Form 1120 Schedule M-3

Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Form 1120 Schedule M-3 Presented by: Melissa Horne Smith & Howard, PC January 20, 2006 Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Purpose of Schedule • Increase transparency between financial accounting net income and taxable income • Identify aggressive transactions that may have occurred • Identify high-risk taxpayers to be audited by IRS • Increase the efficiency of IRS audits Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Who Must File Schedule M-3 • Any domestic corporation or U.S. consolidated tax group with total assets that equal or exceed $10 million. – This is the same criteria used to determine whether a corporation is within the jurisdiction of the IRS’ Large and Mid-Size Business Division (LMSB). Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Basis of Accounting for Determination of Total Assets • Total Assets must be determined based on the Accrual Method unless both of the following apply: – The tax return or returns of all includible corporations in the U.S. consolidated tax group are prepared using an overall cash method of accounting, and – No includible corporation in the U.S. consolidated tax group prepares or is included in the financial statements prepared on an accrual basis. Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Tax Return (Schedule L) previously reported on Cash Basis when Accrual basis Financials prepared under GAAP • Beginning Balance Sheet on tax return should not be restated • Any difference between beginning tax basis retained earnings and beginning GAAP basis retained earnings as reported on the Financial Statements should be reported on Schedule M-2 as a reconciling amount and an explanation provided Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 What does the Schedule M-3 Look Like? Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Schedule M-3, Part I Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Part 1 – Financial Information and Net Income Reconciliation • Source of financial information – SEC Form 10-K – Certified Audited Income Statement – Corporation Prepared Income Statement – Books and Records Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Part 1 – Financial Information and Net Income Reconciliation • Reconciliation of financial statement net income per books and tax return net income per books – Net Income/Loss from nonincludible foreign entities – Net Income/Loss from nonincludible U.S. entities – Net Income/Loss of other includible corporations – Adjustments Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Part 1 – Financial Information and Net Income Reconciliation • Attachments – A schedule for entities (both foreign and domestic) not included in the tax return – A schedule for entities included in the return but not on the financial statements – A schedule for any other adjustments necessary to reconcile financial statement book income to tax return book income Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Schedule M-3, Parts II & III Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Parts II and III – Reconciliation is in a columnar Format as Follows: • • • • Column A – Income Statement Balance Column B – Temporary Differences Column C – Permanent Differences Column D – Tax Return Balance Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Parts II and III – General Reporting Requirements • The first year a corporation is required to file Schedule M-3, Columns A and D are optional. • Columns A and D are optional for any year that a corporation elects to file Schedule M-3 in lieu of Schedule M-1, even though the corporation is not required to file the schedule M-3 • After the first required year, amounts in Columns A and D should reflect the book/return balance even if no current year difference (e.g. Meals & Entertainment) Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Parts II and III – General Reporting Requirements cont. • There is no dollar or ratio threshold for materiality - Every item of difference should be separately stated and adequately disclosed. Separately stated and adequately disclosed? – Specific line instruction: “attach schedule,” “attach details” – No specific line instruction – Do general ledger account titles constitute “adequate disclosure”? Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Parts II and III – General Reporting Requirements cont. • Certain line items in Parts II and III may not correspond to similar line items elsewhere on Form 1120 and/or other schedules and forms included in the return. (i.e. Gains and Losses, stock option expense, etc.) Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Parts II and III – General Reporting Requirements cont. • Adjustments must be shown as either temporary or permanent (Columns B and C) – Temporary differences – Items that will be recognized in different tax years for book and tax – Permanent differences – Items recognized for book and will NEVER be recognized for tax or vice versa Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Schedule M-3, Part II Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Part II – Reconciliation of Income Items • Examples of Income Reconciling Items – Minority interest for includible corporations – Income from equity method of Foreign and U.S. corporations – Net Capital Gains/Losses from flow-through entities – Disallowed Capital Losses and utilization of Capital Loss Carryforward – Sale vs. Lease – Accrual to Cash adjustments – §481(a) Adjustments – Inventory Valuation Adjustments (i.e. 263A, etc.) – Other Income from flow-through entities Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Part II – Reconciliation of Income Items cont. • Flow-Through entities – Separate lines for domestic partnerships, foreign partnerships and other flow-through entities – Entity-by-entity reporting required – ALL items (including separately stated items) of flowthrough entities are reported on line 9, 10, or 11 even if: • The item is described elsewhere on the form (Exceptions: Reportable transactions – Line 12; §199 deductions – Line 22) and/or • There is no current year difference Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Part II – Reconciliation of Income Items cont. • Flow-Through entities – Basis limitation, at-risk limitation, §469 taken into account in determining amount reported in column D – Owner-level limitations such as capital losses and charitable contributions not taken into account in calculating the amounts on lines 9, 10, and 11 – Attachments for each entity reported on lines 9, 10 and 11 • Name, EIN, EOY Profit-Sharing %, EOY LossSharing %, and the amounts included in columns A, B, C and D, as applicable Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Schedule M-3, Part III Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Part III – Reconciliation of Expense Items • Examples of Expense Reconciling Items – Taxes – Federal and State; Current and Deferred – Interest – Stock option expense – Meals & Entertainment – Fines & Penalties – Domestic production activities deduction – Depreciation – Bad Debt Expense – Utilization of Charitable contribution carryforward – Prepaid Expenses Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Consolidated Groups Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 U.S. Consolidated Tax Group • Total assets at the end of the tax year must be based on the total year-end assets of all includible corporations listed on Form 851, net of eliminations for intercompany balances between the includible corporations. Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Consolidated Groups Who must fill out an M-3? • Each member of the consolidated tax group must fill out a Schedule M-3 • You must also attach a Schedule M-3 as follows: – A separate Consolidating Schedule M-3 – A separate Consolidated Schedule M-3 Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Consolidated Groups Who must fill out an M-3? • “Consolidating” Schedule M-3 – Adjustments at the consolidated group level that are not attributable to any specific member (i.e. Disallowance of net capital losses, contribution deduction carryovers and limitations) – Used to report differences in Financial Statement book income and Taxable Income related to intercompany transactions Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Consolidated Groups Who must fill out an M-3? • “Consolidated” Schedule M-3 – Includes Parts I, II and III resulting from consolidating the Schedules M-3 described previously Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Consolidated Groups Example • Facts: A U.S. consolidated tax group consists of a parent and three subsidiaries. • Answer: You would expect to complete six Schedules M-3 to attach to the tax return of the group. Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Consolidated Groups Example, cont. • Facts: One Parent and Three Subsidiaries 1) Parent Company M-3 – Parts I, II and III • • Part I – Information for the entire consolidated group Part II and III – Parent’s own activity 2) - 4) Each of the three subsidiaries’ M-3 – Parts II and III • Part II and III – Each subsidiary’s own activity 5) Consolidating M-3 – Parts II and III 6) Consolidated M-3 – Parts I, II and III Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Reportable Transactions Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Reportable Transactions • Rev. Proc. 2004-45 was issued to address alternate disclosure procedures for reportable transactions • Generally, the filing of Schedule M-3 with the corporation’s timely-filed original tax return (including extensions) satisfies the disclosure requirements for transaction with a significant ($10 million or more) book/tax difference Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Reportable Transactions cont. • Under the alternate disclosure procedures addressed in Rev. Proc. 2004-45 – A taxpayer that is required to disclose transactions with significant book/tax differences, but is not required to file a Schedule M-3 is deemed to satisfy the disclosure requirements if the taxpayer: • Completes Schedule M-3 as if it was required to complete Schedule M-3 and • Separately states and adequately discloses each item on the applicable line of Parts II and III Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Reportable Transactions cont. • Amounts associated with Reportable Transactions, which pass through from other entities to the corporation filing the Schedule M3, should be reported on Part II, Line 12 NOT on Line 9, 10 or 11. Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Reportable Transactions cont. • Details required related to reportable transactions – You must either • Sequentially number each Form 8886 and list each transaction by Form 8886 reference number on the supporting statement for Schedule M-3, Part II, Line 12 and list the amounts associated with columns A, B, C and D; or • Report on the supporting statement for Schedule M3, Part II, Line 12: – A description of each transaction (as would be required on Form 8886) – Information required on lines 1-5 of Form 8886 – The amounts associated with columns A, B, C and D Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Penalties Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Penalties • Penalties related directly to the M-3 – There are currently no penalties specific to the Schedule M-3; however, all penalties applicable to Form 1120 are applicable to Schedule M-3 that is filed as part of Form 1120. Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Penalties, cont. • Rev. Proc. 2005-75 – Describes what is adequate disclosure for purposes of the imposition of accuracy-related penalty on underpayments as described in §6662(d) and avoiding preparer penalties under §6694(a) – Rev. Proc. 2005-75 does not apply with respect to any other penalty provisions, including the “disregard provisions” under §6662. Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Penalties, cont. • Rev. Proc. 2005-75 – Items on the Schedule M-3 must be separately stated and adequately disclosed – Columns B and C must be completed for all items that have differences – Other Income and Expense items with differences on Parts II and III must include a proper description (i.e. Cost of noncompete agreement deductible not capitalizable) Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Latest Information Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Latest Information • If a corporation is required to file Schedule M-3 in one year and in a subsequent year its assets drop below the $10 million requirement, is it still required to file the M-3? – No, the corporation can choose to fill our either the Schedule M-1 or Schedule M-3 – However, should its assets exceed $10 million in a later year, the M-3 must be filled out in its entirety (Columns A, B, C and D) Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Latest Information, cont. • Schedule M-3 filing requirements for other entities – Form 1120PC, 1120L and 1120S • Draft issued December 13, 2005 • Expected compliance date – tax years ending on or after December 31, 2006 • $10 million in total assets Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Latest Information, cont. • Schedule M-3 filing requirements for other entities – Form 1065 • Draft issued December 20, 2005 • Expected compliance date – tax years ending on or after December 31, 2006 • $10 million in total assets • $35 million or more in total receipts or, • 50% owned by an LMSB or other taxpayer required to file Schedule M-3 Oceans 1120 - 2006 Tax Season Kickoff January 19-20, 2006 Need Help with Schedule M-3 • Extensive Q & A on IRS website – www.irs.gov – Provides guidance line by line • Form Instructions provide a great amount of detail