3, Part II, line 7, U.S. dividends not eliminated in tax consolidation?

A. No. The dividend is not reported on Schedule M-3. Since the subsidiary is included in the consolidated return, the book income of the subsidiary must be included in Part I, line 11, Net Income (loss) per income statement of includible corporations. (This is the income of the affiliated tax return group identified on Form 851.) Thus, dividends received by the parent company from the subsidiary would not be included in the amount reported on this line. Therefore, no amounts would be reflected in column (a) of Part II, line 7. However, if the subsidiary was not included in a consolidated return with its parent, the equity in the subsidiary’s income would be included in the parent’s financial statement net income (loss) at Part I, line 11 of the parent’s Schedule M-3. In the parent’s Schedule M-3 at Part II, line 6, column (a), Income (loss) from equity method U.S. corporations, the amount of equity income (loss) included in Part I, line 11 from the subsidiary would be reported. That amount would be removed in column (b) or (c), as applicable. Then, the dividend received from the subsidiary would be reported on Part II, line 7, U.S. dividends not eliminated in tax consolidation.

Q-047. On which line are distributions from RICs and REITs to be reported: Line 7 (U.S. dividends), line 11 (income or loss from other pass-through entities), or elsewhere?

A. How a distribution from a RIC or REIT is reported on Schedule M-3 depends on how each distribution is designated. A distribution which is designated as a capital-gains dividend should be reported on Part II, line 23, Capital gains (losses). Dividends designated as ordinary dividends should be reported on Part II, line 7, U.S. dividends not eliminated in tax consolidation.

Q-064. Corporation A and Corporation B file a consolidated return. A pays B a dividend during the year of $100. Neither corporation has any other activity during the year. On what line of Schedule M-3 does the dividend income get reported on? A. Part I, line 11, should be zero because the dividend is eliminated in the financial statements. A would have a blank Part II and III. B would have $100 on Part II, (either line 7 or line 26 columns (a) and (d)). The eliminations company would have a negative $100 on Part II (either line 7 or line 26, columns (a) and (d)). The consolidated Schedule M-3 would reflect the total of all Schedule M-3’s resulting in a zero being reported on the appropriate lines.
  • Line 8. Minority Interest for Includible Corporations
  • Line 9. Income (Loss) from U.S. Partnerships and Line 10. Income from Foreign Partnerships

Q-017. How must a corporation report on Schedule M-3 the corporation's distributive share of income or loss from a partnership, trust, or other flow-through entity that is reported on Schedule K-1?

A. The corporation must report the corporation's distributive share of income or loss from a partnership, trust, or other flow-through entity that is reported on Schedule K-1 in the following manner, even if the amount does not result in a difference between the net income (or loss) per the income statement and taxable income :

  1. In column (a) of the applicable line 9, 10, or 11 of Part II the sum of the corporation's distributive share of income or loss from a flow-through entity that is included in Part I, line 11, Net income (loss) per income statement of includible corporations;

  2. In column (b) or (c) of line 9, 10, or 11 of Part II, as applicable, the sum of all differences, if any, attributable to the corporation's distributive share of income or loss from a U.S. or foreign partnership or other flow-through entity; and

  3. In column (d) of line 9, 10, or 11 of Part II, as applicable, the sum of all amounts of income, gain, loss, or deduction attributable to the corporation's distributive share of income or loss from a U.S. or foreign partnership or other flow-through entity (i.e., the sum of all amounts reportable on the corporation's Schedule(s) K-1 received from the partnership (if applicable)), without regard to any limitations computed at the partner level (e.g., limitations on utilization of charitable contributions, capital losses, and interest expense).

For each entity reported on line 9 or 10, or 11, attach a supporting schedule that provides the name, EIN (if applicable), end of year profit-sharing percentage (if applicable), end of year loss-sharing percentage (if applicable), and the amount reported in column (a), (b), (c), or (d) of lines 9 or 10 or 11, as applicable.

Q-025. If a corporate investor in a partnership is required to report a pass-through Reportable Transaction from the investee partnership, is it required to reflect the reportable transaction on Schedule M-3, Part II, line 12? In other words, should the book-tax difference associated with the partnership Reportable Transaction be carved out from amounts otherwise reportable on Schedule M-3, Part II, Lines 9, 10, or 11 - whichever is applicable?

A. Yes. Generally, all amounts of the corporation's distributive share of income or loss from a partnership or other pass-through entity (other than a disregarded entity) should be reported on Schedule M-3, Part II, lines 9, 10, or 11, whichever is applicable, regardless of whether the amount would be reported elsewhere in Schedule M-3, Part II or Part III if the transaction had been entered into directly by the corporate investor. However, amounts associated with Reportable Transactions which pass through from pass-through entities to the corporation filing Schedule M-3, should be reported at Part II, line 12. Thus, reporting on Part II, line 12 takes precedence over reporting pass-through amounts on Part II, lines 9, 10, and 11 whenever the book-tax difference relates to transactions reportable under Regulations section 1.6011-4(b) (other than a transaction described in Regulations section 1.6011-4(b)(6)). See instructions for Schedule M-3, page 6, column 2, first full paragraph. Note: this will not satisfy the disclosure requirements of Treasury Regulation section 1.6011-4 for the partnership.

Q-029. If, for a corporation included in a consolidated return, partnership income is eliminated from Part I, Line 11, Net income (loss) per income statement of includible corporations via Part I, Line 6, Net income (loss) from nonincludible U.S. entities, do we include the partnership income on Part II, line 9, Income (loss) from U.S. partnerships, column (a) and then show an eliminating amount on the same line for the Consolidating Schedule M-3 for consolidation eliminations?

A. The distributive share reported on Part II, Line 9 must be the same amount that is included in Part I, Line 11. If it is eliminated from Part I, then there should be no entry in Part II, Line 9 column (a)

Note: If the partnership income is accounted for in the financial statements on the equity method, the amount should not be eliminated in determining Part I, line 11 and should be reported on Part II, line 9, column (a). Part II, line 9, column (d) should reflect the corporation’s distributive share of income or loss from the partnership as reported on the Schedule(s) K-1 received from the partnership. Columns (b) and (c) should be completed, as applicable. If the partnership is fully consolidated in Part I, line 4, then to deconsolidate the partnership in determining Part I, line 11, report on Part I, line 6 the amount included in Part I, line 4 before minority interest, if any, and remove at Part I, line 8 the amount of any related minority interest included in Part I, line 4. Part II, line 9, column (a) would then not include any amount for this entity (barring any other adjustments) and columns (b), (c), and (d) would be completed, as applicable

  • Line 11. Income (Loss) from Other Pass-Through Entities

Q-017. How must a corporation report on Schedule M-3 the corporation's distributive share of income or loss from a partnership, trust, or other flow-through entity that is reported on Schedule K-1?

A. The corporation must report the corporation's distributive share of income or loss from a partnership, trust, or other flow-through entity that is reported on Schedule K-1 in the following manner, even if the amount does not result in a difference between the net income (or loss) per the income statement and taxable income :

  1. In column (a) of the applicable line 9, 10, or 11 of Part II the sum of the corporation's distributive share of income or loss from a flow-through entity that is included in Part I, line 11, Net income (loss) per income statement of includible corporations;

  2. In column (b) or (c) of line 9, 10, or 11 of Part II, as applicable, the sum of all differences, if any, attributable to the corporation's distributive share of income or loss from a U.S. or foreign partnership or other flow-through entity; and

  3. In column (d) of line 9, 10, or 11 of Part II, as applicable, the sum of all amounts of income, gain, loss, or deduction attributable to the corporation's distributive share of income or loss from a U.S. or foreign partnership or other flow-through entity (i.e., the sum of all amounts reportable on the corporation's Schedule(s) K-1 received from the partnership (if applicable)), without regard to any limitations computed at the partner level (e.g., limitations on utilization of charitable contributions, capital losses, and interest expense).

For each entity reported on line 9 or 10, or 11, attach a supporting schedule that provides the name, EIN (if applicable), end of year profit-sharing percentage (if applicable), end of year loss-sharing percentage (if applicable), and the amount reported in column (a), (b), (c), or (d) of lines 9 or 10 or 11, as applicable.

Q-025. If a corporate investor in a partnership is required to report a pass-through Reportable Transaction from the investee partnership, is it required to reflect the reportable transaction on Schedule M-3, Part II, line 12? In other words, should the book-tax difference associated with the partnership Reportable Transaction be carved out from amounts otherwise reportable on Schedule M-3, Part II, Lines 9, 10, or 11 - whichever is applicable?

A. Yes. Generally, all amounts of the corporation's distributive share of income or loss from a partnership or other pass-through entity (other than a disregarded entity) should be reported on Schedule M-3, Part II, lines 9, 10, or 11, whichever is applicable, regardless of whether the amount would be reported elsewhere in Schedule M-3, Part II or Part III if the transaction had been entered into directly by the corporate investor. However, amounts associated with Reportable Transactions which pass through from pass-through entities to the corporation filing Schedule M-3, should be reported at Part II, line 12. Thus, reporting on Part II, line 12 takes precedence over reporting pass-through amounts on Part II, lines 9, 10, and 11 whenever the book-tax difference relates to transactions reportable under Regulations section 1.6011-4(b) (other than a transaction described in Regulations section 1.6011-4(b)(6)). See instructions for Schedule M-3, page 6, column 2, first full paragraph. Note: this will not satisfy the disclosure requirements of Treasury Regulation section 1.6011-4 for the partnership.

Q-047. On which line are distributions from RICs and REITs to be reported: Line 7 (U.S. dividends), line 11 (income or loss from other pass-through entities), or elsewhere?

A. How a distribution from a RIC or REIT is reported on Schedule M-3 depends on how each distribution is designated. A distribution which is designated as a capital-gains dividend should be reported on Part II, line 23, Capital gains (losses). Dividends designated as ordinary dividends should be reported on Part II, line 7, U.S. dividends not eliminated in tax consolidation.

Q-074. Is there a difference between a “pass-through entity” as referenced on Part II, line 11, and a “flow-through entity” as referenced on Part II, lines 23a through 23d?

A. No, a “pass-through entity” and a “flow-through entity” reference the same type of entity. The draft 2005 Schedule M-3 and Instructions fix this inconsistency and refer to this type of entity as a “pass-through entity”.

Q-075. On which line should income received (including interest, accrued OID, accrued market discount, and premium amortization) from mortgage-backed securities, asset-backed securities and REMIC regular interests be reported: on Part II, line 11 (income/loss from other pass-through entities), Part II, line 13 (interest income), line 22 (original issue discount and other imputed interest), or some other line?

A. How income received from mortgage-backed securities, asset-backed securities, and REMIC regular interests is reported on Schedule M-3 depends on how the income is designated. For example, income designated as interest (reported on a 1099-INT) should be reported on Part II, line 13, Interest income. If an amount is specifically known or identified as OID interest, then it should be reported on Part II, line 22, Original issue discount and other imputed interest).

Q-076. On which line should gain (loss) on disposition of mortgage-backed securities, asset-backed securities and REMIC regular interests be reported: on Part II, line 11 (income/loss from other pass-through entities), line 23a (income statement gain/loss on ... disposition of assets other than ... flow-through entities), line 23b/c (gross capital gains/losses from Schedule D, excluding amounts from flow-through entities), line 23g (other gain/loss on disposition of assets other than inventory), or some other line?

A. Any gain (loss) reported in the financial statements and included on Schedule M-3, Part I, line 11, Net income (loss) per income statement of includible corporations, should be reported on Part II, line 23a, column (a). This amount should be reversed in column (b) or (c) of this line, as applicable. The gain (loss) included in taxable income should be reported on line 23b, 23c, or 23g as determined by how the amount was reported on the 1120. For example, if a taxpayer reported a gain from disposition of REMIC regular interests on Schedule D of Form 1120, then this amount would be reported on Schedule M-3, line 23b, Gross capital gains from Schedule D, excluding amounts from pass-through entities.

Q-077. Corporation A holds a residual interest in a REMIC and receives Schedule Q (Form 1066) from the REMIC. On which line of Schedule M-3 should Corporation A report the sum of all taxable amounts of income, gain, loss or deduction reported on Schedule Q received from the REMIC?

A. Corporation A would report on Schedule M-3, Part II, line 11, Income (loss) from other pass-through entities, the sum of all taxable amounts of income, gain, loss or deduction reported on Schedule Q received from the REMIC.

  • Line 12. Items Relating to Reportable Transactions

Q-006. Are differences between financial statement net income and taxable income attributable to any reportable transaction as described in Treas. Reg. § 1.6011-4(b))(other than a transaction described in Reg. § 1.6011-4(b)(6) relating to significant book-tax differences) required to be separately disclosed on Schedule M-3?

A. Yes. Any amounts attributable to any reportable transactions (as described in Regulations section 1.6011-4(b)) other than transactions described in Regulations section 1.6011-4(b)(6) relating to significant book-tax differences must be included on Part II, line 12, regardless of whether the difference, or differences, would otherwise be reported elsewhere in Part II or Part III. Each difference attributable to a reportable transaction must be separately stated and adequately disclosed. A corporation will be considered to have separately stated and adequately disclosed a reportable transaction on line 12 if the corporation sequentially numbers each Form 8886 and lists by identifying number on the supporting schedule for Part II, line 12, each sequentially numbered reportable transaction and the amounts required for Part II, line 12, columns (a) through (d). In lieu of the requirements of the preceding paragraph, a corporation will be considered to have separately stated and adequately disclosed a reportable transaction if the corporation attaches a supporting schedule that provides the following for each reportable transaction:

  1. A description of the reportable transaction disclosed on Form 8886 for which amounts are reported on Part II, line 12;

  2. The name and tax shelter registration number, if applicable, as reported on lines 1a and 1b, respectively, of Form 8886; and

  3. The type of reportable transaction (i.e., listed transaction, confidential transaction, transaction with contractual protection, etc.) as reported on line 2 of Form 8886.

If a transaction is a listed transaction described in Regulations section 1.6011-4(b)(2), the description also must include the description provided on line 3 of Form 8886. In addition, if the reportable transaction involves an investment in the transaction through another entity such as a partnership, the description must include the name and EIN (if applicable) of that entity as reported on line 5 of Form 8886.

Q-007. Are differences between financial statement net income and taxable income attributable to reportable transactions as described in §1.6011-4(b)(6) relating to significant book-tax differences required to be separately disclosed on Schedule M-3?

A. An amount that is attributable to a reportable transaction described in Reg. Section 1.6011-4(b)(6) relating to significant book-tax differences should be reported in Parts II and III on the specifically listed line item that it is in any manner included in the corporation's current year financial statement net income(loss) or in an income or expense account maintained in the corporation's books and records. This type of reportable transaction is not reported on Part II, line 12. Note: If an item is attributable to both a reportable transaction described in Treas. Reg. Section 1.6011-4(b)(6) and a reportable transaction as described in Treas. Reg. Sections 1.6011-4(b)(1) thru (5), the amount must be included on Part II, line 12, regardless of whether the difference or differences would otherwise be reported elsewhere in Part II or Part III. See Q-006 above. If the specific line item that this transaction is reported on does not indicate to "attach schedule" or "attach details, " and the specific instructions for the line do not call for an attachment of a schedule or statement, then the item is considered separately stated and adequately disclosed.

Q-025. If a corporate investor in a partnership is required to report a pass-through Reportable Transaction from the investee partnership, is it required to reflect the reportable transaction on Schedule M-3, Part II, line 12? In other words, should the book-tax difference associated with the partnership Reportable Transaction be carved out from amounts otherwise reportable on Schedule M-3, Part II, Lines 9, 10, or 11 - whichever is applicable?

A. Yes. Generally, all amounts of the corporation's distributive share of income or loss from a partnership or other pass-through entity (other than a disregarded entity) should be reported on Schedule M-3, Part II, lines 9, 10, or 11, whichever is applicable, regardless of whether the amount would be reported elsewhere in Schedule M-3, Part II or Part III if the transaction had been entered into directly by the corporate investor. However, amounts associated with Reportable Transactions which pass through from pass-through entities to the corporation filing Schedule M-3, should be reported at Part II, line 12. Thus, reporting on Part II, line 12 takes precedence over reporting pass-through amounts on Part II, lines 9, 10, and 11 whenever the book-tax difference relates to transactions reportable under Regulations section 1.6011-4(b) (other than a transaction described in Regulations section 1.6011-4(b)(6)). See instructions for Schedule M-3, page 6, column 2, first full paragraph. Note: this will not satisfy the disclosure requirements of Treasury Regulation section 1.6011-4 for the partnership.

Q-073. If a taxpayer files a protective Form 8886, Reportable Transaction Disclosure Statement, for a transaction (other than a significant book-tax difference described in Regulations section 1.6011-4(b)(6)), should the transaction be reported on Schedule M-3, Part II, line 12, Items relating to reportable transactions?

A. If a taxpayer files a Form 8886 attributable to any reportable transaction (as described in Regulations section 1.6011-4) other than transactions described in Regulations sections 1.6011-4(b)(6) relating to significant book-tax differences, then the reportable transaction must be reported on Part II, line 12, regardless of whether the difference, or differences, would otherwise be reported elsewhere in Part II or Part III.

  • Line 13. Interest Income

Q-044. U.S. Corporation invests in U.S. (or foreign) securities that have a stated yield. Due to certain features of the securities, the income from the investment is reported in the GAAP financial statements as interest income. U.S. Corporation reports the income as dividend income for tax purposes. On what line(s) of Schedule M-3 would book and taxable income be reported?

A. Part II, line 13 Column (a) Interest Income would reflect the GAAP interest amount. The amount to be characterized as dividend income for tax purposes should be eliminated via column (b) or (c) as appropriate. Column (d) would reflect total interest income for tax purposes. The appropriate dividend income lines of Part II, most likely line 2, Gross foreign dividends not previously taxed and/or line 7, US dividends not eliminated in tax consolidation should be used to reflect the tax treatment of this item by including the amount determined to be dividend income in column (b) or (c) as appropriate. Column (d) would reflect total dividend income for tax purposes.

Q-075. On which line should income received (including interest, accrued OID, accrued market discount, and premium amortization) from mortgage-backed securities, asset-backed securities and REMIC regular interests be reported: on Part II, line 11 (income/loss from other pass-through entities), Part II, line 13 (interest income), line 22 (original issue discount and other imputed interest), or some other line?

A. How income received from mortgage-backed securities, asset-backed securities, and REMIC regular interests is reported on Schedule M-3 depends on how the income is designated. For example, income designated as interest (reported on a 1099-INT) should be reported on Part II, line 13, Interest income. If an amount is specifically known or identified as OID interest, then it should be reported on Part II, line 22, Original issue discount and other imputed interest).

  • Line 14. Total Accrual to Cash Adjustment

Q-018. Who must complete Part II, Line 14, Total accrual to cash adjustment, and what must be included on this line?

A1. This line is completed only by a corporation with financial statements (or books and records, if permitted) prepared using an accrual method of accounting that uses an overall cash method of accounting for federal income tax purposes (or vice-versa). The corporation must report on Line 14 a single amount net of all adjustments attributable to the use of the different overall methods of accounting (e.g., adjustments related to accounts receivable, accounts payable, compensation, and accrued liabilities). Differences not attributable to the use of the different overall methods of accounting must be reported on the appropriate line of Schedule M- 3 (e.g., depreciation).

  • Line 15. Hedging Transactions
  • Line 16. Mark-to-Market Income (Loss)
  • Line 17. Cost of Goods Sold

Q-031. Do all cost of goods sold get reported on Part II, line 17, Inventory valuation adjustments?

A. Report on Part II, line 17 any amounts included in cost of goods sold during the year, including any amounts attributable to inventory valuation, pricing adjustments, 263A costs, inventory obsolescence reserves, etc. Column (a) should equal the financial statement cost of goods sold amount. Column (d) should report the tax cost of goods sold less any of the items specifically listed in the instructions for Part II, line 17, which are required to be reported elsewhere on the Schedule M-3.

Q-055. If an item of expense is included in cost of goods sold (COGS) but also is an item separately stated on part III, should the item be bifurcated from COGS and reclassified to the separate line item? For example, COGS includes depreciation expense. Depreciation expense is reported on Schedule M-3, Part III, line 31. Should the depreciation expense included in COGS be removed from column (a) of Part II, line 17, Inventory Valuation Reserves and be included on line 31? A. Part II, line 17 should include any amounts deducted as part of cost of good sold during the tax year. Only section 481(a) adjustments, gain or losses from hedging transactions, and mark-to-market income or (loss) that are part of cost of goods sold should be reported elsewhere. See the instructions to Part II, line 17.
  • Line 18. Sale vs. Lease (for Sellers and/or Lessors)

Q-039. A lessor of property generally reports the transaction for accounting purposes in accordance with guidance provided under GAAP, principally Financial Accounting Standards Board, Statement 13, “Accounting for Leases” (“FASB 13”), and certain subsequent interpretations. FASB 13 requires that a lessor classify a lease on its statements as a “sales-type lease”, a “direct financing lease”, a “leveraged lease” or an “operating lease”. How should a corporation report on Schedule M-3 the book-tax differences relating to income from each of these lease types?

A. Book-tax differences related to any transaction characterized as a reportable transaction (other than as described in Regs Sec 1.6011-4(b)(6)) must be reported on Part II, Line 12. For other transactions, book-tax differences arising from sales (for financial accounting purposes) being treated as leases for tax purposes, or leases (for financial accounting purposes) being treated as sales for tax purposes must be reported in accordance with the Schedule M-3 instructions for Part II, line 18. Book-tax differences arising from other financial statement lease transactions must be reported on the specific difference lines of Part II or Part III as otherwise appropriate, with no amount reportable on Part II, Line 18.

  • Line 19. Section 481(a) Adjustments
  • Line 20. Unearned/Deferred Revenue

Q-032. If income is deferred for only one month (i.e. from April 2004 to May 2004) and is not deferred across tax years does it need to be disclosed on Part II, Line 20 Unearned/deferred revenue?

A. No. Only report on line 20 column (a), unearned/deferred revenue that is deferred beyond the end of the current taxable year for financial accounting purposes or is the reversal of prior year deferrals. Complete columns (b), (c), and (d) as applicable.

Q-058. For GAAP purposes, a Sales Returns and Allowances reserve is considered a contra-revenue account (i.e. a reduction to sales revenue not an expense). The change in this reserve is a book/tax difference. Should this difference be reflected on Part II, line 20, Unearned/Deferred revenue, Part II, line 26, Other income(loss) with differences, or Part III, line 35, Other expense/deduction items with differences?  Part II, line 26, Part III, line 35 and Part II, line 20.

A. The contra account may either be reported on Part II, line 26 Other income(loss) with differences, or Part III, line 35, Other expense/deduction items with differences. This type of reserve account is not of the type that would be reported on Part II, line 20, Unearned/Deferred revenue.

Q-071. The draft instructions for the 2005 version of Schedule M-3 have been made public. May taxpayers use those draft instructions in completing a 2004 Schedule M-3?

A. Taxpayers may use the draft instructions for the 2005 version of Schedule M-3 in completing a 2004 Schedule M-3 for the following items only:

  • Part I, line 1, Questions Regarding the Type of Income Statement Prepared – The draft 2005 Instructions state that if the corporation does not prepare financial statements, check Part I, line 1c “No” and report the net income (loss) per the books and records of the U.S. corporation or the U.S. consolidated tax group on Part I, line 4, Worldwide consolidated net income (loss) from income statement source identified in Part I, line 1. Instructions for 2004 Schedule M-3 required that such amount be reported on Part I, line 11. If the corporation does not prepare financial statements, the taxpayer may choose to report the net income (loss) per the books and records according to either the 2004 Instructions or the draft 2005 Instructions in completing the 2004 Schedule M-3.

  • Part I, line 2, Question regarding income statement period and restatements – The draft 2005 Instructions clarify the information required to be included on the statement for Part I, line 2. The requirements in either the 2004 Instructions or the draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part I, line 8, Adjustments to Eliminations of Transactions Between Includible Corporations and Nonincludible Entities – The 2005 Instructions clarify the reporting of adjustments to consolidation and eliminations entries that are contained on Part I, line 4, required as a result of removing amounts on Part I, lines 5 or 6, and amounts of any additional consolidation and elimination entries that are required either as a result of including amounts on Part I, line 7, or to otherwise arrive at the correct amount required to be reported on Part I, line 11. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part I, line 10, Other Adjustments Required To Reconcile to Amount on Line 11 - The draft 2005 Instructions clarify that intercompany dividends received by includible insurance companies, to the extent required by law to be included in statutory accounting net income, should be included on Part I, line 10. In addition, the information required to be included on the schedule required to be attached for amounts on this line has been changed. The taxpayer may choose to configure the attached schedule as described in the 2004 Instructions or the draft 2005 Instructions in completing the 2004 Schedule M-3.

  • Completion of Schedule M-3, Part II and Part III – The 2004 Instructions were not clear as to whether the required line item detail for Part II and Part III of Schedule M-3 had to be attached only for the Consolidated Part II and Part III, only for each separate entity included in the Consolidated Part II and Part III, or both. The draft 2005 Instructions clarify that all required line item detailed schedules for Part II and Part III of Schedule M-3 must be attached for each separate entity included in the Consolidated Part II and Part III, and do not require that the same supporting detailed information be presented on the Consolidated Part II and Part III. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part II, line 20 Unearned/Deferred Revenue – The draft 2005 Instructions clarify what amounts are to be included on Part II, line 20. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part III, line 18, Deferred Compensation - The draft 2005 Instructions clarify what amounts are to be included on Part III, line 18. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Line 21. Income Recognition from Long-Term Contracts
  • Line 22. Original Issue Discount and Other Imputed Interest

Q-075. On which line should income received (including interest, accrued OID, accrued market discount, and premium amortization) from mortgage-backed securities, asset-backed securities and REMIC regular interests be reported: on Part II, line 11 (income/loss from other pass-through entities), Part II, line 13 (interest income), line 22 (original issue discount and other imputed interest), or some other line?

A. How income received from mortgage-backed securities, asset-backed securities, and REMIC regular interests is reported on Schedule M-3 depends on how the income is designated. For example, income designated as interest (reported on a 1099-INT) should be reported on Part II, line 13, Interest income. If an amount is specifically known or identified as OID interest, then it should be reported on Part II, line 22, Original issue discount and other imputed interest).

  • Line 23a. Income Statement Gain/Loss on Sale, Exchange, Abandonment, Worthlessness, or Other Disposition of Assets Other Than Inventory and Pass-Through Entities

Q-076. On which line should gain (loss) on disposition of mortgage-backed securities, asset-backed securities and REMIC regular interests be reported: on Part II, line 11 (income/loss from other pass-through entities), line 23a (income statement gain/loss on ... disposition of assets other than ... flow-through entities), line 23b/c (gross capital gains/losses from Schedule D, excluding amounts from flow-through entities), line 23g (other gain/loss on disposition of assets other than inventory), or some other line?

A. Any gain (loss) reported in the financial statements and included on Schedule M-3, Part I, line 11, Net income (loss) per income statement of includible corporations, should be reported on Part II, line 23a, column (a). This amount should be reversed in column (b) or (c) of this line, as applicable. The gain (loss) included in taxable income should be reported on line 23b, 23c, or 23g as determined by how the amount was reported on the 1120. For example, if a taxpayer reported a gain from disposition of REMIC regular interests on Schedule D of Form 1120, then this amount would be reported on Schedule M-3, line 23b, Gross capital gains from Schedule D, excluding amounts from pass-through entities.

  • Line 23b. Gross Capital Gains from Schedule D, Excluding Amounts from Pass-Through Entities

Q-047. On which line are distributions from RICs and REITs to be reported: Line 7 (U.S. dividends), line 11 (income or loss from other pass-through entities), or elsewhere?

A. How a distribution from a RIC or REIT is reported on Schedule M-3 depends on how each distribution is designated. A distribution which is designated as a capital-gains dividend should be reported on Part II, line 23, Capital gains (losses). Dividends designated as ordinary dividends should be reported on Part II, line 7, U.S. dividends not eliminated in tax consolidation. Q-076: On which line should gain (loss) on disposition of mortgage-backed securities, asset-backed securities and REMIC regular interests be reported: on Part II, line 11 (income/loss from other pass-through entities), line 23a (income statement gain/loss on ... disposition of assets other than ... flow-through entities), line 23b/c (gross capital gains/losses from Schedule D, excluding amounts from flow-through entities), line 23g (other gain/loss on disposition of assets other than inventory), or some other line?

Q-076. On which line should gain (loss) on disposition of mortgage-backed securities, asset-backed securities and REMIC regular interests be reported: on Part II, line 11 (income/loss from other pass-through entities), line 23a (income statement gain/loss on ... disposition of assets other than ... flow-through entities), line 23b/c (gross capital gains/losses from Schedule D, excluding amounts from flow-through entities), line 23g (other gain/loss on disposition of assets other than inventory), or some other line?

A. Any gain (loss) reported in the financial statements and included on Schedule M-3, Part I, line 11, Net income (loss) per income statement of includible corporations, should be reported on Part II, line 23a, column (a). This amount should be reversed in column (b) or (c) of this line, as applicable. The gain (loss) included in taxable income should be reported on line 23b, 23c, or 23g as determined by how the amount was reported on the 1120. For example, if a taxpayer reported a gain from disposition of REMIC regular interests on Schedule D of Form 1120, then this amount would be reported on Schedule M-3, line 23b, Gross capital gains from Schedule D, excluding amounts from pass-through entities.

  • Line 23c. Gross Capital Losses from Schedule D, Excluding Amounts from Pass-Through Entities, Abandonment Losses, and Worthless Stock Losses

Q-076. On which line should gain (loss) on disposition of mortgage-backed securities, asset-backed securities and REMIC regular interests be reported: on Part II, line 11 (income/loss from other pass-through entities), line 23a (income statement gain/loss on ... disposition of assets other than ... flow-through entities), line 23b/c (gross capital gains/losses from Schedule D, excluding amounts from flow-through entities), line 23g (other gain/loss on disposition of assets other than inventory), or some other line?

A. Any gain (loss) reported in the financial statements and included on Schedule M-3, Part I, line 11, Net income (loss) per income statement of includible corporations, should be reported on Part II, line 23a, column (a). This amount should be reversed in column (b) or (c) of this line, as applicable. The gain (loss) included in taxable income should be reported on line 23b, 23c, or 23g as determined by how the amount was reported on the 1120. For example, if a taxpayer reported a gain from disposition of REMIC regular interests on Schedule D of Form 1120, then this amount would be reported on Schedule M-3, line 23b, Gross capital gains from Schedule D, excluding amounts from pass-through entities.

  • Line 23d. Net Gain/Loss Reported on Form 4797, Line 17, Excluding Amounts from Pass-Through Entities, Abandonment Losses, and Worthless Stock Losses

Q-078. Please explain why you require taxpayers to include line 17 of Form 4797 in column (b) of Part II, Line 23d. This represents the entire tax gain reported on Form 4797, whereas column (b) is supposed to report just the tax temporary difference. If the taxpayer includes the entire book gain in column (a) and the entire tax gain, instead of just the tax adjustment, in column (b), then column (d) does not tie to the taxable income reported on page 1, line 28, Form 1120. Please explain why line 23d instructs the taxpayer to report this way.

A. Part II, line 23a column (a) of Schedule M-3 would reflect all gains and losses on that entity’s disposition of assets except for (a) gains and losses on the disposition of inventory, and (b) gains and losses allocated to the corporation from a flow-through entity (e.g., on Schedule K-1) that are included in the net income (loss) per income statement (or books and records, if applicable) of includible corporations reported on Part I, line 11. Reverse the amount reported in column (a) in column (b) or (c), as applicable. The gains and losses reportable for U.S. federal income tax purposes are reported on Part II, lines 23b through 23g, as applicable.

Note: Column (a) of Part II, lines 23b through 23g, is grayed out. No amounts should be reported in this column for these lines.

  • Line 23e. Abandonment Losses
  • Line 23f. Worthless Stock Losses
  • Line 23g. Other Gain/Loss on Disposition of Assets Other Than Inventory

Q-076. On which line should gain (loss) on disposition of mortgage-backed securities, asset-backed securities and REMIC regular interests be reported: on Part II, line 11 (income/loss from other pass-through entities), line 23a (income statement gain/loss on ... disposition of assets other than ... flow-through entities), line 23b/c (gross capital gains/losses from Schedule D, excluding amounts from flow-through entities), line 23g (other gain/loss on disposition of assets other than inventory), or some other line?

A. Any gain (loss) reported in the financial statements and included on Schedule M-3, Part I, line 11, Net income (loss) per income statement of includible corporations, should be reported on Part II, line 23a, column (a). This amount should be reversed in column (b) or (c) of this line, as applicable. The gain (loss) included in taxable income should be reported on line 23b, 23c, or 23g as determined by how the amount was reported on the 1120. For example, if a taxpayer reported a gain from disposition of REMIC regular interests on Schedule D of Form 1120, then this amount would be reported on Schedule M-3, line 23b, Gross capital gains from Schedule D, excluding amounts from pass-through entities.

  • Line 24. Disallowed Capital Loss in Excess of Capital Gains

Q-035. When subsidiaries of a U.S. consolidated tax group have net capital losses in excess of their net capital gains on a stand alone basis, can these subsidiaries show on their separate entity Schedule M-3, Part II, line 24 the disallowed capital loss in excess of capital gains? In turn, the consolidating Schedule M-3 would reflect the sum of these separate entities disallowance amounts as being eliminated and the correct consolidated disallowance amount would be determined and reported on Part II, line 24, column (d). What amounts get reported on Part II, lines 23 – 25 on a separate entity and consolidating Schedule M-3?

A. The Form 1120 Schedule M-3 instructions state that any adjustment made at the consolidated group level that are not attributable to any specific member of the U.S. consolidated tax group (e.g. disallowance of net capital losses, contribution deduction carryovers, and limitation of contribution deductions) must not be reported on the separate Schedule M-3 but rather on the consolidating Schedule M-3 for consolidation eliminations.

Part II, line 23a column (a) on a separate entity schedule M-3 would reflect all gains and losses on that entity’s disposition of assets except for (a) gains and losses on the disposition of inventory, and (b) gains and losses allocated to the corporation from a flow-through entity (e.g., on Schedule K-1) that are included in the net income (loss) per income statement (or books and records, if applicable) of includible corporations reported on Part I, line 11. Reverse the amount reported in column (a) in column (b) or (c), as applicable. The gains and losses reportable for U.S. federal income tax purposes are reported on Part II, lines 23b through 23g, as applicable.

Part II, lines 24 and 25 are not utilized for Schedule M-3’s of separate entities included in a consolidated tax group.

The consolidating Schedule M-3 for consolidation eliminations would reflect, for the entire consolidated group, the appropriate total disallowance of capital losses in excess of capital gains and the total utilization of capital loss carry forwards on Part II, lines 24 and 25, as applicable.

  • Line 25. Utilization of Capital Loss Carryforward
  • Line 26. Other Income (Loss) Items with Differences

Q-058. For GAAP purposes, a Sales Returns and Allowances reserve is considered a contra-revenue account (i.e. a reduction to sales revenue not an expense). The change in this reserve is a book/tax difference. Should this difference be reflected on Part II, line 20, Unearned/Deferred revenue, Part II, line 26, Other income(loss) with differences, or Part III, line 35, Other expense/deduction items with differences?  Part II, line 26, Part III, line 35 and Part II, line 20.

A. The contra account may either be reported on Part II, line 26 Other income(loss) with differences, or Part III, line 35, Other expense/deduction items with differences. This type of reserve account is not of the type that would be reported on Part II, line 20, Unearned/Deferred revenue.

  • Line 28. Total Expense/Deduction Items
  • Line 29. Other Income/Loss and Expense/Deduction Items with No Differences

Q-059. Example 23 of the instructions states that “Q must separately state and adequately disclose on Part II, line 29, Other income (loss) and expense/deduction items with no differences, its prepaid advertising…”. Is a supporting schedule required to be attached for Part II, line 29, Other income (loss) and expense/deduction items with no differences? Part II, line 29

A. No. A supporting schedule is not required to be attached for Part II, line 29.

  • Line 30. Reconciliation Totals
  • Part III. Reconciliation of Net Income (Loss) per Income Statement of Includible Corporations with Taxable Income per Return - Expense/Deduction Items
  • Lines 1 Through 6. Income Tax Expense

Q-020. Must Part III, Lines 1-6, regarding current and deferred U.S., state, and foreign income taxes, be completed by each member of the U.S. consolidated tax group?

A. No. Part III, Lines 1-6, must be completed in accordance with how tax expense is expressed in the financial statements (or the books and records, if applicable) of the members of the U.S. consolidated tax group and reported on Part I, Line 11, and consequently, Part II, Line 30, Column (a). Because Part I, Line 11, is an amount of consolidated net income after tax per the financial statements (or the books and records, if applicable), and because each corporation included in the U.S. consolidated tax group must complete its own Schedule M-3, Part III, Lines 1 through 6 must report in each corporation's Schedule M-3 what has been included in Part I, Line 11, and Part II, Line 30, Column (a). In circumstances, for example, where the current and deferred U.S., state, and foreign income tax expense for the U.S. consolidated tax group is not shared or allocated among all members of the U.S. consolidated tax group but is retained in the parent company's financial statements (or books and records, if applicable), then only the parent company is required to report amounts in Part III, Lines 1 through 6, of its own Schedule M-3.

Q-066. If a taxpayer reports a combined amount in its financial statements for federal and state deferred tax expense, is it required to split this amount for reporting on Schedule M-3?

A. Yes. The taxpayer must separately report the appropriate amounts on Part III, line 2 and line

  • Line 7. Foreign Withholding Taxes
  • Line 8. Interest Expense
  • Line 9. Stock Option Expense

Q-067. The instructions for Schedule M-3, Part III, Line 10, Other equity based compensation, provide examples of amounts reportable on line 10. These examples include payments attributable to employee stock purchase plans (ESPP). It would appear, however, from the language of §423 that an ESPP is a stock option plan. Should amounts related to an ESPP be reported on Part III, line 9, Incentive stock options or Line 10, Other equity based compensation?

A. Amounts attributable to employee stock purchase plans should be reported on Part III, line 10, Other equity based compensation.

  • Line 10. Other Equity-Based Compensation

Q-021. What must be included on Part III, Line 10, Other equity-based compensation?

A. Any amounts for equity-based compensation other than incentive and nonqualified stock option compensation (reported on Part III, Line 8 and 9, respectively) including, for example, compensation attributable to employee stock purchase plans (ESPPs), phantom stock options, phantom stock units, stock warrants, stock appreciation rights, and restricted stock must be included on Part III, Line 10.

Q-067. The instructions for Schedule M-3, Part III, Line 10, Other equity based compensation, provide examples of amounts reportable on line 10. These examples include payments attributable to employee stock purchase plans (ESPP). It would appear, however, from the language of §423 that an ESPP is a stock option plan. Should amounts related to an ESPP be reported on Part III, line 9, Incentive stock options or Line 10, Other equity based compensation? 

A. Amounts attributable to employee stock purchase plans should be reported on Part III, line 10, Other equity based compensation.

  • Line 11. Meals and Entertainment
  • Line 12. Fines and Penalties
  • Line 13. Judgments, Damages, Awards, and Similar Costs
  • Line 14. Parachute Payments
  • Line 15. Compensation with Section 162(m) Limitation

Q-054. Should compensation of any individual who would be subject to §162(m) be reported on Part III, line 15, column (a), Compensation with section 162(m) limitation, regardless of whether or not the $1 million threshold is met? Or should only the compensation that is in fact limited by §162(m) be reported on this line in column (a)?

A. Total compensation of any individual who is subject to §162(m), even if not limited, should be reported on Part III, line 15, column (a). Report in column (b) or (c), as applicable, the total amount of all current compensation included in column (a) that is not deductible pursuant to §162(m).

  • Line 16. Pension and Profit-Sharing
  • Line 17. Other Post-Retirement Benefits
  • Line 18. Deferred Compensation

Q-033. Please clarify exactly what is to be included on Part III, line 18, Deferred compensation. The line title indicates "Deferred Compensation" while the instructions seem to imply that more than just deferred compensation could ultimately be reported on this line. 

A. Report on Part III, line 18, only deferred compensation expense not reported elsewhere on Schedule M-3.

Q-071. The draft instructions for the 2005 version of Schedule M-3 have been made public. May taxpayers use those draft instructions in completing a 2004 Schedule M-3?

A. Taxpayers may use the draft instructions for the 2005 version of Schedule M-3 in completing a 2004 Schedule M-3 for the following items only:

  • Part I, line 1, Questions Regarding the Type of Income Statement Prepared – The draft 2005 Instructions state that if the corporation does not prepare financial statements, check Part I, line 1c “No” and report the net income (loss) per the books and records of the U.S. corporation or the U.S. consolidated tax group on Part I, line 4, Worldwide consolidated net income (loss) from income statement source identified in Part I, line 1. Instructions for 2004 Schedule M-3 required that such amount be reported on Part I, line 11. If the corporation does not prepare financial statements, the taxpayer may choose to report the net income (loss) per the books and records according to either the 2004 Instructions or the draft 2005 Instructions in completing the 2004 Schedule M-3.

  • Part I, line 2, Question regarding income statement period and restatements – The draft 2005 Instructions clarify the information required to be included on the statement for Part I, line 2. The requirements in either the 2004 Instructions or the draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part I, line 8, Adjustments to Eliminations of Transactions Between Includible Corporations and Nonincludible Entities – The 2005 Instructions clarify the reporting of adjustments to consolidation and eliminations entries that are contained on Part I, line 4, required as a result of removing amounts on Part I, lines 5 or 6, and amounts of any additional consolidation and elimination entries that are required either as a result of including amounts on Part I, line 7, or to otherwise arrive at the correct amount required to be reported on Part I, line 11. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part I, line 10, Other Adjustments Required To Reconcile to Amount on Line 11 - The draft 2005 Instructions clarify that intercompany dividends received by includible insurance companies, to the extent required by law to be included in statutory accounting net income, should be included on Part I, line 10. In addition, the information required to be included on the schedule required to be attached for amounts on this line has been changed. The taxpayer may choose to configure the attached schedule as described in the 2004 Instructions or the draft 2005 Instructions in completing the 2004 Schedule M-3.

  • Completion of Schedule M-3, Part II and Part III – The 2004 Instructions were not clear as to whether the required line item detail for Part II and Part III of Schedule M-3 had to be attached only for the Consolidated Part II and Part III, only for each separate entity included in the Consolidated Part II and Part III, or both. The draft 2005 Instructions clarify that all required line item detailed schedules for Part II and Part III of Schedule M-3 must be attached for each separate entity included in the Consolidated Part II and Part III, and do not require that the same supporting detailed information be presented on the Consolidated Part II and Part III. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part II, line 20 Unearned/Deferred Revenue – The draft 2005 Instructions clarify what amounts are to be included on Part II, line 20. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Part III, line 18, Deferred Compensation - The draft 2005 Instructions clarify what amounts are to be included on Part III, line 18. The draft 2005 Instructions may be used in completing the 2004 Schedule M-3.

  • Line 19. Charitable Contribution of Cash and Tangible Property
  • Line 20. Charitable Contribution of Intangible Property
  • Line 21. Charitable Contribution Limitation/Carryforward
  • Line 22. Domestic Production Activities Deduction
  • Line 23. Current Year Acquisition or Reorganization Investment Banking Fees
  • Line 24. Current Year Acquisition or Reorganization Legal and Accounting Fees
  • Line 25. Current Year Acquisition/Reorganization Other Costs
  • Line 26. Amortization/Impairment of Goodwill
  • Line 27. Amortization of Acquisition, Reorganization, and Start-Up Costs
  • Line 28. Other Amortization or Impairment Write-Offs

Q-045. Does computer software amortization go on Part III, line 28, Other amortization or impairment write-offs?

A. Yes. Report on line 28 any amortization not otherwise includible on Schedule M-3.

  • Line 29. Section 198 Environmental Remediation Costs

Q-034. Should Section 198 costs or any type of environmental costs be reported on Part III, line 29, Section 198 Environmental Remediation Costs?

A. Only Section 198 costs are to be reported on this line.

Q-072. State insurance regulators have prescribed rules for determining when a security is impaired for book accounting purposes. Are these impairment charges reported on Part III, line 28, Other amortization or impairment write-offs?

A. If the impairment charges are not substantively the same as a requirement to mark securities to market value, report such impairment charges on Part III, line 28, other amortization or impairment write-offs. However, if such charges must be accrued on a regular basis (monthly, quarterly, annually, for example), and are more in the substantive nature of regularly marking the values of securities to their current market value, report all such charges on Part II, line 16, Mark to market income (loss).

  • Line 30. Depletion
  • Line 31. Depreciation
  • Line 32. Bad Debt Expense

Q-079. A calendar year end Corporation A sets up a Reserve for Bad debts for financial statement purposes during 2004. For tax purposes, a temporary book-tax difference is reported on Schedule M-3, Part III, line 32, column (b) for the entire amount of the reserve. During 2005, Corporation A determines that the Reserve for Bad Debt is no longer needed. For financial statement purposes, Corporation A closes the reserve by recording Miscellaneous Income. For tax purposes, a book-tax difference needs to be reported. Should the reversal of a reserve into income be reported on the same line as the originating temporary difference, Part III, line 32, Bad debt expense, or should it be reported on Part II, line 26, Other income (loss) items with differences?

A. As a general rule, the reversal of a temporary difference should be reported on the same line as the originating difference.

  • Line 33. Corporate Owned Life Insurance Premiums
  • Line 34. Purchase Versus Lease (for Purchasers and/or Lessees)
  • Line 35. Other Expense/Deduction Items with Differences

Q-058. For GAAP purposes, a Sales Returns and Allowances reserve is considered a contra-revenue account (i.e. a reduction to sales revenue not an expense). The change in this reserve is a book/tax difference. Should this difference be reflected on Part II, line 20, Unearned/Deferred revenue, Part II, line 26, Other income(loss) with differences, or Part III, line 35, Other expense/deduction items with differences? Part II, line 26, Part III, line 35 and Part II, line 20.

A. The contra account may either be reported on Part II, line 26 Other income(loss) with differences, or Part III, line 35, Other expense/deduction items with differences. This type of reserve account is not of the type that would be reported on Part II, line 20, Unearned/Deferred revenue.

Q-080. There are various tax credits that reduce the otherwise allowable deduction of an expense by the amount of the credit. May this deduction reduction amount be reported on Part III, line 35, Other expense/deduction items with differences regardless of whether the deduction amount is prescribed in Part III, line 1-34? If the deduction reduction is reported on Part III, line 35, what amount should be reported in column (a)? Is the deduction reduction reported in column (b) or column (c)?

A. It is equally acceptable to report the deduction reduction amount on Part III, line 35 or to include the amount on the prescribed line, if applicable, on Part III. If the taxpayer chooses to report the amount on Part III, line 35, the amount must be separately stated and adequately described on the required attachment. To accomplish this, a cross reference to the related deduction must be identified. If the deduction reduction is reported on Part III, line 35, the taxpayer would leave Part III, line 35, column (a), blank.

The deduction reduction is reported in column (b) or (c) as appropriate, but would probably most often be reported in column (c) as a permanent difference.

For example, the deduction for pension startup costs is reduced if a taxpayer claims a credit on Form 8881. The taxpayer can report as a negative number the amount of the reduction to the deduction on Part III, line 35, and attach a schedule that separately states this item and refers to the pension start up costs. The taxpayer would leave Part III, line 35, column (a), blank.

Alternatively, if the pension startup costs are reported as part of the Pension and profit-sharing expense/deduction at Part III, line 16, the reduction to the deduction could be reported on Part III, line 16, Pension and profit-sharing. The deduction reduction would probably be reported as a permanent difference.

 

 

Page Last Reviewed or Updated: 16-Jan-2014