General Instructions

Applicable schedule and instructions.   Use the 2014 Schedule M-3 (Form 1065) with these instructions for tax years ending December 31, 2014, through December 30, 2015. For previous tax years, see the applicable Schedule M-3 (Form 1065) and instructions. (For example, use the 2013 Schedule M-3 (Form 1065) with the 2013 instructions for tax years ending December 31, 2013, through December 30, 2014.)

Forms 1065 and 1065-B.   Schedule M-3 (Form 1065) is filed with Forms 1065, U.S. Return of Partnership Income, and 1065-B, U.S. Return of Income for Electing Large Partnerships. Line references to these returns are the same unless otherwise noted.

Purpose of Schedule

Schedule M-3, Part I, asks certain questions about the partnership's financial statements and reconciles financial statement net income (loss) for the consolidated financial statement group to income (loss) per the income statement for the partnership.

Schedule M-3, Parts II and III, reconcile financial statement net income (loss) for the partnership (per Schedule M-3, Part I, line 11) to line 1 of the Analysis of Net Income (Loss) found on Form 1065 and Form 1065-B.

Where To File

If the partnership is required to file (or voluntarily files) Schedule M-3 (Form 1065), the partnership must file Form 1065 or Form 1065-B and all attachments and schedules, including Schedule M-3 (Form 1065), at the following address.  
 
 
Department of the Treasury  
Internal Revenue Service Center  
Ogden, UT 84201-0011

Who Must File

Any entity that files Form 1065 or Form 1065-B must file Schedule M-3 (Form 1065), if any of the following is true:

  1. The amount of total assets at the end of the tax year reported on Schedule L, line 14, column (d), is equal to $10 million or more.

  2. The amount of adjusted total assets for the tax year is equal to $10 million or more. See Total Assets and Adjusted Total Assets, below.

  3. The amount of total receipts for the tax year is equal to $35 million or more. Total receipts is defined in the instructions for Codes for Principal Business Activity and Principal Product or Service in the Instructions for Form 1065 or Instructions for Form 1065-B.

  4. An entity that is a reportable entity partner with respect to the partnership (as defined under these instructions) owns or is deemed to own, directly or indirectly, an interest of 50% or more in the partnership's capital, profit, or loss, on any day during the tax year of the partnership.

A common trust fund or foreign partnership must file Schedule M-3 if it meets any of the tests discussed above.

Note.

All references to a U.S. partnership in these instructions refer to any entity required to file Schedule M-3 (Form 1065), where appropriate.

Partnerships not required to file Schedule M-3 may voluntarily file Schedule M-3.

Completing Schedule M-3 (Form 1065)

Form 1065 and Form 1065-B filers that are required to file Schedule M-3 (Form 1065) and have at least $50 million total assets at the end of the tax year must complete Schedule M-3 (Form 1065) entirely.

Form 1065 and Form 1065-B filers that (a) are required to file Schedule M-3 (Form 1065) and have less than $50 million total assets at the end of the tax year or (b) are not required to file Schedule M-3 (Form 1065) and voluntarily file Schedule M-3 (Form 1065) must either (i) complete Schedule M-3 (Form 1065) entirely or (ii) complete Schedule M-3 (Form 1065) through Part I and complete Form 1065, Schedule M-1 instead of completing Parts II and III of Schedule M-3 (Form 1065). If the filer chooses to complete Form 1065, Schedule M-1 instead of completing Parts II and III of Schedule M-3 (Form 1065), line 1 of Form 1065, Schedule M-1 must equal line 11 of Part I of Schedule M-3 (Form 1065).

For any part of Schedule M-3 (Form 1065) that is completed, all columns must be completed, all applicable questions must be answered, all numerical data requested must be provided, any statement required to support a line item must be attached and provide the information required for that line item. Any partnership required to file Schedule M-3 must check all boxes above Part I that apply for the reason(s) for which the Schedule M-3 is required to be filed. A partnership not required to file Schedule M-3, but that is doing so voluntarily, should check box E above Part I.

Note. For tax years ending before December 31, 2014, there were different completion rules. See the applicable Schedule M-3 (Form 1065) and its instructions.

Total Assets and Adjusted Total Assets

The partnership should figure its adjusted total assets using the Adjusted Total Assets Worksheet, below.

For purposes of determining for Schedule M-3 whether the partnership's adjusted total assets (under these instructions) equal $10 million or more, the partnership's total assets at the end of the tax year must be determined on an overall accrual method of accounting unless both of the following apply: (a) the tax return of the partnership is prepared using an overall cash method of accounting, and (b) the partnership does not prepare financial statements using, and is not included in financial statements prepared on, an accrual basis.

See the instructions for Schedule M-3, Part I, line 1, regarding non-tax-basis income statements and related non-tax-basis balance sheets to be used in the preparation of Schedule M-3 and the related non-tax-basis balance sheets to be used in the preparation of Schedule L.

In the case of a partnership year ending because of a section 708 termination (sale or exchange within a 12-month period of 50% or more of the partnership interest in income and capital), the total assets of the partnership at the end of the year for determining the requirement to file Schedule M-3 are determined immediately before the section 708 termination and any actual or deemed contribution or distribution of the partnership assets under the provisions of section 708. 
 
 

Example 1.

  1. U.S. partnership A, a limited liability company (LLC), owns 60% of the income and capital of U.S. partnership B, also an LLC. For its 2014 tax year ending December 31, 2014, A prepares non-tax-basis GAAP (generally accepted accounting principles) consolidated financial statements with B that report total assets at the end of the year of $12 million. For 2014, A files Form 1065 and reports on its non-tax-basis unconsolidated GAAP Schedule L total assets at the end of the year of $7 million. The $7 million total includes $3 million for its investment in B under the equity method of accounting. The amount of total liabilities at the end of 2014 reported to A's partners on Schedules K-1 is $5 million. A made distributions of $1 million during 2014 reflected on Schedule M-2, line 6. The amount of A's adjusted total assets is $8 million for the 2014 tax year. A has total receipts for the 2014 tax year of $15 million. A has no reportable entity partners (as defined under Reportable Entity Partner Reporting Responsibilities, later). A is not required to file Schedule M-3 under any of the four tests discussed earlier. A may voluntarily file Schedule M-3 for the 2014 tax year. If A does not file Schedule M-3, it must complete Schedule M-1. If A files Schedule M-3, it must either: (i) complete Schedule M-3 entirely; or (ii) complete Schedule M-3 through Part I and complete Schedule M-1 instead of completing Parts II and III of Schedule M-3.

  2. Same facts as in Example 1.1 except that A has total receipts for 2014 of $40 million. A must file Schedule M-3 for 2014 and either: (i) complete Schedule M-3 entirely; or (ii) complete Schedule M-3 through Part I and complete Schedule M-1 instead of completing Parts II and III of Schedule M-3.

  3. R, a U.S. partnership, files Form 1065 for the tax year ending December 31, 2014. R has total assets at the end of 2014 reported on Schedule L, line 14, column (d), of $7.5 million. The aggregate amount of total liabilities at the end of 2014 reported to R's partners on Schedules K-1 is $5 million. R made distributions of $3 million during 2014 reflected on Schedule M-2, line 6. R did not report a loss for 2014 on Schedule M-2, line 3. R did not report adjustments to capital on Schedule M-2, lines 4 or 7. R has adjusted total assets for 2014 in the tentative amount of $10.5 million, the sum of $7.5 million plus $3 million (the amount of distributions that must be added back to determine adjusted total assets for 2014), an amount that is not less than the total liabilities at the end of 2014 reported to R's partners on Schedules K-1. Because R has adjusted total assets of $10 million or more for its tax year ending December 31, 2014, R must file Schedule M-3 for 2014 and either: (i) complete Schedule M-3 entirely; or (ii) complete Schedule M-3 through Part I and complete Schedule M-1 instead of completing Parts II and III of Schedule M-3.

  4. Same facts as in Example 1.3 except that the amount of total liabilities at the end of 2014 reported to R's partners on Schedules K-1 is $11 million. R made distributions of $1.5 million during 2014 as reflected on Schedule M-2, line 6. R has adjusted total assets for 2014 equal to $11 million, the greater of the tentative amount of $9 million, the sum of $7.5 million plus $1.5 million (the amount of distributions that must be added back to determine adjusted total assets for 2014), or $11 million (the amount of the total liabilities at the end of 2014 reported to R's partners on Schedules K-1). Because R has adjusted total assets of $10 million or more for its tax year ending December 31, 2014, R must file Schedule M-3 for 2014 and either: (i) complete Schedule M-3 entirely; or (ii) complete Schedule M-3 through Part I and complete Schedule M-1 instead of completing Parts II and III of Schedule M-3.

  5. S, a U.S. partnership, files Form 1065 for the tax year ending December 31, 2014. S has total assets at the end of 2014 reported on Schedule L, line 14, column (d), of $7.5 million. The amount of total liabilities at the end of 2014 reported to S's partners on Schedules K-1 is $5 million. S made no distributions during 2014 reflected on Schedule M-2, line 6. S reported a loss of ($3 million) for 2014 on Schedule M-2, line 3. S did not report adjustments to capital on Schedule M-2, lines 4 or 7. S has adjusted total assets for 2014 in the tentative amount of $10.5 million, the sum of $7.5 million plus $3 million (the amount of the loss stated as a positive amount that must be added back to determine adjusted total assets for 2014). This tentative amount is compared to the total liabilities at the end of 2014 as reported to S's partners on Schedules K-1, and the greater of the two amounts is considered the adjusted total assets. Because S has adjusted total assets of $10 million or more for its tax year ending December 31, 2014, S must file Schedule M-3 for 2014 and either: (i) complete Schedule M-3 entirely; or (ii) complete Schedule M-3 through Part I and complete Schedule M-1 instead of completing Parts II and III of Schedule M-3.

  6. T, a U.S. partnership, files Form 1065 for the tax year ending December 31, 2014. T has total assets at the end of 2014 reported on Schedule L, line 14, column (d), of $7.5 million. The amount of total liabilities at the end of 2014 reported to T's partners on Schedules K-1 is $5 million. T made no distributions during 2014 reflected on Schedule M-2, line 6. T did not report a loss for 2014 on Schedule M-2, line 3. T did not report adjustments to capital on Schedule M-2, line 7, but did report a negative adjustment of ($3 million) on Schedule M-2, line 4. T has adjusted total assets for 2014 in the tentative amount of $10.5 million, the sum of $7.5 million plus $3 million (the amount of the negative adjustment stated as a positive amount that must be added back to determine adjusted total assets for 2014), an amount that is not less than the total liabilities at the end of 2014 reported to T's partners on Schedules K-1. Because T has adjusted total assets of $10 million or more for its tax year ending December 31, 2014, T must file Schedule M-3 for 2014 and either: (i) complete Schedule M-3 entirely; or (ii) complete Schedule M-3 through Part I and complete Schedule M-1 instead of completing Parts II and III of Schedule M-3.

  7. Z has $50 million in total assets at the end of its 2014 tax year ending December 31, 2014, and files Form 1065. Z must file Schedule M-3 and complete it entirely.

Adjusted Total Assets Worksheet

1. Enter total assets at the end of the tax year on Schedule L, line 14, column (d) 1.  
2. Enter capital distributions on Schedule M-2, lines 6a and 6b (shown as a positive amount) 2.  
3. Enter any loss reported on Schedule M-2, line 3 (shown as a positive amount) 3.  
4. Enter the amount of any positive adjustment on Schedule M-2, line 7 4.  
5. Enter the amount of any negative adjustment on Schedule M-2, line 4 (shown as a positive amount) 5.  
6. Add lines 1 through 5 6.  
7. Enter combined total liabilities (recourse and nonrecourse) on all Schedules K-1 (Form 1065), Part II, Item K, or Schedules K-1 (Form 1065-B) 7.  
8. Adjusted Total Assets. Enter the greater of line 6 or line 7 8.  
Note: For line 2 above, if the partnership reflects partner capital account changes resulting from the sale of a partnership interest on Schedule M-2 as matching contributions and distributions (on lines 2a and 2b and on lines 6a and 6b, respectively), reduce the amounts shown on lines 6a and 6b by such matching amounts.

Reportable Entity Partner Reporting Responsibilities

For the purposes of these instructions, a reportable entity partner with respect to a partnership filing Form 1065 or Form 1065-B is an entity that:

  • Owns or is deemed to own, directly or indirectly, under these instructions, a 50% or greater interest in the income, loss, or capital of the partnership on any day of the tax year, and

  • Was required to file Schedule M-3 on its most recently filed U.S. federal income tax return or return of income filed prior to that day.

For the purposes of these instructions, the following rules apply.

  1. The parent corporation of a consolidated tax group is deemed to own all corporate and partnership interests owned or deemed to be owned under these instructions by any member of the tax consolidated group.

  2. The owner of a disregarded entity is deemed to own all corporate and partnership interests owned or deemed to be owned under these instructions by the disregarded entity.

  3. The owner of 50% or more of a corporation by vote on any day of the corporation tax year is deemed to own all corporate and partnership interests owned or deemed to be owned under these instructions by the corporation during the corporation tax year.

  4. The owner of 50% or more of partnership income, loss, or capital on any day of the partnership tax year is deemed to own all corporate and partnership interests owned or deemed to be owned under these instructions by the partnership during the partnership tax year.

  5. The beneficial owner of 50% or more of the beneficial interest of a trust or nominee arrangement on any day of the trust or nominee arrangement tax year is deemed to own all corporate and partnership interests owned or deemed to be owned under these instructions by the trust or nominee arrangement.

A reportable entity partner with respect to a partnership (as defined above) must report the following to the partnership within 30 days of first becoming a reportable entity partner and, after first reporting to the partnership under these instructions, thereafter within 30 days of the date of any change in the interest it owns or is deemed to own, directly or indirectly, under these instructions, in the partnership.

  1. Name.

  2. Mailing address.

  3. Employer identification number (EIN), if applicable.

  4. Entity or organization type.

  5. State or country in which it is organized.

  6. Date on which it first became a reportable entity partner.

  7. Date with respect to which it is reporting a change in its ownership interest in the partnership, if applicable.

  8. The interest in the partnership it owns or is deemed to own in the partnership, directly or indirectly (as defined under these instructions) as of the date with respect to which it is reporting.

  9. Any change in that interest as of the date with respect to which it is reporting.

The reportable entity partner must retain copies of required reports it makes to partnerships under these instructions. Each partnership must retain copies of the required reports it receives under these instructions from reportable entity partners.

For more information, see Item D. Reportable Entity Partner, below.

Example 2.

  1. P, a U.S. corporation, is the parent of a financial consolidation group with 50 domestic subsidiaries, DS1 through DS50, and 50 foreign subsidiaries, FS1 through FS50, all 100% owned on September 16, 2014. On September 15, 2014, P filed a consolidated tax return on Form 1120 and was required to file Schedule M-3 for the tax year ending December 31, 2013. On September 16, 2014, DS1, DS2, DS3, FS1, and FS2 each acquire a 10% partnership interest in partnership K, which files Form 1065 for the tax year ending December 31, 2014. P is deemed to own, directly or indirectly, under these instructions, all corporate and partnership interests of DS1, DS2, and DS3, as the parent of the tax consolidation group, and therefore is deemed to own 30% of K on September 16, 2014. P is deemed to own, directly or indirectly, under these instructions all corporate and partnership interests of FS1 and FS2 as the owner of 50% or more of each corporation by vote and therefore is deemed to own 20% of K on September 16, 2014. P is therefore deemed to own 50% of K on September 16, 2014. P owns or is deemed to own, directly or indirectly, under these instructions 50% or more of K on September 16, 2014, and was required to file Schedule M-3 on its most recently filed U.S. income tax return filed before that date. Therefore, P is a reportable entity partner of K as of September 16, 2014. On October 5, 2014, P reports to K, as it is required to do, that P is a reportable entity partner as of September 16, 2014, deemed to own under these instructions a 50% interest in K. K is therefore required to file Schedule M-3 when it files its Form 1065 for its tax year ending December 31, 2014.

  2. Throughout 2014, A, a limited liability company (LLC) filing Form 1065 for calendar year 2014, owns, as its only asset, 50% of each of B, C, D, and E, each also an LLC filing Form 1065 for calendar year 2014. A is owned by individuals and S corporations not required to file Schedule M-3 for 2013, 2014, or 2015. B, C, D, and E are owned by A and by individuals and S corporations not required to file Schedule M-3 for 2013, 2014, or 2015. For the partnership tax years ending December 31, 2014, each of B, C, D, and E has no year-end liabilities, $3 million in total assets and $6 million in adjusted total assets (the difference equal to the distributions by each in 2014), and 2014 total receipts of $20 million. As of December 31, 2014, no owner, direct or indirect, of B, C, D, or E was required to file Schedule M-3 on its most recently filed U.S. income tax return or return of income. Neither B, C, D, or E is required to file Schedule M-3 for 2014. For the partnership tax year ending December 31, 2014, A has no year-end liabilities, $6 million in total assets and $12 million in adjusted total assets (the difference equal to the distributions in 2014), and 2014 total receipts of $6 million. As of December 31, 2014, no owner, direct or indirect, of A was required to file Schedule M-3 on its most recently filed U.S. income tax return. A must file Schedule M-3 when it files its Form 1065 for 2014 because A has adjusted total assets of $10 million or more.

  3. Same ownership facts as in Example 2.2 continued to calendar year 2015. On March 3, 2015, A files its Form 1065 with Schedule M-3 for the partnership tax year ended December 31, 2014. As of March 4, 2015, A becomes a reportable entity partner with respect to any partnership in which it owns or is deemed to own, directly or indirectly, under these instructions a 50% or greater interest in the income, loss, or capital of the partnership. A owns 50% of each of B, C, D, and E and is therefore a reportable entity partner with respect to each as of March 4, 2015, the day after it filed its 2014 Form 1065 with a required Schedule M-3. On March 20, 2015, A reports to B, C, D, and E, as it is required to do within 30 days of March 4, that it is a reportable entity partner owning a 50% interest. Each of B, C, D, and E is required to file Schedule M-3 for 2015 because each has a reportable entity partner. A will determine if it must file Schedule M-3 for 2015 based on its separate facts for 2015.

  4. Same ownership facts as in Example 2.2 for calendar year 2014 except that A is owned 50% by corporation Z that was first required to file Schedule M-3 for its corporate tax year ended December 31, 2013, and that filed its Form 1120 with Schedule M-3 for 2013 on September 15, 2014. As of September 16, 2014, Z was a reportable entity partner with respect to A and, through A, with respect to B, C, D, and E. On October 5, 2014, Z reports to A, B, C, D, and E, as it is required to do within 30 days of September 16, that Z is a reportable entity partner directly owning (with respect to A) or deemed to own indirectly (with respect to B, C, D, and E) a 50% interest. Therefore, because Z was a reportable entity partner for 2014, each of A, B, C, D, and E is required to file Schedule M-3 for 2014, regardless of whether they would otherwise be required to file Schedule M-3 for that year.

Other Form 1065 Schedules Affected by Schedule M-3 Requirements

Schedule L

If a non-tax-basis income statement and related non-tax-basis balance sheet are prepared for any purpose for a period ending with or within the tax year, Schedule L must be prepared showing non-tax-basis amounts. See the discussion in the instructions for Schedule M-3, Part I, line 1, of non-tax-basis income statements and related non-tax-basis balance sheets prepared for any purpose and the impact on the selection of the income statement used for Schedule M-3 and the related non-tax-basis balance sheet amounts that must be used for Schedule L.

Total assets at the end of the tax year shown on Schedule L, line 14, column (d), must equal the total assets of the partnership as of the last day of the tax year, and must be the same total assets reported by the partnership in the non-tax-basis financial statements, if any, used for Schedule M-3. If the partnership prepares non-tax-basis financial statements, Schedule L must report the non-tax-basis financial statement total assets. If the partnership does not prepare non-tax-basis financial statements, Schedule L must be based on the partnership's books and records. The Schedule L balance sheet can show tax-basis balance sheet amounts if the partnership is allowed to use books and records for Schedule M-3 and the partnership's books and records reflect only tax-basis amounts.

Generally, total assets at the beginning of the year (Schedule L, line 14, column (b)) must equal total assets at the close of the prior year (Schedule L, line 14, column (d)). For each Schedule L balance sheet item reported for which there is a difference between the current opening balance sheet amount and the prior closing balance sheet amount, attach a statement that reports the balance sheet item, the prior closing amount, the current opening amount, and a short explanation of the change. Such reasons for these differences include technical terminations and mergers.

For purposes of measuring total assets at the end of the year, the partnership's assets may not be netted or reduced by partnership liabilities. In addition, total assets may not be reported as a negative amount. If Schedule L is prepared on a non-tax-basis method, an investment in another partnership may be shown as appropriate under the partnership's non-tax-basis method of accounting, including, if required by the partnership's reporting methodology, the equity method of accounting for investments. If Schedule L is prepared on a tax-basis method, an investment by the partnership in another partnership must be shown as an asset and measured by the partnership's adjusted basis in its partnership interest. Any liabilities contributing to such adjusted basis must be shown on Schedule L as partnership liabilities.

Example 3.

A, a limited liability company (LLC), files Form 1065 for calendar year 2014. B, a general partnership, also files Form 1065 for calendar year 2014. A is a general partner in B. A's capital account in B at the close of 2014 is negative $4 million. This reflects A's 2014 contribution to B's capital of $2 million reduced by A's share of 2014 losses passing through to it from B, $6 million. A's adjusted basis in B at December 31, 2014, is $16 million, its $4 million negative tax capital account in B plus its $20 million share of B's liabilities under section 752. A prepares only tax-basis income statements and balance sheets. On its Schedule L, A reports as an asset the adjusted basis of its investment in B, $16 million. A also reports its $20 million share of B's liabilities in the liabilities section of Schedule L. A does not report its $4 million negative capital account in B on Schedule L.

Example 4.

Same facts as in Example 3, except that B is an LLC and A is a member of B. None of B's liabilities are recourse with respect to A. A is not obligated to restore any deficit capital account in B. A prepares non-tax-basis income statements and balance sheets under an accounting method that requires the use of the equity method of accounting to account for its investment in B. On its non-tax-basis books and records, A initially reports $2 million as its investment in B, the amount of A's capital contribution. A then reduces its $2 million investment in B by its share of B's allocable losses. Because A's allocable share of B's losses is $6 million, A's investment in B under the equity method is reduced to $0. Because A is not liable to repay any of B's liabilities and is not obligated to restore any deficit with respect to its capital account in B, A does not report any of B's liabilities on A's Schedule L balance sheet.

Entity Considerations for Schedule M-3

For purposes of Schedule M-3, references to the classification of an entity (for example, as a corporation, a partnership, or a trust) are references to the treatment of the entity for U.S. income tax purposes. An entity that generally is disregarded as separate from its owner for U.S. income tax purposes (disregarded entity) must not be separately reported on Schedule M-3 except, if required, on Part I, line 7a or 7b. On Schedule M-3, Parts II and III, any item of income, gain, loss, deduction, or credit of a disregarded entity must be reported as an item of its owner. In particular, the income or loss of a disregarded entity must not be reported on Part II, lines 7, 8, or 9 as from a separate partnership or other pass-through. The financial statement income or loss of a disregarded entity is included on Part I, line 7a or 7b, only if its financial statement income or loss is included on Part I, line 11, but not on Part I, line 4a.


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