Schedule M-3 (Form 1120-S)

Instructions for

Schedule M-3 (Form 1120-S)

Department of the Treasury

Internal Revenue Service

(Rev. December 2019)

Net Income (Loss) Reconciliation for S Corporations With Total Assets of

$10 Million or More

Section references are to the Internal Revenue

Code unless otherwise noted.

Future Developments

For the latest information about

developments related to Schedule M-3

(Form 1120-S) and its instructions, such

as legislation enacted after they were

published, go to

IRS.gov/Form1120S.

General Instructions

Applicable schedule and instructions. Due to the generally unchanging

nature of Schedule M-3 (Form 1120-S),

these instructions will no longer be

updated annually, unless necessary.

For previous tax years, see the

applicable Schedule M-3 (Form 1120-S)

and instructions. For example, use the

2018 Schedule M-3 (Form 1120-S) with

the 2018 Instructions for Schedule M-3

(Form 1120-S) for tax years ending

December 31, 2018, through December

30, 2019.

Purpose of Schedule

Schedule M-3, Part I, asks certain

questions about the corporation's

financial statements and reconciles

financial statement worldwide net

income (loss) for the corporation (or

consolidated financial statement group,

if applicable), as reported on Part I,

line 4a, to income (loss) per the income

statement of the corporation for U.S.

income tax purposes, as reported on

Part I, line 11.

Schedule M-3, Parts II and III,

reconcile financial statement net income

(loss) for the U.S. tax return (per

Schedule M-3, Part I, line 11) to total

income (loss) on Form 1120-S,

Schedule K, line 18.

Where To File

If the corporation is required to file (or

voluntarily files) Schedule M-3 (Form

1120-S), the corporation must file Form

1120-S and all attachments, schedules,

including Schedule M-3 (Form 1120-S),

and statements at the following

address.

Nov 21, 2019

Department of the Treasury

Internal Revenue Service Center

Ogden, UT 84201-0013

Who Must File

Any corporation required to file Form

1120-S, U.S. Income Tax Return for an

S Corporation, that reports on

Schedule L of Form 1120-S total assets

at the end of the corporation's tax year

that equal or exceed $10 million must

file Schedule M-3 (Form 1120-S). A

corporation or group of corporations that

completes Parts II and III of

Schedule M-3, isn't required to

complete Form 1120-S, Schedule M-1,

Reconciliation of Income (Loss) per

Books With Income (Loss) per Return.

A U.S. corporation filing Form 1120-S

that isn't required to file Schedule M-3

may voluntarily file Schedule M-3

instead of Schedule M-1.

Any corporation filing Schedule M-3

must check the box on Form 1120-S,

item C, indicating that Schedule M-3 is

attached (whether required or

voluntary).

Example 1.

1. U.S. corporation A owns U.S.

subsidiary B and foreign subsidiary F.

For its current tax year, A prepares

consolidated financial statements with B

and F that report total assets of $12

million. A files a U.S. income tax return

with B (a corporation that has made a

qualified subchapter S subsidiary

election) and reports total assets on

Schedule L of $8 million. A's U.S. tax

group isn't required to file Schedule M-3

for the current tax year. A may

voluntarily file Schedule M-3 for the

current tax year. If A doesn't file

Schedule M-3, it must file

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. U.S. corporation C owns U.S.

subsidiary D. For its current tax year, C

prepares consolidated financial

statements with D, but C and D file

Cat. No. 48245B

separate U.S. income tax returns. The

consolidated accrual basis financial

statements for C and D report total

assets at the end of the tax year of $12

million after intercompany eliminations.

C reports separate company total

year-end assets on its Schedule L of $7

million. D reports separate company

total year-end assets on its Schedule L

of $6 million. Neither C nor D is required

to file Schedule M-3 for the current tax

year. C or D may voluntarily file

Schedule M-3 for the current tax year. If

C or D doesn't file Schedule M-3, it must

file Schedule M-1. If C or D 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.

Completing Schedule M-3

(Form 1120-S)

A corporation that is required to file

Schedule M-3 (Form 1120-S) and has at

least $50 million total assets at the end

of the tax year must complete

Schedule M-3 (Form 1120-S) entirely.

A corporation that (a) is required to

file Schedule M-3 (Form 1120-S) and

has less than $50 million total assets at

the end of the tax year or (b) isn't

required to file Schedule M-3 (Form

1120-S) and voluntarily files

Schedule M-3 (Form 1120-S) must

either (i) complete Schedule M-3 (Form

1065) entirely or (ii) complete

Schedule M-3 (Form 1120-S) through

Part I and complete Form 1120-S,

Schedule M-1 instead of completing

Parts II and III of Schedule M-3 (Form

1120-S). If the corporation chooses to

complete Form 1120-S, Schedule M-1

instead of completing Parts II and III of

Schedule M-3 (Form 1120-S), line 1 of

Form 1120-S, Schedule M-1 must equal

line 11 of Part I of Schedule M-3 (Form

1120-S).

For any part of Schedule M-3 (Form

1120-S) that is completed, all columns

must be completed, all applicable

questions must be answered, all

numerical data asked for must be

provided, any statement required to

support a line item must be attached

and provide the information required for

that line item.

Any corporation filing Schedule M-3

must check the box on Form 1120-S,

item C, indicating that Schedule M-3 is

attached (whether required or

voluntary).

Other Issues Affecting

Schedule M-3 Filing

Requirements

If a corporation was required to file

Schedule M-3 for the preceding tax

year, but reports on Form 1120-S,

Schedule L, total assets at the end of

the current tax year of less than $10

million, the corporation isn't required to

file Schedule M-3 for the current tax

year.

For purposes of determining whether

the corporation has total assets at the

end of the current tax year of $10 million

or more, the corporation's total assets

must be determined on an overall

accrual method of accounting unless

both of the following apply: (a) the tax

return of the corporation is prepared

using an overall cash method of

accounting, and (b) no includible entity

in the U.S. tax return prepares or is

included in financial statements

prepared on an accrual basis.

See the instructions for Part I,

TIP line 1, for a discussion of

non-tax-basis income

statements and related non-tax-basis

balance sheets to be used in the

preparation of Schedule M-3 and of

Form 1120-S, Schedule L.

Other Form 1120-S

Schedules Affected by

Schedule M-3

Requirements

Schedule L

If a non-tax-basis income statement and

related non-tax-basis balance sheet is

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

instructions for Part I, line 1, for a

discussion 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 shown on Schedule L,

line 15, column (d), must equal the total

assets of the corporation as of the last

day of the tax year, and must be the

same total assets reported by the

corporation in the non-tax-basis

financial statements, if any, used for

Schedule M-3. If the corporation doesn't

prepare non-tax-basis financial

statements, Schedule L must be based

on the corporation's books and records.

The Schedule L balance sheet can

show tax-basis balance sheet amounts

if the corporation is allowed to use

books and records for Schedule M-3

and the corporation's books and records

reflect only tax-basis amounts.

Generally, total assets at the

beginning of the year (Schedule L,

line 15, column (b)) must equal total

assets at the close of the prior year

(Schedule L, line 15, 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 difference. In

particular, indicate if the differences

occurred because of acquisitions or

mergers.

For purposes of measuring total

assets at the end of the year, the

corporation's assets may not be netted

or reduced by the corporation's

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

a partnership may be shown as

appropriate under the corporation's

non-tax-basis method of accounting,

including, if required by the

corporation's reporting methodology,

the equity method of accounting for

investments. If Schedule L is prepared

on a tax-basis method, an investment

by the corporation in a partnership must

be shown as an asset and measured by

the corporation's adjusted basis in its

partnership interest. Any liabilities

contributing to such adjusted basis must

be shown on Schedule L as corporate

liabilities. In any event, any investments

or other assets reported on Schedule L

can never be reported as negative

amounts.

Schedule M-1

A corporation that completes Parts II

and III of Schedule M-3 isn't required to

complete Form 1120-S, Schedule M-1.

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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) mustn't

be separately reported on Schedule M-3

except, if required, on Part I, line 7a, 7b,

or 7c. 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 mustn't be

reported on Part II, line 7, 8, or 9 as from

a separate partnership or other

pass-through. The financial statement

income or loss of a disregarded entity

other than a qualified subchapter S

subsidiary (QSub) is included on Part I,

line 7b, if and only if its financial

statement income or loss is included on

Part I, line 11, but not on Part I, line 4a.

The financial statement income or loss

of a QSub is included on Part I, line 7c, if

and only if its financial statement

income or loss is included on Part I,

line 11, but not on Part I, line 4a.

Qualified Subchapter S Subsidiaries

(QSubs). Because a QSub is a

disregarded entity, for purposes of

Schedule M-3, Schedule L, and the tax

return in general, the subsidiary is

deemed to have liquidated into the

parent S corporation. As such, all

QSubs are treated as divisions of the S

corporation parent and they mustn't be

separately reported on Schedule M-3

except, if required, on Part I, line 7c.

Reportable Entity Partner

Reporting Responsibilities

A reportable entity partner to a

partnership filing Form 1065, U.S.

Return of Partnership Income, 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:

1. The parent corporation of a

consolidated tax group is deemed to

own all corporate and partnership

Instructions for Schedule M-3 (Form 1120-S)

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; and

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 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, after that 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. Taxpayer identification number

(TIN or 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 for 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 for which it is reporting.

9. Any change in that interest as of

the date for which it is reporting.

The reportable entity partner must

keep copies of required reports it makes

to partnerships under these instructions.

Each partnership must keep copies of

the required reports it receives under

these instructions from reportable entity

partners.

Example 2. A, a limited liability

company (LLC) filing a Form 1065 for its

current tax year is owned 50% by U.S.

corporation Z which files Form 1120-S.

A owns 50% of each of B, C, D, and E,

each also an LLC filing a Form 1065 for

its current tax year. Z was first required

to file Schedule M-3 (Form 1120-S) for

its prior corporate tax year ended

December 31 and filed its Form 1120-S

with Schedule M-3 on September 15.

As of September 16, Z was a reportable

entity partner regarding A and, through

A, regarding B, C, D, and E. On October

5, 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 (regarding

A) or deemed to own indirectly

(regarding B, C, D, and E) a 50%

interest. So, because Z was a

reportable entity partner for its current

tax year, each of A, B, C, D, and E is

required to file Schedule M-3 (Form

1065) for its current tax year, regardless

of whether they would otherwise be

required to file Schedule M-3 for that

year.

Specific Instructions

for Part I

Part I. Financial

Information and Net

Income (Loss)

Reconciliation

Line 1. Questions Regarding

the Type of Income Statement

Prepared

For Part I, lines 1 through 12, use only

the financial statements of the U.S.

corporation filing the U.S. income tax

return.

Non-Tax-Basis Financial

Statements and Tax-Basis

Financial Statements

A tax-basis income statement is allowed

for Schedule M-3 and a tax-basis

balance sheet for Schedule L only if no

non-tax-basis income statement and no

non-tax-basis balance sheet was

prepared for any purpose and the books

and records of the corporation reflect

only tax-basis amounts. The corporation

Instructions for Schedule M-3 (Form 1120-S)

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is deemed to have non-tax-basis

income statements and the related

non-tax-basis balance sheets for the

current tax year for purposes of

Schedule M-3 and Schedule L if such

non-tax-basis financial statements were

prepared for and presented to

management, creditors, shareholders,

government regulators, or any other

third parties for a period ending with or

within the tax year.

If a non-tax-basis income statement

is prepared that is a certified

non-tax-basis income statement for the

period ending with or within the tax year,

the corporation must check “Yes” for

Part I, line 1a, and use that income

statement for Schedule M-3. If no

certified non-tax-basis income

statement is prepared but an unaudited

non-tax-basis income statement is

prepared for the period ending with or

within the tax year, the corporation must

check “Yes” for Part I, line 1b, and use

that income statement for

Schedule M-3.

Order of priority in accounting

standards. If two or more

non-tax-basis income statements are

both certified non-tax-basis income

statements for the period, the income

statement prepared according to the

following order of priority in accounting

standards must be used.

1. U.S. Generally Accepted

Accounting Principles (GAAP).

2. International Financial Reporting

Standards (IFRS).

3. Any other International

Accounting Standards (IAS).

4. Other regulatory accrual

accounting.

5. Any other accrual accounting

standard.

6. Any fair market value standard.

7. Any cash basis standard.

If no non-tax-basis income statement

is certified and two or more

non-tax-basis income statements are

prepared, the income statement

prepared according to the first listed of

the accounting standards listed above

must be used.

If no non-tax-basis financial

statements are prepared for a U.S.

corporation filing Schedule M-3 (Form

1120-S), the U.S. corporation must

check “No” on questions 1a and 1b, skip

Part I, lines 2, 3a, and 3b, and enter the

net income (loss) per the books and

records of the U.S. corporation on Part I,

line 4a.

Lines 2 and 3. Questions

Regarding Income Statement

Period and Restatements

Enter the beginning and ending dates

on line 2 for the corporation's annual

income statement period ending with or

within the current tax year.

The questions on Part I, lines 3a and

3b, regarding income statement

restatements refer to the worldwide

consolidated income statement issued

by the corporation filing the U.S. income

tax return and used to prepare

Schedule M-3. Answer “Yes” on lines 3a

and/or 3b if the corporation's annual

income statement has been restated for

any reason. Attach a short explanation

of the reasons for the restatement in net

income for each annual income

statement period that is restated,

including the original amount and

restated amount of each annual

statement period's net income.

Line 4. Worldwide Consolidated

Net Income (Loss) per Income

Statement

Report on Part I, line 4a, the worldwide

consolidated net income (loss) per the

income statement (or books and

records, if applicable) of the

corporation.

In completing Schedule M-3, the

corporation must use financial

statement amounts from the financial

statement type checked “Yes” on Part I,

line 1, or from its books and records if

Part I, line 1b, is checked “No.”

If a corporation prepares

non-tax-basis financial statements, the

amount on line 4a must equal the

financial statement net income (loss) for

the income statement period ending

with or within the tax year as indicated

on Part I, line 2.

If the corporation prepares

non-tax-basis financial statements and

the income statement period differs

from the corporation's tax year, the

income statement period indicated on

Part I, line 2, applies for purposes of

Part I, lines 4 through 8.

If the corporation doesn't prepare

non-tax-basis financial statements and

has checked “No” on Part I, line 1b,

enter the net income (loss) per the

books and records of the U.S.

corporation on Part I, line 4a.

Indicate on Part I, line 4b, which of

the following accounting standards were

used for line 4a.

1. U.S. Generally Accepted

Accounting Principles (GAAP).

2. International Financial Reporting

Standards (IFRS).

3. Tax basis.

4. Other (Specify).

Report on Part I, lines 5a through 10,

as instructed below, all adjustment

amounts required to adjust worldwide

net income (loss) reported on this Part I,

line 4a (whether from financial

statements or books and records), to

net income (loss) of the corporation that

must be reported on Part I, line 11.

Report on line 12a the worldwide

consolidated total assets and total

liabilities amounts for the corporation

using the same financial statements (or

book and records) used for the

worldwide consolidated income (loss)

amount reported on line 4a.

For example, if the net income (after

consolidation and elimination entries) of

a nonincludible foreign

sub-consolidated group is being

reported on line 5a, the attached

supporting statement should report the

income (loss) of each separate

nonincludible foreign legal entity from

each such entity's own financial

accounting net income statement or

books and records, and any

consolidation or elimination entries (for

intercompany dividends, minority

interests, etc.) not reportable on Part I,

line 8, should be reported on the

attached supporting statement as a net

amount on a line separate and apart

from lines that report each nonincludible

foreign entity's separate net income

(loss).

Line 5. Net Income (Loss) of

Nonincludible Foreign Entities

Line 6. Net Income (Loss) of

Nonincludible U.S. Entities

Remove the financial net income

(line 5a) or loss (line 5b) of each foreign

entity that is included on line 4a and isn't

an includible entity in the U.S. tax return

(nonincludible foreign entity). In

addition, on Part I, line 8, adjust for

consolidation eliminations and correct

for minority interest and intercompany

dividends between any nonincludible

foreign entity and the entity filing Form

1120-S. Don't remove in Part I the

financial net income (loss) of any

nonincludible foreign entity accounted

for on line 4a using the equity method.

Remove the financial net income

(line 6a) or loss (line 6b) of each U.S.

entity that is included on line 4a and isn't

an includible entity in the U.S. tax return

(nonincludible U.S. entity). In addition,

on Part I, line 8, adjust for consolidation

eliminations and correct for minority

interest and intercompany dividends

between any nonincludible U.S. entity

and any includible entity. Don't remove

in Part I the financial net income (loss)

of any nonincludible U.S. entity

accounted for on line 4a using the

equity method.

Attach a supporting statement that

provides the name, EIN (if applicable),

and net income (loss) included on

line 4a that is removed on this line 5 for

each separate nonincludible foreign

entity. Also state the total assets and

total liabilities for each such separate

nonincludible foreign entity and include

those assets and liabilities amounts in

the total assets and total liabilities

reported on Part I, line 12b. The

amounts of income (loss) detailed on

the supporting statement should be

reported for each separate

nonincludible foreign entity without

regard to the effect of consolidation or

elimination entries. If there are

consolidation or elimination entries

relating to nonincludible foreign entities

whose income (loss) is reported on the

attached statement that aren't

reportable on Part I, line 8, the net

amounts of all such consolidation and

elimination entries must be reported on

a separate line on the attached

statement, so that the separate financial

accounting income (loss) of each

nonincludible foreign entity remains

separately stated.

Attach a supporting statement that

provides the name, EIN, and net income

(loss) included on line 4a that is

removed on this line 6 for each separate

nonincludible U.S. entity. Also state the

total assets and total liabilities for each

such separate nonincludible U.S. entity

and include those assets and liabilities

amounts in the total assets and total

liabilities reported on Part I, line 12c.

The amounts of income (loss) detailed

on the supporting statement should be

reported for each separate

nonincludible U.S. entity without regard

to the effect of consolidation or

elimination entries. If there are

consolidation or elimination entries

relating to nonincludible U.S. entities

whose income (loss) is reported on the

attached statement that aren't

reportable on Part I, line 8, the net

amounts of all such consolidation and

elimination entries must be reported on

a separate line on the attached

statement, so that the separate financial

accounting income (loss) of each

nonincludible U.S. entity remains

separately stated. For example, if the

net income (after consolidation and

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Instructions for Schedule M-3 (Form 1120-S)

elimination entries) of a nonincludible

U.S. sub-consolidated group is being

reported on line 6a, the attached

supporting statement should report the

income (loss) of each separate

nonincludible U.S. legal entity from each

such entity's own financial accounting

net income statement or books and

records, and any consolidation or

elimination entries (for intercompany

dividends, minority interests, etc.) not

reportable on Part I, line 8, should be

reported on the attached supporting

statement as a net amount on a line

separate and apart from lines that report

each nonincludible U.S. entity's

separate net income (loss).

Lines 7a, 7b, and 7c. Net

Income (Loss) of Other Foreign

Disregarded Entities, Net

Income (Loss) of Other

Disregarded Entities (Except

Qualified Subchapter S

Subsidiaries), and Net Income

(Loss) of Other Qualified

Subchapter S Subsidiaries

(QSubs)

Include on line 7a the financial income

of any foreign disregarded entity that

isn't included on Part I, line 4a, but is

included in Part I, line 11 (other foreign

disregarded entities). Include on line 7b

or 7c the financial net income or (loss)

of each disregarded entity in the U.S.

tax return that isn't included in the

consolidated financial group and

therefore not included in the income

reported on Part I, line 4a. Include on

line 7b the financial income of any U.S.

disregarded entity that isn't a qualified

subchapter S subsidiary (QSub) or a

foreign disregarded entity and that isn't

included in the income reported on Part

I, line 4a, but is included in Part I, line 11

(other disregarded entities). Include on

line 7c the financial income of any QSub

that isn't included in the income

reported on line 4a, but is included on

line 11 (other QSub). In addition, on Part

I, line 8, adjust for consolidation

eliminations and correct for minority

interest and intercompany dividends for

any other disregarded entity or other

QSub.

Attach a supporting statement that

provides the name, EIN, and net income

(loss) per the financial statement or

books and records on this line 7 for

each separate other disregarded entity

or other QSub. Also state the total

assets and total liabilities for each such

separate included entity and include

those assets and liabilities amounts in

the total assets and total liabilities

reported on Part I, line 12d. The

amounts of income (loss) detailed on

the supporting statement should be

reported for each separate other

disregarded entity or other QSub

without regard to the effect of

consolidation or elimination entries

solely between or among the entities

listed. If there are consolidation or

elimination entries relating to such other

disregarded entities or other QSub

whose income (loss) is reported on the

attached statement that aren't

reportable on Part I, line 8, the net

amounts of all such consolidation and

elimination entries must be reported on

a separate line on the attached

statement, so that the separate financial

accounting income (loss) of each other

disregarded entity or other QSub

remains separately stated. For example,

if the net income (after consolidation

and elimination entries) of a

sub-consolidated group of other

disregarded entities is being reported

on line 7b, the attached supporting

statement should report the income

(loss) of each separate other

disregarded entity from each entity's

own financial accounting net income

statement or books and records, and

any consolidation or elimination entries

(for intercompany dividends, minority

interests, etc.) not reportable on Part I,

line 8, should be reported on the

attached supporting statement as a net

amount on a line separate and apart

from lines that report each other

disregarded entity's separate net

income (loss).

Line 8. Adjustment to

Eliminations of Transactions

Between Includible Entities and

Nonincludible Entities

Adjustments on Part I, line 8, to reverse

certain financial accounting

consolidation or elimination entries are

necessary to ensure that transactions

between includible entities and

nonincludible U.S. or foreign entities

aren't eliminated, in order to report the

correct total amount on Part I, line 11.

Also, additional consolidation entries

and elimination entries may be

necessary on Part I, line 8, related to

transactions between includible entities

that are in the consolidated financial

group and other disregarded entities

and QSubs that aren't in the

consolidated financial group but that are

reported on Part I, line 7a, 7b, or 7c, in

order to report the correct total amount

on Part I, line 11.

Instructions for Schedule M-3 (Form 1120-S)

-5-

Include on Part I, line 8, the total of

the following: (a) amounts of any

adjustments to consolidation entries

and elimination entries that are

contained in the amount reported on

Part I, line 4a, required as a result of

removing amounts on Part I, line 5 or 6;

and (b) amounts of any additional

consolidation entries and elimination

entries that are required as a result of

including amounts on Part I, line 7a, 7b,

or 7c. This is necessary in order that the

consolidation entries and intercompany

elimination entries included in the

amount reported on Part I, line 11, are

only those applicable to the financial net

income (loss) of includible entities for

the financial statement period. For

example, adjustments must be reported

on line 8 to remove minority interest and

to reverse the elimination of

intercompany dividends included on

Part I, line 4a, that relate to the net

income of entities removed on Part I,

line 5 or 6, because the income to which

the consolidation or elimination entries

relate has been removed. Also, for

example, consolidation or elimination

entries must be reported on line 8 to

eliminate any intercompany dividends

between entities whose income is

included on Part I, line 7a, 7b, or 7c, and

other entities included in the U.S.

income tax return. See Example 3A, 3B,

and 4 in the instructions for line 11.

If a corporate owner of an interest in

another entity: (a) accounts for the

interest in entity in the owner

corporation's separate general ledger

on the equity method, and (b) fully

consolidates entity in the owner

corporation's consolidated financial

statements, but entity isn't includible in

the owner corporation's U.S. income tax

return, then, as part of reversing all

consolidation and elimination entries for

the nonincludible entity, the corporate

owner must reverse on Schedule M-3,

Part I, line 8, the elimination of the equity

income inclusion from entity. If the

owner corporation doesn't account for

entity on the equity method on its own

general ledger, it won't have eliminated

the equity income for consolidated

financial statement purposes, so it will

have no elimination of equity income to

reverse.

The attached supporting statement

for Part I, line 8, must identify the type

(for example, minority interest,

intercompany dividends, etc.) and

amount of consolidation or elimination

entries reported, as well as the names

of the entities to which they pertain. It

isn't necessary, but it is permitted, to

report intercompany eliminations that

net to zero on Part I, line 8, such as

intercompany interest income and

expense.

Line 9. Adjustment To

Reconcile Income Statement

Period to Tax Year

Include on line 9 any adjustments

necessary to the income (loss) of

includible entities to reconcile

differences between the corporation's

income statement period reported on

line 2 and the corporation's tax year.

Attach a statement describing the

adjustment.

Line 10. Other Adjustments To

Reconcile to Amount on Line 11

Include on line 10 any other

adjustments to reconcile net income

(loss) on Part I, line 4a, through Part I,

line 9, with net income (loss) on Part I,

line 11.

For any adjustments reported on Part

I, line 10, attach a supporting statement

with an explanation of each net

adjustment included on line 10.

Line 11. Net Income (Loss) per

Income Statement of the

Corporation

Report on line 11 the net income (loss)

per the income statement (or books and

records, if applicable) of the

corporation. Amounts reported in

column (a) of Parts II and III (see later)

must be reported on the same

accounting method used to report the

amount of net income (loss) per income

statement of the corporation on Part I,

line 11.

Don't, in any event, report on this

line 11 the net income of entities not

included in the U.S. income tax return

for the tax year. For example, it isn't

permissible to remove the income of

nonincludible entities on lines 5 and/or

6, above, then to add back such income

on lines 7 through 10, such that the

amount reported on line 11 includes the

net income of entities not includible in

the U.S. income tax return. A principal

purpose of Schedule M-3 is to report on

this Part I, line 11, only the financial

accounting net income of only the

entities included in the U.S. income tax

return.

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 they aren't 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

nonincludible entities. If the corporation

prepares unconsolidated financial

statements using the same accounting

method used to determine worldwide

consolidated net income (loss) for Part I,

line 4a, and if it uses the equity method

for investments, the amount reported on

Part I, line 11, will equal the amount of

the unconsolidated net income (loss)

reported on the unconsolidated financial

statements. See items 3 and 4 under

Example 3B, later.

Example 3A. U.S. corporation P

files a Form 1120-S U.S. tax return and

prepares certified audited income

statements for GAAP. P owns 100% of

the stock of U.S. corporations DS1

through DS75, between 51% and 99%

of the stock of U.S. corporations DS76

through DS100, and 100% of the stock

of foreign entities FS1 through FS50. P

eliminates all dividend income from DS1

through DS100 and FS1 through FS50

in financial statement consolidation

entries. Furthermore, P eliminates the

minority interest ownership, if any, of

DS76 through DS100 in financial

statement consolidation entries.

P must check “Yes” on Part I, line 1a.

On Part I, line 4a, P must report the

consolidated net income for the

consolidated financial statement group

of P, DS1 through DS100, and FS1

through FS50. P must remove the net

income (loss) of FS1 through FS50 on

Part I, line 5a or 5b, as applicable, and

remove on Part I, line 6a or 6b, as

applicable, any net income (loss) from

DS1 through DS75 where a QSub

election hasn't been made by P. P must

remove the net income (loss) before

minority interests of DS76 through

DS100 on Part I, line 6a or 6b, as

applicable. P must reverse on Part I,

line 8, the elimination of any

transactions between the includible

entity (P and any QSubs) and the

nonincludible entities (DS1 through

DS75 with no QSub election, DS76

through DS100 and FS1 through FS50),

including dividends received from

non-QSub DS1 through DS75, DS76

through DS100, and FS1 through FS50

and the minority interest's share of the

net income (loss) of DS76 through

DS100.

P reports on Part I, line 11, the

consolidated financial statement net

income (loss) attributable to the

corporation and QSubs. Intercompany

transactions between the corporation

and the QSubs that had been eliminated

-6-

in the net income amount on line 4a

remain eliminated in the net income

amount on line 11. Transactions

between the corporation and the

nonincludible entities that are eliminated

in the net income amount on line 4a are

included in the net income amount on

line 11 since the elimination of those

transactions were reversed on line 8.

Example 3B.

1. U.S. corporation P owns 60% of

corporation DS1 which is fully

consolidated in P's financial statements.

P doesn't account for DS1 in P's

separate general ledger on the equity

method. DS1 has net income of $100

(before minority interests) and pays

dividends of $50, of which P receives

$30. The dividend is eliminated in the

consolidated financial statements. In its

financial statements, P consolidates

DS1 and includes $60 of net income

($100 less the minority interest of $40)

on Part I, line 4a.

P must remove the $100 net income

of DS1 on Part I, line 6a. P must reverse

on Part I, line 8, the elimination of the

$40 minority interest net income of DS1.

In addition, P reverses its elimination of

the $30 intercompany dividend in its

financial statements on Part I, line 8.

The net result is that P includes the $30

dividend from DS1 at Part I, line 11, and

on Part II, line 6, column (a). P's

dividend income included on the tax

return from DS1 must be reported on

Part II, line 6, column (d).

2. U.S. corporation C owns 60% of

the capital and profits interests in U.S.

LLC N. C doesn't account for N in C's

separate general ledger on the equity

method. N has net income of $100

(before minority interests) and makes no

distributions during the tax year. C

treats N as a corporation for financial

statement purposes and as a

partnership for U.S. income tax

purposes. In its financial statements, C

consolidates N and includes $60 of net

income ($100 less the minority interest

of $40) on Part I, line 4a.

C must remove the $100 net income

of N on Part I, line 6a. C must reverse on

Part I, line 8, the elimination of the $40

minority interest net income of N. The

result is that C includes no income for N

either on Part I, line 11, or on Part II,

line 7, column (a). C's taxable income

from N must be reported by C on Part II,

line 7, column (d).

3. U.S. corporation P owns 60% of

corporation DS1, which is fully

consolidated in P's financial statements.

P accounts for DS1 in P's separate

general ledger on the equity method.

Instructions for Schedule M-3 (Form 1120-S)

DS1 has net income of $100 (before

minority interests) and pays dividends of

$50, of which P receives $30. The

dividend reduces P's investment in DS1

for equity method reporting on P's

separate general ledger where P

includes its 60% equity share of DS1

income, which is $60. In its financial

statements, P eliminates the DS1 equity

method income of $60 and consolidates

DS1, including $60 of net income ($100

less the minority interest of $40) on Part

I, line 4a.

P must remove the $100 net income

of DS1 on Part I, line 6a. P must reverse

on Part I, line 8, the elimination of the

$40 minority interest net income of DS1

and the elimination of the $60 of DS1

equity income. The net result is that P

includes the $60 of equity method

income from DS1 at Part I, line 11, and

on Part II, line 5, column (a). P's

dividend income included on the tax

return from its investment in DS1 must

be reported on Part II, line 6, column (d).

4. U.S. corporation C owns 60% of

the capital and profits interests in U.S.

LLC N. C accounts for N in C's separate

general ledger on the equity method. N

has net income of $100 (before minority

interests) and makes no distributions

during the tax year. C treats N as a

corporation for financial statement

purposes and as a partnership for U.S.

income tax purposes. For equity method

reporting on C's separate general

ledger, C includes its 60% equity share

of N income, which is $60. In its

financial statements, C eliminates the

$60 of N net income ($100 less the

minority interest of $40) on Part I,

line 4a.

C must remove the $100 net income

of N on Part I, line 6a. C must reverse on

Part I, line 8, the elimination of the $40

minority interest net income of N and the

elimination of the $60 of N equity

method income. The result is that C

includes the $60 of equity method

income for N on Part I, line 11, and on

Part II, line 7, column (a). C's taxable

income from N must be reported by C

on Part II, line 7, column (d).

Example 4. U.S. corporation P

owns 100% of the stock of QSub

corporation DS1. DS1 is included in P's

federal income tax return, even though

DS1 isn't included in P's consolidated

financial statements on either a

consolidated basis or on the equity

method. DS1 has current year net

income of $100 after taking into account

its $40 interest payment to P. P has net

income of $1,040 after recognition of the

interest income from DS1. Because

DS1 is a QSub, 100% of the net income

of both P and DS1 must be reported on

Form 1120-S of P's U.S. income tax

return, and the intercompany interest

income and expense must be removed

by consolidation elimination entries.

P must report its financial statement

net income of $1,040 on Part I, line 4a,

and reports DS1's net income of $100

on Part I, line 7c. Then, in order to

reflect the full consolidation of the

financial accounting net income of P

and DS1 at Part I, line 11, the following

consolidation and elimination entries are

reported on Part I, line 8: offsetting

entries to remove the $40 of interest

income received from DS1 included by

P on line 4a, and to remove the $40 of

interest expense of DS1 included in

line 7c for a net change of zero. The

result is that Part I, line 11, reports

$1,140: $1,040 from line 4a, and $100

from line 7c. Stated another way, Part I,

line 11, includes the entire $1,000 net

income of P, measured before

recognition of the intercompany interest

income from DS1 and the consolidation

of DS1 operations, plus the entire $140

net income of DS1, measured before

interest expense to P. P's U.S. income

tax group isn't required to include on the

attached supporting statement for Part I,

line 8, the offsetting adjustment to the

intercompany elimination of interest

income and interest expense (though it

is permitted to do so).

Line 12. Total Assets and

Liabilities of Entities Included

or Removed on Part I, Lines 4,

5, 6, and 7

Line 12 must be completed by all

corporations that file Schedule M-3.

Report on lines 12a, 12b, 12c, and 12d

the total amount (not just the

corporation's share) of assets and

liabilities of entities included or removed

on Part I, lines 4, 5, 6, and 7. All assets

and liabilities reported on lines 12a

through 12d must be reported as

positive amounts.

On line 12a, enter the worldwide

consolidated total assets and total

liabilities of all of the entities included in

computing Part I, line 4a. On line 12b,

enter the total assets and total liabilities

of the entities removed in completing

Part I, line 5. On line 12c, enter the total

assets and total liabilities removed in

completing Part I, line 6. On line 12d,

enter total assets and total liabilities

included in completing Part I, line 7.

Instructions for Schedule M-3 (Form 1120-S)

-7-

Specific Instructions for

Parts II and III

General Reporting information

A schedule or statement may be

attached to any line even if none is

required.

For each line item in Parts II and III,

report in column (a) the amount of net

income (loss) included in Part I, line 11,

and report in column (d) the amount

included in total income (loss) on Form

1120-S, Schedule K, line 18.

Part II, line 26, column (a) must

TIP equal Part I, line 11, and column

(d) must equal the amount on

Form 1120-S, Schedule K, line 18.

For any item of income, gain, loss,

expense, or deduction for which there is

a difference between columns (a) and

(d), the portion of the difference that is

temporary must be entered in column

(b) and the portion of the difference that

is permanent must be entered in column

(c).

If financial statements are prepared

by the corporation under with generally

accepted accounting principles (GAAP),

differences that are treated as

temporary under GAAP must be

reported in column (b) and differences

that are permanent (that is, not

temporary) for GAAP must be reported

in column (c). Generally, under to

GAAP, a temporary difference affects

(creates, increases, or decreases) a

deferred tax asset or liability.

If the corporation doesn't prepare

financial statements, or the financial

statements aren't prepared under

GAAP, report in column (b) any

difference that the corporation believes

will reverse in a future tax year (that is,

have an opposite effect on total income

(loss) in a future tax year (or years) due

to the difference in timing of recognition

for financial accounting and U.S.

income tax purposes) or is the reversal

of such a difference that arose in a prior

tax year. Report in column (c) any

difference that the corporation believes

won't reverse in a future tax year (and

isn't the reversal of such a difference

that arose in a prior tax year).

If the corporation is unable to

determine whether a difference between

column (a) and column (d) for an item

will reverse in a future tax year or is the

reversal of a difference that arose in a

prior tax year, report the difference for

that item in column (c).

Example 5. At the end of

Corporation A's first tax year, it wasn't

required to file Schedule M-3 for any

reason.

A may elect to file Schedule M-3

instead of completing Schedule M-1.

If A elects to file 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.

If A elects to complete Schedule M-3

entirely, it must complete all columns of

Parts II and III.

If A completes Schedule M-3 through

Part I and completes Schedule M-1

instead of completing Parts II and III of

Schedule M-3, line 11 of Part I of

Schedule M-3 must equal line 1 of

Schedule M-1.

Example 6. Corporation B is a U.S.

corporation that files a U.S. tax return

and prepares GAAP financial

statements. In prior years, B acquired

intellectual property (IP) and goodwill.

The IP is amortizable for both U.S.

income tax and financial statement

purposes. In the current year, B's annual

amortization expense for IP is $9,000 for

U.S. income tax purposes and $6,000

for financial statement purposes. In its

financial statements, B treats the

difference in IP amortization as a

temporary difference. The goodwill isn't

amortizable for U.S. income tax

purposes and is subject to impairment

for financial statement purposes. In the

current year, B records an impairment

charge on the goodwill of $5,000. In its

financial statements, B treats the

goodwill impairment as a permanent

difference. B must report the

amortization attributable to the IP on

Part III, line 21, and report $6,000 in

column (a), a temporary difference of

$3,000 in column (b), and $9,000 in

column (d). B must report the goodwill

impairment on Part III, line 19, and

report $5,000 in column (a), a

permanent difference of ($5,000) in

column (c), and $0 in column (d).

Reporting Requirements

for Parts II and III

General Reporting

Requirements

If an amount is attributable to a

reportable transaction described in

Regulations section 1.6011-4(b), the

amount must be reported in columns

(a), (b), (c), and (d), as applicable, of

Part II, line 10, regardless of whether the

amount would otherwise be reported on

Schedule M, Part II or Part III. So, if a

taxpayer is required to file Form 8886,

Reportable Transaction Disclosure

Statement, the amounts attributable to

that reportable transaction must be

reported on Part II, line 10.

A corporation is required to report in

column (a) of Parts II and III the amount

of any item specifically listed on

Schedule M-3 that 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, even if there is no

difference between that amount and the

amount included in total income (loss)

unless (a) otherwise provided in these

instructions or (b) the amount is

attributable to a reportable transaction

described in Regulations section

1.6011-4(b) so it is reported on Part II,

line 10. For example, with the exception

of interest income reflected on a

Schedule K-1 received by a corporation

as a result of the corporation's

investment in a partnership or other

pass-through entity, all interest income

included on Part I, line 11, whether from

affiliated companies, third parties,

banks, or other entities, whether from

foreign or domestic sources, whether

taxable or exempt from tax, and whether

classified as some other type of income

for U.S. income tax purposes (such as

dividends), must be included on Part II,

line 11, column (a). Likewise, all fines

and penalties included in Part I, line 11,

paid to a government or other authority

for the violation of any law for which

fines or penalties are assessed must be

included on Part III, line 9, column (a),

regardless of the government authority

that imposed the fines or penalties,

regardless of whether the fines or

penalties are civil or criminal, regardless

of the classification, nomenclature, or

terminology attached to the fines or

penalties by the imposing authority in its

actions or documents.

If a corporation would be required to

report in column (a) of Parts II and III the

amount of any item specifically listed on

Schedule M-3 in accordance with the

preceding paragraph, except that the

corporation has capitalized the item of

income or expense and reports the

amount in its financial statement

balance sheet or in asset and liability

accounts maintained in the

corporation's books and records, the

corporation must report the proper tax

treatment of the item in columns (b), (c),

and (d), as applicable.

-8-

Furthermore, in applying the two

preceding paragraphs, a corporation is

required to report in column (a) of Parts

II and III the amount of any item

specifically listed on Schedule M-3 that

is included in the corporation's financial

statements or exists in the corporation's

books and records, regardless of the

nomenclature associated with that item

in the financial statements or books and

records. Accurate completion of

Schedule M-3 requires reporting

amounts according to the substantive

nature of the specific line items included

in Schedule M-3 and consistent

reporting of all transactions of like

substantive nature that occurred during

the tax year. For example, all expense

amounts that are included in the

financial statements or exist in the

books and records that represent some

form of “Bad debt expense,” must be

reported on Part III, line 25, in column

(a), regardless of whether the amounts

are recorded or stated under different

nomenclature in the financial

statements or the books and records

such as: “Provision for doubtful

accounts”; “Expense for uncollectible

notes receivable”; or “Impairment of

trade accounts receivable.” Likewise, as

stated in the preceding paragraph, all

fines and penalties must be included on

Part III, line 9, column (a), regardless of

the terminology or nomenclature

attached to them by the corporation in

its books and records or financial

statements.

With limited exceptions, Part II

includes lines for specific items of

income, gain, or loss (income items).

(See Part II, lines 1 through 21.) If an

income item is described in Part II, lines

1 through 21, report the amount of the

item on the applicable line, regardless of

whether there is a difference for the

item. If there is a difference for the

income item, or only a portion of the

income item has a difference and a

portion of the item doesn't have a

difference, and the item isn't described

in Part II, lines 1 through 21, report and

describe the entire amount of the item

on Part II, line 22.

With limited exceptions, Part III

includes lines for specific items of

expense or deduction (expense items).

(See Part III, lines 1 through 28.) If an

expense item is described on Part III,

lines 1 through 28, report the amount of

the item on the applicable line,

regardless of whether there is a

difference for the item. If there is a

difference for the expense item, or only

a portion of the expense item has a

difference and a portion of the item

Instructions for Schedule M-3 (Form 1120-S)

doesn't have a difference and the item

isn't described in Part III, lines 1 through

28, report and describe the entire

amount of the item on Part III, line 31.

If there is no difference between the

financial accounting amount and the

taxable amount of an entire item of

income, loss, expense, or deduction

and the item isn't described or included

in Part II, lines 1 through 21, or Part III,

lines 1 through 28, report the entire

amount of the item in columns (a) and

(d) of Part II, line 25.

Separately stated and adequately

disclosed. Each difference reported in

Parts II and III 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 the difference arises. For

further guidance about adequate

disclosure, see Regulations section

1.6662-4(f). If a specific item of income,

gain, loss, expense, or deduction is

described on Part II, lines 7 through 21,

or Part III, lines 1 through 28, and the

line doesn't indicate to “attach

statement,” and the specific instructions

for the line don't call for an attachment

of a statement, then the item is

considered separately stated and

adequately disclosed if the item is

reported on the applicable line and the

amount(s) of the item(s) are reported in

the applicable columns of the applicable

line. See the instructions for Part II, lines

1 through 6, for specific additional

information required to be provided for

these particular lines.

Except as otherwise provided,

differences for the same item must be

combined or netted together and

reported as one amount on the

applicable line of Schedule M-3.

However, differences for separate items

mustn't be combined or netted together.

Each item (and corresponding amount

attributable to that item) must be

separately stated and adequately

disclosed on the applicable line of

Schedule M-3, or any statement

required to be attached, even if the

amounts are below a certain dollar

amount.

Required statements for Part II,

line 22, and Part III, line 31. A

separate statement must be attached to

Schedule M-3 (Form 1120-S) that

includes a detailed description of each

item and adjustment entered on Part II,

line 22, and Part III, line 31.

The description for each amount

entered in column (a) must be readily

identifiable to the name of the account

in the financial statements or books and

records of the taxpayer, under which the

amount in column (a) was recorded in

the accounting records. Also, the

description for each amount entered in

column (a) must include detailed

information supporting each adjustment

reported in columns (b) and (c),

including how the adjustment is

identified in the accounting records. The

entire description is considered the tax

description for the amount reported in

column (d) for each item reported on

Part II, line 22, or Part III, line 31.

Each description should adequately

describe all four columns of Part II,

line 22, or Part III, line 31. If additional

information is required to provide an

acceptable description, provide a

supporting statement.

Example 7. Corporation C is a

calendar year taxpayer that files and

entirely completes Schedule M-3 for its

current tax year. C placed in service 10

depreciable fixed assets in a previous

year. C's total depreciation expense for

its current tax year for five of the assets

is $50,000 for income statement

purposes and $70,000 for U.S. income

tax purposes. C's total annual

depreciation expense for its current tax

year for the other five assets is $40,000

for income statement purposes and

$30,000 for U.S. income tax purposes.

In its financial statements, C treats the

differences between financial statement

and U.S. income tax depreciation

expense as giving rise to temporary

differences that will reverse in future

years. C must combine all of its

depreciation adjustments. Accordingly,

C must report on Part III, line 24, for its

current tax year income statement

depreciation expense of $90,000 in

column (a), a temporary difference of

$10,000 in column (b), and U.S. income

tax depreciation expense of $100,000 in

column (d).

Example 8. Corporation D is a

calendar year taxpayer that files and

entirely completes Schedule M-3 for its

current tax year. On December 31, of its

current tax year, D establishes three

reserve accounts in the amount of

$100,000 for each account. One

reserve account is an allowance for

accounts receivable that are estimated

to be uncollectible. The second reserve

is an estimate of coupons outstanding

that may have to be paid. The third

reserve is an estimate of future warranty

expenses. In its financial statements, D

treats the three reserve accounts as

giving rise to temporary differences that

will reverse in future years. The three

Instructions for Schedule M-3 (Form 1120-S)

-9-

reserves are expenses in D's current

financial statements but aren't

deductions for U.S. income tax

purposes in its current tax years. D

mustn't combine the Schedule M-3

differences for the three reserve

accounts. D must report the amounts

attributable to the allowance for

uncollectible accounts receivable on

Part III, line 25, and must separately

state and adequately disclose the

amounts attributable to each of the

other two reserves, coupons

outstanding and warranty costs, on a

required, attached statement that

supports the amounts at Part III, line 31.

D must also provide a description for

each reserve that meets the

requirements for Part III, line 31,

discussed earlier under Required

statements for Part II, line 22, and Part

III, line 31. In this example, an

acceptable description would be

"Coupon Issue Reserves - Rewards

Expense" and "Future Warranty

Expense Reserve."

There is no need to add the title

TIP of the reserve account to the

description if the account name

for the amount in column (a) is already

part of the adjustment description.

Example 9. Corporation E is a

calendar year taxpayer that files and

entirely completes Schedule M-3 for its

current tax year. On January 2 of its

current tax year, E establishes an

allowance for uncollectible accounts

receivable (bad debt reserve) of

$100,000. During its current tax year, E

increased the reserve by $250,000 for

additional accounts receivable that may

become uncollectible. Additionally,

during its current tax year, E decreases

the reserve by $75,000 for accounts

receivable that were discharged in

bankruptcy during its current tax year.

The balance in the reserve account on

December 31 of its current tax year is

$275,000. The $100,000 amount to

establish the reserve account and the

$250,000 to increase the reserve

account are expenses on E's current tax

year financial statements but aren't

deductible for U.S. income tax purposes

in its current tax year. However, the

$75,000 decrease to the reserve is

deductible for U.S. income tax purposes

in its current tax year. In its financial

statements, E treats the reserve

account as giving rise to a temporary

difference that will reverse in future tax

years. E must report on Part III, line 25,

for its current tax year income statement

bad debt expense of $350,000 in

column (a), a temporary difference of

($275,000) in column (b), and U.S.

income tax bad debt expense of

$75,000 in column (d).

Example 10. Corporation F is a

calendar year taxpayer that files and

entirely completes Schedule M-3 for its

current tax year. During its current tax

year, F incurs $200 in meal expenses

and $100 in entertainment expenses

that F deducts in computing net income

per the income statement. All of the

$200 meal expense is subject to the

50% limitation under section 274(n).

The $100 of entertainment expenses is

disallowed as a deduction under section

274(a). In its financial statements, F

treats the limitation on deductions for

meals and entertainment as a

permanent difference. Because meal

and entertainment expenses are

specifically described in Part III, line 8, F

must report all of its meal and

entertainment expenses on this line,

regardless of whether there is a

difference. Accordingly, F must report

$300 in column (a), $200 in column (c),

and $100 in column (d). F must report

all meal and entertainment expenses,

whether allowed fully or subject to

limitations, on Part III, line 8. No amount

should be reflected on Part II, line 25.

Part II. Reconciliation of

Net Income (Loss) per

Income Statement of the

Corporation With Total

Income (Loss) per Return

Lines 1 Through 9. Additional

Information for Each Entity

For any item reported on Part II, lines 1,

and 3 through 5, attach a supporting

statement that provides the name of the

entity for which the item is reported, the

entity's EIN (if applicable), the type of

entity (corporation, partnership, etc.),

and the item amounts for columns (a)

through (d). See the instructions for Part

II, lines 2 and 6 through 9, for the

specific information required for those

particular lines.

Line 1. Income (Loss) From

Equity Method Foreign

Corporations

Report on line 1, column (a), the

financial income (loss) included in Part I,

line 11, for any foreign corporation

accounted for on the equity method and

remove such amount in column (b) or

(c), as applicable. Report the amount of

dividends received and other taxable

amounts received or includible from

foreign corporations on Part II, lines 2

through 4, as applicable.

Also include on line 3 passive foreign

investment company (PFIC)

mark-to-market gains and losses under

section 1296. Don't report such gains

and losses on Part II, line 14.

Line 2. Gross Foreign

Dividends Not Previously

Taxed

Except as otherwise provided in this

paragraph, report on line 2, column (d),

the amount (before any withholding tax)

of any foreign dividends included in

current year total income (loss) on Form

1120-S, Schedule K, line 18, and report

on line 2, column (a), the amount of

dividends from any foreign corporation

included in Part I, line 11. Don't report

on line 2 any amounts that must be

reported on Part II, line 3, or dividends

that were previously taxed and must be

reported on Part II, line 4. (See the

instructions below for Part II, lines 3 and

4.) Report withholding taxes on Part III,

line 31, or Part II, line 25, as applicable.

For any dividends reported on Part II,

line 2, that are received on a class of

voting stock of which the corporation

directly or indirectly owned 10% or more

of the outstanding shares of that class at

any time during the tax year, report on

an attached supporting statement: (1)

the name of the dividend payer, (2) the

payer's EIN (if applicable), (3) the class

of voting stock on which the dividend

was paid, (4) the percentage of the

class directly or indirectly owned, and

(5) the amounts for columns (a) through

(d).

Line 3. Subpart F, QEF, and

Similar Income Inclusions

Report on line 3, column (d), the amount

included in income under section 951

(relating to Subpart F), the amount

included in income under section 951A

(relating to global intangible low-taxed

income (GILTI)), gains or other income

inclusions resulting from elections under

sections 1291(d)(2) and 1298(b)(1), and

any amount included in income

pursuant to section 1293 (relating to

qualified electing funds (QEFs)). The

amount of Subpart F income

corresponds to the total of the amounts

reported by the corporation on

Schedule I, lines 1 through 4, of all

Forms 5471, Information Return of U.S.

Persons With Respect To Certain

Foreign Corporations. The amount of

QEF income corresponds to the total of

the amounts reported by the corporation

on all Forms 8621, Information Return

by a Shareholder of a Passive Foreign

Investment Company or Qualified

Electing Fund. See Form 8621 and the

Instructions for Form 8621.

-10-

Line 4. Gross Foreign

Distributions Previously Taxed

Report on line 4, column (a), any

distributions received from foreign

corporations that were included in Part I,

line 11, and that were previously taxed

for U.S. income tax purposes. For

example, include in column (a) amounts

that are excluded from income under

sections 959 and 1293(c). Remove

such amount in column (b) or (c), as

applicable. Report the full amount of the

distribution before any withholding tax.

Report withholding taxes on Part III,

line 31, or Part II, line 25, as applicable.

Since previously taxed foreign

distributions aren't currently taxable,

line 4, column (d), is shaded. Also, see

the instructions above for Part II, line 2.

Line 5. Income (Loss) From

Equity Method U.S.

Corporations

Report on line 5, column (a), the

financial income (loss) included in Part I,

line 11, for any U.S. corporation

accounted for on the equity method and

remove such amount in column (b) or

(c), as applicable. Report on Part II,

line 6, dividends received from any U.S.

corporation accounted for on the equity

method.

Line 6. U.S. Dividends Not

Eliminated in Tax Consolidation

Report on line 6, column (a), the amount

of dividends included in Part I, line 11,

that were received from any U.S.

corporation. Report on line 6, column

(d), the amount of any U.S. dividends

included in total income (loss) on Form

1120-S, Schedule K, line 18.

For any dividends included on Part II,

line 6, that are received on classes of

voting stock in which the corporation

directly or indirectly owned 10% or more

of the outstanding shares of that class at

any time during the tax year, report on

an attached supporting statement for

Part II, line 6: (1) the name of the

dividend payer, (2) the payer's EIN (if

applicable), (3) the class of voting stock

on which the dividend was paid, (4) the

percentage of the class directly or

indirectly owned, and (5) the item

amounts for columns (a) through (d).

Instructions for Schedule M-3 (Form 1120-S)

Line 7. Income (Loss) From

U.S. Partnerships and Line 8.

Income (Loss) From Foreign

Partnerships

For any interest owned by the

corporation that is treated as an

investment in a partnership for U.S.

income tax purposes (other than an

interest in a disregarded entity), report

amounts on Part II, line 7 or 8, as

described below.

1. In column (a), the sum of the

corporation's distributive share of

income or loss from a U.S. or foreign

partnership that is included in Part I,

line 11.

2. In column (b) or (c), 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.

3. In column (d), 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 (that is, 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.

For each partnership reported on

line 7 or 8, attach a supporting

statement 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 7 or 8, as

applicable.

Example 11. U.S. corporation H is a

calendar year taxpayer that files and

entirely completes Schedule M-3 for its

current tax year. H has an investment in

a U.S. partnership USP. H prepares

financial statements in accordance with

GAAP. In its financial statements, H

treats the difference between financial

statement net income and taxable

income from its investment in USP as a

permanent difference. For its current tax

year, H's financial statement net income

includes $10,000 of income attributable

to its share of USP's net income. H's

Schedule K-1 from USP reports $5,000

of ordinary income, $7,000 of long-term

capital gains, $4,000 of charitable

contributions, and $200 of section 179

expense. H must report on Part II, line 7,

$10,000 in column (a), a permanent

difference of ($2,200) in column (c), and

$7,800 in column (d).

Line 9. Income (Loss) From

Other Pass-Through Entities

For any interest in a pass-through entity

(other than an interest in a partnership

reportable on Part II, line 7 or 8, as

applicable) owned by the corporation

(other than an interest in a disregarded

entity), report the following on line 9.

1. In column (a), the sum of the

corporation's distributive share of

income or loss from the pass-through

entity that is included in Part I, line 11.

2. In column (b) or (c), as

applicable, the sum of all differences, if

any, attributable to the pass-through

entity.

3. In column (d), the sum of all

taxable amounts of income, gain, loss,

or deduction reportable on the

corporation's Schedules K-1 received

from the pass-through entity (if

applicable).

For each pass-through entity

reported on line 9, attach a supporting

statement that provides that entity's

name, EIN (if applicable), the

corporation's end of year profit-sharing

percentage (if applicable), the

corporation's end of year loss-sharing

percentage (if applicable), and the

amounts reported by the corporation in

column (a), (b), (c), or (d) of line 9, as

applicable.

Line 10. Items Relating to

Reportable Transactions

Any amounts attributable to any

reportable transactions (as described in

Regulations section 1.6011-4(b)) must

be included on Part II, line 10,

regardless of whether the difference, or

differences, would otherwise be

reported elsewhere in Part II or Part III.

So, if a taxpayer is required to file Form

8886 for any reportable transaction

described in Regulations section

1.6011-4(b), the amounts attributable to

that reportable transaction must be

reported on Part II, line 10. In addition,

all income and expense amounts

attributable to a reportable transaction

must be reported on Part II, line 10,

columns (a) and (d), even if there is no

difference between the financial

amounts and the taxable amounts.

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 10 if the corporation

sequentially numbers each Form 8886

and lists by identifying number on the

Instructions for Schedule M-3 (Form 1120-S)

-11-

supporting statement for Part II, line 10,

each sequentially numbered reportable

transaction and the amounts required

for Part II, line 10, 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 statement 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 10.

2. The name and reportable

transaction or tax shelter registration

number, if applicable, as reported on

lines 1a and 1c, respectively, of Form

8886.

3. The type of reportable transaction

(that is, 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.

Example 12. Corporation J is a

calendar year taxpayer that files and

entirely completes Schedule M-3 for its

current tax year. J incurred seven

different abandonment losses during its

current tax year. One loss of $12 million

results from a reportable transaction

described in Regulations section

1.6011-4(b)(5), another loss of $5

million results from a reportable

transaction described in Regulations

section 1.6011-4(b)(4), and the

remaining five abandonment losses

aren't reportable transactions. J

discloses the reportable transactions

giving rise to the $12 million and $5

million losses on separate Forms 8886

and sequentially numbers them X1 and

X2, respectively. J must separately state

and adequately disclose the $12 million

and $5 million losses on Part II, line 10.

The $12 million loss and the $5 million

loss will be adequately disclosed if J

attaches a supporting statement for

line 10 that lists each of the sequentially

numbered forms, Form 8886-X1 and

Form 8886-X2, and for each reportable

transaction reports the appropriate

amounts required for Part II, line 10,

columns (a) through (d). Alternatively,

J's disclosures will be adequate if the

description provided for each loss on

the supporting statement includes the

names and reportable transaction or tax

shelter registration numbers, if any,

disclosed on the applicable Form 8886,

identifies the type of reportable

transaction for the loss, and reports the

appropriate amounts required for Part II,

line 10, columns (a) through (d). J must

report the losses attributable to the

other five abandonment losses on Part

II, line 21e, regardless of whether a

difference exists for any or all of those

abandonment losses.

Example 13. Corporation K is a

calendar year taxpayer that files and

entirely completes Schedule M-3 for its

current tax year. K enters into a

transaction with contractual protection

that is a reportable transaction

described in Regulations section

1.6011-4(b)(4). This reportable

transaction is the only reportable

transaction for K's current tax year and

results in a $7 million capital loss for

both financial accounting purposes and

U.S. income tax purposes. Although the

transaction doesn't result in a

difference, K is required to report on

Part II, line 10, the following amounts:

($7 million) in column (a), zero in

columns (b) and (c), and ($7 million) in

column (d). The transaction will be

adequately disclosed if K attaches a

supporting statement for line 10 that (a)

sequentially numbers the Form 8886

and refers to the sequentially-numbered

Form 8886-X1 and (b) reports the

applicable amounts required for line 10,

columns (a) through (d). Alternatively,

the transaction will be adequately

disclosed if the supporting statement for

line 10 includes a description of the

transaction, the name and tax shelter

registration number, if any, and the type

of reportable transaction disclosed on

Form 8886.

Line 11. Interest Income

Attach Form 8916-A, Supplemental

Attachment to Schedule M-3. Complete

Part II and enter the amounts shown on

line 6, columns (a) through (d), on

Schedule M-3, line 11, columns (a)

through (d), as applicable.

Any corporation that files Form

TIP 1120-S that (a) is required to file

a Schedule M-3 and has less

than $50 million in total assets at the

end of the tax year or (b) isn't required

to file a Schedule M-3 and voluntarily

files a Schedule M-3, isn't required to

file Form 8916-A but may voluntarily do

so.

Report on Part II, line 11, column (a),

the total amount of interest income

included on Part I, line 11, and report on

Part II, line 11, column (d), the total

amount of interest income included on

Form 1120-S, Schedule K, line 18, that

isn't required to be reported elsewhere

on Schedule M-3. In columns (b) or (c),

as applicable, adjust for any amounts

treated for U.S. income tax purposes as

interest income that are treated as some

other form of income for financial

accounting purposes, or vice versa. For

example, adjustments to interest

income resulting from adjustments

made in accordance with the

instructions for Part II, line 16, should be

made in columns (b) and (c) of this

line 11.

Don't report on this line 11 or include

on Form 8916-A amounts reported in

accordance with instructions for Part II,

lines 7, 8, 9, 10, and 20.

Line 12. Total Accrual to Cash

Adjustment

This line is completed by a corporation

that prepares financial statements (or

books and records, if permitted) using

an overall accrual method of accounting

and uses an overall cash method of

accounting for U.S. income tax

purposes (or vice versa). With the

exception of amounts required to be

reported on Part II, line 10, the

corporation must report on Part II,

line 12, a single amount net of all

adjustments attributable solely to the

use of the different overall methods of

accounting (for example, adjustments

related to accounts receivable,

accounts payable, compensation,

accrued liabilities, etc.), regardless of

whether a separate line on

Schedule M-3 corresponds to an item

within the accrual to cash reconciliation.

Differences not attributable to the use of

the different overall methods of

accounting must be reported on the

appropriate lines of Schedule M-3 (for

example, a depreciation difference must

be reported on Part III, line 24).

Example 14. Corporation L is a

calendar year taxpayer that files and

entirely completes Schedule M-3 for its

current tax year. L prepares financial

statements in accordance with GAAP

using an overall accrual method of

accounting. L uses an overall cash

method of accounting for U.S. income

tax purposes. L's financial statements

for the year ending December 31 of its

-12-

current tax year report accounts

receivable of $35,000, an allowance for

bad debts of $10,000, and accounts

payable of $17,000 related to current

year acquisition and reorganization

legal and accounting fees. In addition,

for L's year ending December 31 of its

current tax year, L reported financial

statement depreciation expense of

$15,000 and depreciation for U.S.

income tax purposes of $25,000. For L's

current tax year using an overall cash

method of accounting, L doesn't

recognize the $35,000 of revenue

attributable to the accounts receivable,

can't deduct the $10,000 allowance for

bad debt, and can't deduct the $17,000

of accounts payable. In its financial

statements, L treats both the difference

in overall accounting methods used for

financial statement and U.S. income tax

purposes and the difference in

depreciation expense as temporary

differences. L must combine all

adjustments attributable to the

differences related to the overall

accounting methods on Part II, line 12.

As a result, L must report on Part II,

line 12, $8,000 in column (a) ($35,000 –

$10,000 – $17,000), ($8,000) in column

(b), and zero in column (d). L mustn't

report the accrual to cash adjustment

attributable to the legal and accounting

fees on Part III, line 17. Because the

difference in depreciation expense

doesn't relate to the use of the cash or

accrual method of accounting, L must

report the depreciation difference on

Part III, line 24, and report $15,000 in

column (a), $10,000 in column (b), and

$25,000 in column (d).

Line 13. Hedging Transactions

Report on line 13, column (a), the net

gain or loss from hedging transactions

included on Part I, line 11. Report in

column (d) the amount of income (loss)

from hedging transactions as defined in

section 1221(b)(2). Use columns (b)

and (c) to report all differences caused

by treating hedging transactions

differently for financial accounting

purposes and for U.S. income tax

purposes. For example, if a portion of a

hedge is considered ineffective under

GAAP but still is a valid hedge under

section 1221(b)(2), the difference must

be reported on line 13. The hedge of a

capital asset, which isn't a valid hedge

for U.S. income tax purposes but may

be considered a hedge for GAAP

purposes, must also be reported here.

Report hedging gains and losses

computed under the mark-to-market

method of accounting on line 13 and not

on Part II, line 14.

Instructions for Schedule M-3 (Form 1120-S)

Report any gain or loss from

inventory hedging transactions on

line 13 and not on Part II, line 15.

Line 14. Mark-to-Market Income

(Loss)

Report on line 14 any amount

representing the mark-to-market income

or loss for any securities held by a

dealer in securities, a dealer in

commodities having made a valid

election under section 475(e), or a

trader in securities or commodities

having made a valid election under

section 475(f). “Securities” for these

purposes are securities described in

section 475(c)(2) and “commodities” are

described in section 475(e)(2).

“Securities” don't include any items

specifically excluded from sections

475(c)(2) and 475(e)(2), such as certain

contracts to which section 1256(a)

applies.

Report hedging gains and losses

computed under the mark-to-market

method of accounting on Part II, line 13,

and not on line 14.

Traders in securities and commodities. For a trader in securities or

commodities that made a valid election

under section 475(f) to use the

mark-to-market method to account for

securities or commodities held in

connection with a trading business that

files Form 4797, Sales of Business

Property, any Schedule M-3 entries

required as a result of marking to market

these securities or commodities are

reported as follows: (a) mark-to-market

gains and losses from Form 4797,

line 10, are included on Schedule M-3

(Form 1120-S), Part II, line 14; (b) any

other Schedule M-3 entries required

based on other results (non

mark-to-market gains and losses)

included in the total reported on Form

4797, line 17, should be reported on

Schedule M-3 (Form 1120-S), Part II,

line 21d, unless the instructions for

Schedule M-3 require the amounts to be

reported on another line.

Line 15. Cost of Goods Sold

Report on line 15 any amounts

deducted as part of cost of goods sold

during the tax year, regardless of

whether the amounts would otherwise

be reported elsewhere in Part II or Part

III.

Examples of amounts that must be

included as cost of goods sold items are

amounts attributable to inventory

valuation, such as amounts attributable

to cost-flow assumptions, additional

costs required to be capitalized

(including depreciation) such as section

263A costs, inventory shrinkage

accruals, inventory obsolescence

reserves, and lower of cost or market

(LCM) write-downs.

Complete Part I of Form 8916-A.

Enter the amounts from line 8, columns

(a) through (d) of Form 8916-A, on

Schedule M-3, Part II, line 15, columns

(a) through (d), as applicable. Attach

Form 8916-A.

The entries in columns (a) and

TIP (d) of Schedule M-3, line 15, are

negative amounts.

Don't report the following on line 15

or on Form 8916-A.

• Amounts reportable on Part II, line 10.

• Any gain or loss from inventory

hedging transactions reportable on Part

II, line 13.

• Amounts reportable on Part II, line 16.

• Amounts reportable on Part II, line 19.

• Mark-to-market income or (loss)

associated with the inventories of

dealers in securities under section 475

reportable on Part II, line 14.

• Section 481(a) adjustments related to

cost of goods sold or inventory valuation

reportable on Part II, line 17.

• Fines and penalties reportable on

Part III, line 9.

• Judgments, damages, awards, and

similar costs, reportable on Part III,

line 10.

• Amounts included on Part III, line 28.

Form 8916-A. Any corporation filing

Form 1120-S that (a) is required to file a

Schedule M-3 and has less than $50

million in total assets at the end of the

tax year or (b) isn't required to file a

Schedule M-3 and voluntarily files a

Schedule M-3, isn't required to file Form

8916-A but may voluntarily do so.

If you are required to (or voluntarily)

file Form 8916-A, complete Part I to

provide a detailed schedule of cost of

goods sold. Enter the amounts from

line 8, columns (a) through (d) of Form

8916-A, on Schedule M-3, Part II,

line 15, columns (a) through (d), as

applicable. Attach Form 8916-A.

Example 15. Corporation C is a

calendar year taxpayer that files and

entirely completes Schedule M-3 for its

current tax year. C placed in service 10

depreciable fixed assets in a previous

tax year. C's total depreciation expense

for its current tax year for five of the

assets is $50,000 for financial

accounting purposes and $70,000 for

U.S. income tax purposes. C's total

annual depreciation expense for its

current tax year for the other five assets

is $40,000 for financial accounting

Instructions for Schedule M-3 (Form 1120-S)

-13-

purposes and $30,000 for U.S. income

tax purposes. In addition, C incurs $200

of meal expenses that C deducts in

computing net income for financial

accounting purposes. All $200 of the

meal expenses is subject to the 50%

limitation under section 274(n). In its

financial statements, C treats the

$50,000 depreciation and $100 of the

meals as other costs in computing cost

of goods sold. C must include on

Schedule M-3, Part II, line 15, in column

(a), the $50,000 of depreciation and

$100 of meals. C must also include a

temporary difference of $20,000 in

column (b), a permanent difference of

($50) in column (c), and $70,050 in

column (d) ($70,000 depreciation and

$50 meal expenses). In addition, C must

report on Part III, line 24, for its current

tax year income statement, depreciation

expense of $40,000 in column (a), a

temporary difference of ($10,000) in

column (b), and $30,000 in column (d);

and on Part III, line 8, meals and

entertainment expense of $100 in

column (a), a permanent difference of

($50) in column (c), and $50 in column

(d). All other cost of goods sold items

would be added to the amounts

included on Part II, line 15, detailed in

this example and reported on Part II,

line 15, in the appropriate columns.

Line 16. Sale Versus Lease (for

Sellers and/or Lessors)

Also see the instructions at Part

TIP III, line 28.

Asset transfer transactions with periodic

payments characterized for financial

accounting purposes as either a sale or

a lease may, under some

circumstances, be characterized as the

opposite for tax purposes. If the

transaction is treated as a lease, the

seller/lessor reports the periodic

payments as gross rental income and

also reports depreciation expense or

deduction. If the transaction is treated

as a sale, the seller/lessor reports gross

profit (sale price less cost of goods sold)

from the sale of assets and reports the

periodic payments as payments of

principal and interest income.

On Part II, line 16, column (a), report

the gross profit or gross rental income

for financial accounting purposes for all

sale or lease transactions that must be

given the opposite characterization for

U.S. income tax purposes. On Part II,

line 16, column (d), report the gross

profit or gross rental income for federal

income tax purposes. Interest income

amounts for such transactions must be

reported on Part II, line 11, in column (a)

or (d), as applicable. Depreciation

expense for such transactions must be

reported on Part III, line 24, in column

(a) or (d), as applicable. Use columns

(b) and (c) of Part II, lines 11 and 16,

and Part III, line 24, as applicable to

report the differences between column

(a) and (d).

Example 16. Corporation M is a

calendar year taxpayer that files and

entirely completes Schedule M-3 for its

current tax year. M sells and leases

property to customers. For financial

accounting purposes, M accounts for

each transaction as a sale. For U.S.

income tax purposes, each of M's

transactions must be treated as a lease.

In its financial statements, M treats the

difference in the financial accounting

and the U.S. income tax treatment of

these transactions as temporary. During

its current tax year, M reports in its

financial statements $1,000 of sales and

$700 of cost of goods sold regarding its

current tax year lease transactions. M

receives periodic payments of $500 in

its current tax year for these current tax

year transactions and similar

transactions from prior years and treats

$400 as principal and $100 as interest

income. For financial accounting

purposes, M reports gross profit of $300

($1,000 – $700) and interest income of

$100 from these transactions. For U.S.

income tax purposes, M reports $500 of

gross rental income (the periodic

payments) and (based on other facts)

$200 of depreciation deduction on the

property. On its current tax year

Schedule M-3, M must report on Part II,

line 11, $100 in column (a), ($100) in

column (b), and zero in column (d). In

addition, M must report on Part II,

line 16, $300 of gross profit in column

(a), $200 in column (b), and $500 of

gross rental income in column (d).

Lastly, M must report on Part III, line 24,

$200 in columns (b) and (d).

Line 17. Section 481(a)

Adjustments

With the exception of a section 481(a)

adjustment that is required to be

reported on Part II, line 10, for

reportable transactions, any difference

between an income or expense item

attributable to an authorized (or

unauthorized) change in method of

accounting made for U.S. income tax

purposes that results in a section 481(a)

adjustment must be reported on Part II,

line 17, regardless of whether a

separate line for that income or expense

item exists in Part II or Part III.

Example 17. Corporation N is a

calendar year taxpayer that files and

entirely completes Schedule M-3 for its

current tax year. N was depreciating

certain fixed assets over an erroneous

recovery period and, effective for its

current tax year, N receives IRS consent

to change its method of accounting for

the depreciable fixed assets and begins

using the proper recovery period. The

change in method of accounting results

in a positive section 481(a) adjustment

of $100,000 that is required to be

spread over 4 tax years, beginning with

the current tax year. In its financial

statements, N treats the section 481(a)

adjustment as a temporary difference. N

must report on Part II, line 17, $25,000

in columns (b) and (d) for its current tax

year and each of the subsequent 3 tax

years (unless N is otherwise required to

recognize the remainder of the 481(a)

adjustment earlier). N mustn't report the

section 481(a) adjustment on Part III,

line 24.

Line 18. Unearned/Deferred

Revenue

Report on line 18, column (a), amounts

of revenues included in Part I, line 11,

that were deferred from a prior financial

accounting year. Report on line 18,

column (d), amounts of revenues

recognizable for U.S. income tax

purposes in the current tax year that are

recognized for financial accounting

purposes in a different year. Also report

on line 18, column (d), any amount of

revenues reported on line 18, column

(a), that are recognizable for U.S.

income tax purposes in the current tax

year. Use columns (b) and (c) of line 18,

as applicable, to report the differences

between columns (a) and (d).

Line 18 mustn't be used to report

income recognized from long-term

contracts. Instead, use line 19.

Line 19. Income Recognition

From Long-Term Contracts

Report on line 19 the amount of net

income or loss for financial statement

purposes (or books and records, if

applicable) or U.S. income tax purposes

for any contract accounted for under a

long-term contract method of

accounting.

Line 20. Original Issue Discount

and Other Imputed Interest

Report on line 20 any amounts of

original issue discount (OID) and other

imputed interest. The term “original

issue discount and other imputed

interest” includes, but isn't limited to:

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1. The excess of a debt instrument's

stated redemption price at maturity over

its issue price, as determined under

section 1273;

2. Amounts that are imputed interest

on a deferred sales contract under

section 483;

3. Amounts treated as interest or

OID under the stripped bond rules under

section 1286; and

4. Amounts treated as OID under

the below-market interest rate rules

under section 7872.

Line 21a. Income Statement

Gain/Loss on Sale, Exchange,

Abandonment, Worthlessness,

or Other Disposition of Assets

Other Than Inventory and

Pass-Through Entities

Report on line 21a, column (a), all gains

and losses on the 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 pass-through entity (for example,

on Schedule K-1) that are included in

the net income (loss) of the corporation

reported on Part I, line 11. Reverse the

amount reported in column (a) in

column (b) or (c), as applicable. The

corresponding gains and losses for U.S.

income tax purposes are reported on

Part II, lines 21b through 21g, as

applicable.

Line 21b. Gross Capital Gains

From Schedule D, Excluding

Amounts From Pass-Through

Entities

Report on line 21b gross capital gains

reported on Schedule D (Form 1120-S),

Capital Gains and Losses and Built-in

Gains, or Form 8949, Sales and Other

Dispositions of Capital Assets,

excluding capital gains from

pass-through entities, which must be

reported on Part II, lines 7, 8, or 9, as

applicable.

Line 21c. Gross Capital Losses

From Schedule D, Excluding

Amounts From Pass-Through

Entities, Abandonment Losses,

and Worthless Stock Losses

Report on line 21c gross capital losses

reported on Schedule D (Form 1120-S)

or Form 8949, excluding capital losses

from (a) pass-through entities, which

must be reported on Part II, lines 7, 8, or

9, as applicable; (b) abandonment

losses, which must be reported on Part

II, line 21e; and (c) worthless stock

Instructions for Schedule M-3 (Form 1120-S)

losses, which must be reported on Part

II, line 21f.

Line 21d. Net Gain/Loss

Reported on Form 4797,

Line 17, Excluding Amounts

From Pass-Through Entities,

Abandonment Losses, and

Worthless Stock Losses

Report on line 21d the net gain or loss

reported on line 17 of Form 4797,

excluding amounts from (a)

pass-through entities, which must be

reported on Part II, lines 7, 8, or 9, as

applicable; (b) abandonment losses,

which must be reported on Part II,

line 21e; and (c) worthless stock losses,

which must be reported on Part II,

line 21f. The amount reported on

line 21d is the amount that would have

been carried to line 17 of Form 4797 in

the case of a corporation that isn't an S

corporation.

Traders in securities or

TIP commodities that have made a

valid election under section

475(f) to use the mark-to-market

method to account for securities or

commodities, see the instructions for

Part II, line 14.

Line 21e. Abandonment Losses

Report on line 21e any abandonment

losses, regardless of whether the loss is

characterized as an ordinary loss or a

capital loss.

Line 21f. Worthless Stock

Losses

Report on line 21f any worthless stock

loss, regardless of whether the loss is

characterized as an ordinary loss or a

capital loss. Attach a statement that

separately states and adequately

discloses each transaction that gives

rise to a worthless stock loss and the

amount of each loss.

Line 21g. Other Gain/Loss on

Disposition of Assets Other

Than Inventory

Report on line 21g any gains or losses

from the sale or exchange of property

other than inventory that aren't reported

on lines 21b through 21f.

Line 22. Other Income (Loss)

Items With Differences

Separately state and adequately

disclose on Part II, line 22, all items of

income (loss) with differences that aren't

otherwise listed on Part II, lines 1

through 21. Attach a statement that

itemizes the type of income (loss) and

the amount of each item and provides a

description that states the income (loss)

name for book purposes for the amount

recorded in column (a) and describes

the adjustment being recorded in

column (b) or (c). The entire description

completes the tax description for the

amount included in column (d) for each

item separately stated on this line.

The attached statement should have

five columns. The first column has the

description for the next four columns.

The second column is column (a)

income (loss) per income statement,

third column is column (b) temporary

difference, the fourth column is column

(c) permanent difference, and the fifth

column is column (d) income (loss) per

tax return. Every item listed on the

attached statement for line 22 must

always have columns (a) + (b) + (c) =

(d). Each item with amounts in columns

(a), (b), (c), and (d) will be totaled and

included as one line on line 22.

deduction and the item isn't described

or included in Part II, lines 1 through 22,

or Part III, lines 1 through 31, report the

entire amount of the item in columns (a)

and (d) of line 25. If a portion of an item

of income, loss, expense, or deduction

has a difference and a portion of the

item doesn't have a difference, don't

report any portion of the item on line 25.

Instead, report the entire amount of the

item (that is, both the portion with a

difference and the portion without a

difference) on the applicable line of Part

II, lines 1 through 22, or Part III, lines 1

through 31. See Example 10, earlier.

Part III. Reconciliation of

Net Income (Loss) per

Income Statement of the

Corporation With Total

Income (Loss) per

Return—Expense/

Deduction Items

If any “comprehensive income” as

defined by Statement of Financial

Accounting Standards (SFAS) No. 130

is reported on this line, describe the

item(s) in detail. Examples of sufficiently

detailed descriptions include “Foreign

currency translation

adjustments—comprehensive income”

and “Gains and losses on

available-for-sale

securities—comprehensive income.”

must be reported on Part III,

column (a), as positive amounts.

Deduction amounts that reduce taxable

income must be reported on Part III,

column (d), as positive amounts.

Amounts reported on Part II, line 24,

must be the negative of the amounts

reported on Part III, line 32.

Line 23. Total Income (Loss)

Items

Lines 1 Through 6. Income Tax

Expense

Combine lines 1 through 22 and enter

the total on line 23.

Line 15, Cost of goods sold,

TIP columns (a) and (d), are

negative amounts which will

affect the totals entered on line 23.

Line 24. Total Expense/

Deduction Items

Report on Part II, line 24, columns (a)

through (d), as applicable, the negative

of the amounts reported on Part III,

line 32, columns (a) through (d). For

example, if Part III, line 32, column (a),

reflects an amount of $1 million, then

report on Part II, line 24, column (a), ($1

million). Similarly, if Part III, line 32,

column (b), reflects an amount of

($50,000), then report on Part II, line 24,

column (b), $50,000.

Line 25. Other Items With No

Differences

If there is no difference between the

financial accounting amount and the

taxable amount of an entire item of

income, gain, loss, expense, or

Instructions for Schedule M-3 (Form 1120-S)

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Expense amounts that reduce

TIP financial accounting income

If the corporation doesn't distinguish

between current and deferred income

tax expense in its financial statements

(or its books and records, if applicable),

report income tax expense as current

income tax expense using lines 1, 3,

and 5, as applicable.

Line 7. Equity-Based

Compensation

Report on line 7 any amounts for

equity-based compensation or

consideration that are reflected as

expense for financial accounting

purposes (column (a)) or deducted in

the U.S. income tax return (column (d))

other than amounts reportable

elsewhere on Schedule M-3, Parts II

and III. Examples of amounts reportable

on line 7 include payments attributable

to stock options (including incentive

stock options and nonqualified stock

options), employee stock purchase

plans (ESPPs), phantom stock options,

phantom stock units, stock warrants,

stock appreciation rights, and restricted

stock, regardless of whether such

payments are made to employees or

non-employees, or as payment for

property or compensation for services.

Line 8. Meals and

Entertainment

Report on line 8, column (a), any

amounts paid or accrued by the

corporation during the tax year for

meals, beverages, and entertainment

that are accounted for in financial

accounting income, regardless of the

classification, nomenclature, or

terminology used for such amounts, and

regardless of how or where such

amounts are classified in the

corporation's financial income statement

or the income and expense accounts

maintained in the corporation's books

and records. Report only amounts not

otherwise reportable elsewhere on

Schedule M-3, Parts II and III (for

example, Part II, line 15).

Line 9. Fines and Penalties

Report on line 9 any fines or similar

penalties paid to a government or other

authority for the violation of any law for

which fines or penalties are assessed.

All fines and penalties expensed in

financial accounting income (paid or

accrued) must be included on this line 9,

column (a), regardless of the

government or other authority that

imposed the fines or penalties,

regardless of whether the fines and

penalties are civil or criminal, regardless

of the classification, nomenclature, or

terminology used for the fines or

penalties by the imposing authority in its

actions or documents, and regardless of

how or where the fines or penalties are

classified in the corporation's financial

income statement or the income and

expense accounts maintained in the

corporation's books and records. Also

report on line 9, column (a), the reversal

of any overaccrual of any amount

described in this paragraph. See section

162(f) for additional guidance.

Report on line 9, column (d), any

such amounts as described in the

preceding paragraph that are includible

in taxable income, regardless of the

financial accounting period in which

such amounts were or are included in

financial accounting net income.

Complete columns (b) and (c) as

appropriate.

Don't report on this Part III, line 9,

amounts required to be reported in

accordance with instructions for Part III,

line 10.

Don't report on this Part III, line 9,

amounts recovered from insurers or any

other indemnitors for any fines and

penalties described above.

Line 10. Judgments, Damages,

Awards, and Similar Costs

Report on line 10, column (a), the

amount of any estimated or actual

judgments, damages, awards,

settlements, and similar costs, however

named or classified, included in

financial accounting income, regardless

of whether the amount deducted was

attributable to an estimate of future

anticipated payments or actual

payments. Also report on line 10,

column (a), the reversal of any

overaccrual of any amount described in

this paragraph.

Report on line 10, column (d), any

such amounts as are described in the

preceding paragraph that are includible

in taxable income, regardless of the

financial accounting period in which

such amounts were or are included in

financial accounting net income.

Complete columns (b) and (c) as

appropriate.

Don't report on this Part III, line 10,

amounts required to be reported in

accordance with instructions for Part III,

line 9.

Don't report on this Part III, line 10,

amounts recovered from insurers or any

other indemnitors for any judgments,

damages, awards, or similar costs

described above.

Line 11. Pension and

Profit-Sharing

Report on line 11 any amounts

attributable to the corporation's pension

plans, profit-sharing plans, and any

other retirement plans.

Line 12. Other Post-Retirement

Benefits

Report on line 12 any amounts

attributable to other post-retirement

benefits not otherwise includible on Part

III, line 11 (for example, retiree health

and life insurance coverage, dental

coverage, etc.).

Line 13. Deferred

Compensation

Report on line 13, column (a), any

compensation expense included in the

net income (loss) amount reported in

Part I, line 11, that isn't deductible for

U.S. income tax purposes in the current

tax year and that wasn't reported

elsewhere on Schedule M-3, column

(a). Report on line 13, column (d), any

compensation deductible in the current

tax year that wasn't included in the net

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income (loss) amount reported in Part I,

line 11, for the current tax year and that

isn't reportable elsewhere on

Schedule M-3. For example, report

originations and reversals of deferred

compensation subject to section 409A

on line 13.

Line 15. Charitable

Contribution of Intangible

Property

Report on line 15 any charitable

contribution of intangible property, for

example, contributions of:

• Intellectual property, patents

(including any amounts of additional

contributions allowable by virtue of

income earned by donees subsequent

to the year of donation), copyrights,

trademarks;

• Securities (including stocks and their

derivatives, stock options, and bonds);

• Conservation easements (including

scenic easements or air rights);

• Railroad rights of way;

• Mineral rights; and

• Other intangible property.

Line 16. Current Year

Acquisition or Reorganization

Investment Banking Fees

Report on line 16 any investment

banking fees paid or incurred in

connection with a taxable or tax-free

acquisition of property (for example,

stock or assets) or a tax-free

reorganization. Report on this line any

investment banking fees incurred at any

stage of the acquisition or

reorganization process including, for

example, fees paid or incurred to

evaluate whether to investigate an

acquisition, fees to conduct an actual

investigation, and fees to consummate

the acquisition. Also include on this

line 16 investment banking fees incurred

in connection with the liquidation of a

subsidiary, a spin-off of a subsidiary, or

an initial public stock offering.

Line 17. Current Year

Acquisition or Reorganization

Legal and Accounting Fees

Report on line 17 any legal and

accounting fees paid or incurred in

connection with a taxable or tax-free

acquisition of property (for example,

stock or assets) or tax-free

reorganization. Report on this line any

legal and accounting fees incurred at

any stage of the acquisition or

reorganization process including, for

example, fees paid or incurred to

evaluate whether to investigate an

acquisition, fees to conduct an actual

Instructions for Schedule M-3 (Form 1120-S)

investigation, and fees to consummate

the acquisition. Also include on this line

legal and accounting fees incurred in

connection with the liquidation of a

subsidiary, a spin-off of a subsidiary, or

an initial public stock offering.

Line 18. Current Year

Acquisition/Reorganization

Other Costs

Report on line 18 any other fees paid or

incurred in connection with a taxable or

tax-free acquisition of property (for

example, stock or assets) or a tax-free

reorganization not otherwise reportable

on Schedule M-3 (for example, Part III,

line 16 or 17). Report on this line any

fees paid or incurred at any stage of the

acquisition or reorganization process

including, for example, fees paid or

incurred to evaluate whether to

investigate an acquisition, fees to

conduct an actual investigation, and

fees to consummate the acquisition.

Also include on this line other

acquisition/reorganization costs

incurred in connection with the

liquidation of a subsidiary, a spin-off of a

subsidiary, or an initial public stock

offering.

Line 19. Amortization/

Impairment of Goodwill

Report on line 19 amortization of

goodwill or amounts attributable to the

impairment of goodwill.

Line 20. Amortization of

Acquisition, Reorganization,

and Start-Up Costs

Report on line 20 amortization of

acquisition, reorganization, and start-up

costs. For purposes of columns (b), (c),

and (d), include amounts amortizable

under section 167, 195, or 248.

Line 21. Other Amortization or

Impairment Write-Offs

Report on line 21 any amortization or

impairment write-offs not otherwise

includible on Schedule M-3.

Line 22.

When using this line to figure amounts

on other tax forms or worksheets, this

line should be considered to be zero.

Line 23a. Depletion—Oil & Gas

Report on line 23a, column (a), any oil

and gas depletion included on Part I,

line 11.

Line 23b. Depletion—Other

than Oil & Gas

Report on line 23b any depletion

expense/deduction other than oil and

gas that isn't required to be reported

elsewhere on Schedule M-3 (for

example, on Part II, line 7, 8, 9, or 15).

Line 24. Depreciation

Report on line 24 any depreciation

expense that isn't required to be

reported elsewhere on Schedule M-3

(for example, on Part II, line 7, 8, 9, or

15).

Line 25. Bad Debt Expense

Report on line 25, column (a), any

amounts attributable to an allowance for

uncollectible accounts receivable or

actual write-offs of accounts receivable

included on Part I, line 11. Report in

column (d) the amount of bad debt

expense deductible for federal income

tax purposes under section 166.

Line 26. Interest Expense

Attach Form 8916-A. Complete Part III

and enter the amounts shown on line 5,

columns (a) through (d), on

Schedule M-3, line 27, columns (a)

through (d), as applicable.

Any corporation that files Form

TIP 1120-S that (a) is required to file

a Schedule M-3 and has less

than $50 million in total assets at the

end of the tax year or (b) isn't required

to file a Schedule M-3 and voluntarily

files a Schedule M-3, isn't required to

file Form 8916-A but may voluntarily do

so.

Report on Part III, line 26, column (a),

the total amount of interest expense

included on Part I, line 11, and report on

Part III, line 26, column (d), the total

amount of interest deduction included

on Form 1120-S, Schedule K, line 18,

that isn't required to be reported

elsewhere on Schedule M-3. In columns

(b) or (c), as applicable, include any

adjustments for any amounts treated for

U.S. income tax purposes as interest

deduction that are treated as some

other form of expense for financial

accounting purposes, or vice versa. For

example, adjustments to interest

expense/deduction resulting from

adjustments made in accordance with

the instructions for Part III, line 28,

should be made in columns (b) and (c),

as applicable, of this line 26.

Don't report on Form 8916-A and on

line 26 amounts reported in accordance

with the instructions for Part II, lines 7, 8,

9, and 10.

Line 27. Corporate Owned Life

Insurance Premiums

Report on line 27 all amounts of

insurance premiums attributable to any

Instructions for Schedule M-3 (Form 1120-S)

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life insurance policy if the corporation is

directly or indirectly a beneficiary under

the policy or if the policy has a cash

value. Report in column (d) the amount

of the premiums that are deductible for

federal income tax purposes.

Line 28. Purchase Versus

Lease (for Purchasers and/or

Lessees)

Also see the instructions for

TIP sellers and/or lessors in the

instructions for Part II, line 16.

Asset transfer transactions with periodic

payments characterized for financial

accounting purposes as either a

purchase or a lease may, under some

circumstances, be characterized as the

opposite for tax purposes.

If a transaction is treated as a lease,

the purchaser/lessee reports the

periodic payments as gross rental

expense. If the transaction is treated as

a purchase, the purchaser/lessee

reports the periodic payments as

payments of principal and interest and

also reports depreciation expense or

deduction regarding the purchased

asset.

Report in column (a) gross rent

expense for a transaction treated as a

lease for financial accounting purposes

but as a sale for U.S. income tax

purposes. Report in column (d), gross

rental deductions for a transaction

treated as a lease for U.S. income tax

purposes but as a purchase for financial

accounting purposes. Report interest

expense for such transactions on Part

III, line 26, in column (a) or (d), as

applicable. Report depreciation

expense or deductions for such

transactions on Part III, line 24, in

column (a) or (d), as applicable. Use

columns (b) and (c) of Part III, lines 24,

26, and 28, as applicable, to report the

differences between column (a) and (d)

for such recharacterized transactions.

Example 18. U.S. Corporation X is a

calendar year taxpayer that files and

entirely completes Schedule M-3 for its

current tax year. X acquired property in

a transaction that, for financial

accounting purposes, X treats as a

lease. Because of its terms, the

transaction is treated for U.S. income

tax purposes as a purchase and X must

treat the periodic payments it makes

partially as payment of principal and

partially as payment of interest. In its

financial statements, X treats the

difference between the financial

accounting and U.S. income tax

treatment of this transaction as a

temporary difference. During its current

tax year, X reports in its financial

statements $1,000 of gross rental

expense that, for U.S. income tax

purposes, is recharacterized as a $700

payment of principal and a $300

payment of interest, accompanied by a

depreciation deduction of $1,200

(based on other facts). On its current tax

year Schedule M-3, X must report the

following on Part III, line 28: column (a),

$1,000, its financial accounting gross

rental expense; column (b), ($1,000);

and column (d), zero. On Part III, line 26,

X reports zero in column (a) and $300 in

columns (b) and (d) for the interest

deduction. On Part III, line 24, X reports

zero in column (a) and $1,200 in

columns (b) and (d) for the depreciation

deduction.

Line 29. Research and

Development Costs

Report in column (a) the amount of

expenses included in net income

reported on Part I, line 11, that are

related to research and development

expense. Report in column (d) the

amount of deductions included in Form

1120-S, line 21, and/or separately

reported on Form 1120-S, Schedule K,

that are recognized and reported as

Section 174 research and experimental

expenditures consistent with the

corporation’s adopted method of

accounting for such expenditures. In

column (c), as applicable, include any

adjustments for any amounts treated for

U.S. income tax purposes as research

or experimental expenditures that are

treated as some other form of expense

for financial accounting purposes, or

vice versa. Report any difference in

timing recognition in column (b). For

example, if the taxpayer's financial

accounting method doesn't specify

otherwise, column (b) adjustments

include adjustments for timing

differences between financial and tax

accounting for: (1) deferral and

amortization of research expenditures,

(2) reduction of section 174

expenditures under section 280C or

section 482, (3) costs attributable to

obtaining a patent, (4) research in social

sciences, and (5) cost elements for

property of a character subject to

depreciation.

Section 174 provides two methods

for the treatment of research and

experimental expenditures paid or

incurred by a taxpayer in connection

with the taxpayer’s trade or business.

These expenditures may be treated as

expenses not chargeable to a capital

account and deducted in the year in

which they are paid or incurred, or they

may be deferred and amortized.

Example 19. Corporation X is a

calendar year taxpayer that files and

entirely completes Schedule M-3 for its

current tax year. During its current tax

year, X incurred $100,000 of research

and development costs that X

recognized as an expense in its

financial statements. Also, X incurred

$20,000 in attorney fees in obtaining a

patent application that X capitalized and

amortized in its financial statements. X

recognized a $2,000 amortization

deduction. In compliance with its

adopted method of accounting under

section 174, X deducts research and

experimental expenditures for U.S.

income tax purposes. Accordingly, X

must report $100,000 in column (a),

$20,000 in column (b), and $120,000 in

column (d). X must also report $2,000 in

column (a), ($2,000) in column (b), and

$0 in column (d) on Part III, line 21.

Example 20. Assume the same

facts as Example 19 except Corporation

X elected to capitalize and amortize its

research and expenditures over 60

months for all its research programs for

U.S. tax purposes. X first realized

benefits from such expenditures on

August 1. Accordingly, X must report

$100,000 in column (a), a temporary

difference of ($90,000) ($20,000 less

($120,000/60 months X 55 months)) in

column (b), and $10,000 in column (d).

Example 21. Corporation X is a

calendar year taxpayer that files and

entirely completes Schedule M-3 for its

current tax year. X adopted the current

expense method for research and

experimental expenditures for U.S.

income tax purposes. During it current

tax year, X incurred $50,000 of research

and development costs that X

recognized as an expense in its

financial statements. Also, X undertook

to develop a new machine for its

business. X expended $30,000 on the

project of which $10,000 represents

actual costs of material, labor, and

component cost to construct the

machine, and $20,000 represents

research costs not attributable to the

machine itself. X capitalized all costs of

$30,000 related to the machine and

recognized $6,000 of depreciation

expense in its financial statements. X’s

depreciation expense on the $10,000 of

costs related to the machine itself was

$2,000 for U.S. income tax purposes.

Accordingly, X must report $50,000 in

column (a), $20,000 (research costs

which aren't attributable to the machine

itself) in column (b), and $70,000 in

-18-

column (d). X must also report $6,000 in

column (a), ($4,000) in column (b), and

$2,000 in column (d) on Part III, line 24.

Example 22. Corporation X is a

calendar year taxpayer that files and

entirely completes Schedule M-3 for its

current tax year. During its current tax

year, X incurred $10,000 of research

and development costs related to social

sciences that it recognized as an

expense in its financial statements. X

adopted the current expense method for

research and experimental

expenditures for U.S. income tax

purposes. Because such costs aren't

allowable costs under section 174, X

must report $10,000 in column (a),

permanent difference ($10,000) in

column (c), and $0 in column (d). If such

costs are otherwise deductible for U.S.

income tax purposes, X must report this

item of expense on Part III, line 31.

Example 23. Corporation X is a

calendar year taxpayer that files and

entirely completes Schedule M-3 for its

current tax year. During its current tax

year, X paid $75,000 to acquire or

in-license intangible assets under a

collaborative arrangement with another

company that X recognized as a

research and development expense in

its financial statements. X adopted the

current expense method for research

and experimental expenditures for U.S.

income tax purposes. Because

payments made to acquire rights to a

product or technology are excluded

costs from the definition of research and

experimental expenditures, X must

report $75,000 in column (a), ($75,000)

in column (c), and $0 in column (d). X

must report any amortization otherwise

allowable related to the payments on

Part III, line 21.

Line 30. Section 118 Exclusion

Report on line 30 any inducements

received in the current year and treated

as contributions to the capital of a

corporation by a non-shareholder. The

following non-shareholder contributions

to capital are not eligible for exclusion

under section 118.

• Any contribution in aid of construction

or any other contribution as a customer

or potential customer.

• Any contribution by any civic group.

• Any contribution by any governmental

entity, except any contribution made

after December 22, 2017, and made

pursuant to a master development plan

that was approved prior to December

22, 2017, by a governmental entity.

Instructions for Schedule M-3 (Form 1120-S)

Report in column (a) any income

amount as a negative number and any

expense amount as a positive number.

Corporations must identify on an

accompanying statement referencing

line 36 the fair market value of land or

other property (including cash) provided

to the corporation by any

non-shareholder, including a

governmental unit as an inducement, or

for any other purpose.

On the accompanying statement,

also identify any inducements that

include refundable or transferable tax

credits, including transferable credits

that were sold.

The statement must separately state,

adequately disclose, and identify all of

the dollar amounts summarized by this

line. An accompanying statement is

required even if there are no dollar

amounts reported on line 30.

Line 31. Other Expense/

Deduction Items With

Differences

Separately state and adequately

disclose on Part III, line 31, all items of

expense/deduction that aren't otherwise

listed on Part III, lines 1 through 30.

Attach a statement that describes

and itemizes the type of expense/

deduction and the amount of each item,

and provides a description that states

the expense/deduction name for book

purposes for the amount recorded in

column (a) and describes the

adjustment being recorded in column

(b) or (c). The entire description

completes the tax description for the

amount included in column (d) for each

item separately stated on this line.

The statement of details attached to

the Schedule M-3 for line 31 must

separately state and adequately

disclose the nature and amount of the

expense related to each reserve and/or

contingent liability. The appropriate level

of disclosure depends upon each

taxpayer’s operational activity and the

nature of its accounting records. For

example, if a corporation’s net income

amount reported in the income

statement includes anticipated

expenses for a discontinued operation

as a single amount, and its general

ledger or other books, records, and

work papers provide details for the

anticipated expenses under more

explanatory and defined categories,

such as employee termination costs,

lease cancellation costs, loss on sale of

equipment, etc., a supporting statement

that lists those categories of expenses

and their details will satisfy the

requirement to separately state and

adequately disclose. In order to

separately state and adequately

disclose the employee termination

costs, it isn't required that an anticipated

termination cost amount be listed for

each employee, or that each asset (or

category of asset) be listed along with

the anticipated loss on disposition.

The attached statement should have

five columns. The first column has the

description for the next four columns.

The second column is column (a)

expense per income statement, the third

column is column (b) temporary

difference, the fourth column is column

(c) permanent difference, and the fifth

column is column (d) deduction per tax

return. Every item listed on the attached

statement for line 31 must always have

columns (a) + (b) + (c) = (d). Each item

with amounts in columns (a), (b), (c),

and (d) will be totaled and included as

one line on line 31.

Comprehensive income. If any

“comprehensive income” as defined by

SFAS No. 130 is reported on this line,

describe the item(s) in detail as, for

example, “Foreign currency translation

adjustments—comprehensive income”

and “Gains and losses on

available-for-sale

securities—comprehensive income.”

Reserves and contingent liabilities.

Report on line 31 amounts related to the

change in each reserve or contingent

liability that isn't required to be reported

elsewhere on Schedule M-3. For

example: (1) amounts relating to

changes in reserves for litigation must

be reported on Part III, line 10; and (2)

amounts relating to changes in reserves

for uncollectible accounts receivable

must be reported on Part III, line 25. See

Example 8 and Example 9, earlier; and

Example 24, later.

Report on line 31, the amortization of

various items of prepaid expense, such

as prepaid subscriptions and license

fees, prepaid insurance, etc.

Report on line 31, column (a),

expenses included in net income

reported on Part I, line 11, that are

related to reserves and contingent

liabilities. Report on line 31, column (d),

amounts related to liabilities for reserves

and contingent liabilities that are

Instructions for Schedule M-3 (Form 1120-S)

-19-

deductible in the current tax year for

U.S. income tax purposes. Examples of

reserves that are allowed for book

purposes, but not for tax purposes,

include warranty reserves, restructuring

reserves, reserves for discontinued

operations, and reserves for

acquisitions and dispositions. Only

report on line 31 items that aren't

required to be reported elsewhere on

Schedule M-3, Parts II and III.

Example 24. Corporation Q is a

calendar year taxpayer that files and

entirely completes Schedule M-3 for its

current tax year. On July 1 of each year,

Q has a fixed liability for its annual

insurance premiums on its home office

building that provides a 12-month

coverage period beginning July 1

through June 30. In addition, Q

historically prepays 12 months of

advertising expense on July 1. On July

1 of its current tax year, Q prepays its

insurance premium of $500,000 and

advertising expenses of $800,000. For

financial accounting purposes, Q

capitalizes and amortizes the prepaid

insurance and advertising over 12

months. For U.S. income tax purposes,

Q deducts the insurance premium when

paid and amortizes the advertising over

the 12-month period. In its financial

statements, Q treats the differences

attributable to the financial statement

treatment and U.S. income tax

treatment of the prepaid insurance and

advertising as temporary differences.

Q also has a legal expense reserve

where $300,000 was expensed for

financial accounting purposes and a

($100,000) temporary difference was

calculated to arrive at the income tax

deduction of $200,000. The statement

attached to Q's return for Part III, line 31,

must be separately stated and

adequately disclosed as shown below.

Line 32. Total Expense/

Deduction Items

Report on Part II, line 24, columns (a)

though (d), as applicable, the negative

of the amounts reported on Part III,

line 32, columns (a) through (d), as

applicable. Report positive amounts as

negative and negative amounts as

positive. For example, if Part III, line 32,

column (a), reflects an amount of $1

million, then report on Part II, line 24,

column (a), ($1 million). Similarly, if Part

III, line 32, column (b), reflects an

amount of ($50,000), then report on Part

II, line 24, column (b), $50,000.

Line 31—Example 24

Statement Concerning Other Expense/Deduction Items With Differences

Description

Column (a) Expense Column (b) Temporary

per Income Statement

Difference

Column (c)

Column (d) Deduction

Permanent Difference

per Tax Return

Prepaid insurance premium

expensed not capitalized

$250,000

$250,000

-0-

$500,000

Legal expense reserve

$300,000

($100,000)

-0-

$200,000

Total line 31

$550,000

$150,000

-0-

$700,000

-20-

Instructions for Schedule M-3 (Form 1120-S)