Expanded reconciliation: IRS expects new form to be used for 2004.

The U.S. Treasury and IRS released a draft Jan. 28 of a three-page Schedule M-3 (Form 1120), titled "Net Income (Loss) Reconciliation for Corporations With Total Assets of $10 Million or More." The Treasury and IRS expect the final version of this form to be used for tax years ending on or after Dec. 31, 2004.

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Schedule M-3 is a separate form to be attached to the regular corporate income tax return, Form 1120. It has been released to increase the transparency of these corporate income tax returns.

Corporations required to complete Schedule M-3 will not have to complete Schedule M-1, "Reconciliation of Income (Loss) per Books With Income per Return." Other corporations will continue to complete only Schedule M-1, which consists of just 10 lines and occupies less than half of Page 4, Form 1120. However, Schedule M-1 has not been updated in several decades.

According to Jan. 28 Treasury Department News Release JS-1121 and Internal Revenue News Release IR-2004-14, "Other federal tax returns that also require the completion of Schedule M-1 (e.g., Form 1065, U.S. Partnership Return of Income, and Form 1120S, U.S. Income Tax Return for an S Corporation) may incorporate Schedule M-3 in the future."

Schedule M-3's Contents

This new form has four parts:

Part I has five questions regarding the corporation's financial statements and its publicly traded common stock.

Part II is an eight-line "Reconciliation of Net Income (Loss) per Income Statement With Net Income (Loss) of Includible Corporations." The net income (loss) per the income statement is entered on Line 1 and is reconciled to the net income (loss) per income statement of includible corporations reported on Line 8.

Part III is a 37-line "Reconciliation of Net Income (Loss) per Income Statement of Includible Corporations With Taxable Income per Return--Income (Loss) Items" and has the following four columns:

(A) Income (loss) per income statement;

(B) Temporary difference;

(C) Permanent difference; and

(D) Income (loss) per tax return.

Part IV is a 38-line "Reconciliation of Net Income (Loss) per Income Statement of Includible Corporations With Taxable Income per Return--Expense/Deduction Items" and has the following four columns:

(A) Expense per income statement;

(B) Temporary difference;

(C) Permanent difference; and

(D) Deduction per tax return.

There is a specific item of expense/deduction printed on each of the first 34 lines of this part, such as:

* State current tax expense;

* Charitable contribution of intangible property; and

* Corporate owned life insurance premiums.

Line 35 deals with other amounts relating to reportable transactions and requests details to be attached. Line 36 concerns other expense/deduction items with differences and requests a schedule to be attached.

Other expense/deduction items with no differences are reported on Line 37 (in columns (A) and (D) only).

The total expense/deduction items are reflected on Line 38 of Part IV and then also entered on Line 36 of Part III.

Likewise, there is a specific item of income (loss) printed on each of the first 32 lines of Part III, such as:

* Life insurance proceeds;

* Like-kind exchanges; and

* Other amounts relating to reportable transactions (with details to be attached).

Line 33 pertains to other income (loss) items with differences and requests a schedule to be attached. Other income (loss) items with no differences are reported on Line 34 (in columns (A) and (D) only).

The total income (loss) items are reflected on Line 35 of Part III. The total expense/deduction items shown on Line 36 (as discussed above) are then subtracted from the total income (loss) items on Line 35 to arrive at the "reconciliation totals" on Line 37.

Line 37, column (A) must equal the net income (loss) per the income statement of includible corporations (reported, as described above, on Part II, Line 8). Line 37, column (D) must equal the taxable income (loss) per the tax return (as shown on Form 1120, page 1, Line 28).

Other Form 1120 Schedules Affected by Schedule M-3

The draft 2004 Schedule M-3 instructions discuss Schedule L, "Balance Sheet per Books," as follows:

"Total assets shown on Schedule L, Line 15, column (D) must equal the total consolidated assets of the U.S. consolidated tax group as of the last day of the tax year, and must be based on the same financial statements used for Schedule M-3. The Schedule L balance sheet may show tax-basis balance sheet amounts if the corporation is allowed to use books and records for Schedule M-3 and the corporation's only books and records reflect tax-basis amounts."

These instructions also discuss Schedule M-2, "Analysis of Unappropriated Retained Earnings per Books," as follows:

"Schedule M-2, Line 2, net income (loss) must equal the amount shown on Schedule M-3, Part II, Line 8. Schedule M-2 must reflect activity only of corporations included in the U.S. consolidated tax return."

There also are discussions regarding consolidated returns and "entity considerations" in these draft instructions.

By Stuart R. Josephs, CPA 

Stuart R. Josephs, CPA, has a San Diego-based Tax Assistance Practice (TAP) that specializes in assisting practitioners in resolving their clients' tax questions and problems. Josephs, chair of the Federal Subcommittee of CalCPA's Committee on Taxation, can be reached at [phone] or [e-mail].

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