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 Loss-Sharing %, 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 M-3, 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 M-3, 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