Part III. Reconciliation of Net Income (Loss) per Income Statement of Partnership With…

Note. Expense amounts that reduce financial 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 31.

Lines 1 Through 4. Income Tax Expense If the partnership 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 and 3, as applicable.

Line 5. Equity-Based Compensation Report on line 5 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 5 include expense/deduction items attributable to options to acquire capital interest units, profits interest units, and other rights to acquire partnership equity, regardless of whether such payments are made to employees or nonemployees, or as payment for property or compensation for services.

Line 6. Meals and Entertainment Report on line 6, column (a), any amounts paid or accrued by the partnership 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 partnership's financial income statement or the income and expense accounts maintained in the partnership'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 7. Fines and Penalties Report on line 7 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 line 7, 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 partnership's financial income statement or the income and expense accounts maintained in the partnership's books and records. Also report on line 7, column (a), the reversal of any over accrual of any amount described in this paragraph. See sections 162(f) and 162(g) for additional guidance.

Report on line 7, column (d), any such amounts 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 line 7 amounts required to be reported in accordance with the instructions for line 8.

Don't report on line 7 amounts recovered from insurers or any other indemnitors for any fines and penalties described above.

Line 8. Judgments, Damages, Awards, and Similar Costs Report on line 8, 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 8, column (a), the reversal of any over accrual of any amount described in this paragraph.

Report on line 8, column (d), any such amounts 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 line 8 amounts required to be reported in accordance with the instructions for line 7.

Don't report on line 8 amounts recovered from insurers or any other indemnitors for any judgments, damages, awards, or similar costs described above.

Line 9. Guaranteed Payments Include on line 9, column (a), the amount of guaranteed payments expense that is included on Part I, line 11. Report in column (d) the net amount of guaranteed payments deduction. The net amount of the deduction reported in column (d) is the amount reported as a deduction on Form 1065, page 1, line 10, reduced by the amount reported as income on Form 1065, Schedule K, line 4. The net amount of the guaranteed payments reported in column (d) will be zero if no guaranteed payments are capitalized and all are deducted on Form 1065, page 1, line 10, or a negative amount (reported in parentheses) if any of the guaranteed payments are capitalized by the partnership. Generally, if guaranteed payments expense is recognized for

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financial accounting purposes, the amount reported in column (c) as a permanent difference will be the negative of the guaranteed payment income reported on Form 1065, Schedule K, line 4. If no guaranteed payment expense is recognized for financial accounting purposes, the amount reported in column (c) as a permanent difference will generally be zero. Any amount of guaranteed payments capitalized for tax purposes on Form 1065, page 1, but not capitalized for financial accounting purposes, will generally be reported as a negative temporary difference amount in column (b).

Example 19.

1. ArrowRoot is a calendar year partnership that files and entirely completes Schedule M-3 for its 2023 tax year. ArrowRoot has total income in 2023 of $5,000 for both financial accounting and tax accounting purposes before taking into account guaranteed payments expense or deductions. Partner Arrow is paid a deductible guaranteed payment of $3,000 for services rendered to the partnership during the tax year. Partner Root is paid a $1,000 guaranteed payment, which is capitalized to land for tax accounting. Both guaranteed payments, in the total amount of $4,000, are treated as expenses in arriving at net financial accounting income. There are no other expenses or deductions for financial accounting or tax accounting purposes. The amount shown on Part I, line 11, Net income (loss) per income statement of the partnership, is $1,000 ($5,000 − $3,000

• $1,000 = $1,000). The amount shown on line 9, column (a), is $4,000, the amount of guaranteed payments expenses for financial accounting purposes. The amount shown on line 9, column (d), is ($1,000), the net amount deducted after taking into consideration the $4,000 of total guaranteed payments allocated to the partners as income on Schedule K, netted against $3,000 deducted on Form 1065, page 1, line 10. The amount reported on line 9, column (b), is a temporary difference of ($1,000), the negative of the amount of guaranteed payments capitalized for Form 1065, page 1. The amount reported on line 9, column (c), is a permanent difference of ($4,000), equal to the guaranteed payment income shown on Form 1065, Schedule K, line 4, expressed as a negative amount. Part II, line 23, reports $5,000 in column (a), $0 in column (b), $0 in column (c), and $5,000 in column (d). Part II, line 24, reports ($4,000) in column (a), $1,000 in column (b), $4,000 in column (c), and $1,000 in column (d). Part II, line 26, reports $1,000 in column (a), $1,000 in column (b), $4,000 in column (c), and $6,000 in column (d).

2. The facts are the same as in Example 19.1, except that no guaranteed payments expense is recognized for financial accounting purposes. The amount shown on Part I, line 11, is $5,000. On line 9, ArrowRoot reports $0 in column (a), ($1,000) in column (b), $0 in column (c), and ($1,000) in column (d). Part II, line 23, reports $0 in column (a), $1,000 in column (b), $0 in column (c), and $1,000 in column (d). On Part II, line 25, ArrowRoot reports $5,000 in column (a), $1,000 in column (b), $0 in column (c), and $6,000 in column (d).

Line 10. Pension and Profit-Sharing Report on line 10 any amounts attributable to the partnership's pension plans, profit-sharing plans, and any other retirement plans.

Line 11. Other Post-Retirement Benefits Report on line 11 any amounts attributable to other post-retirement benefits not otherwise includible on line 10 (for example, retiree health and life insurance coverage, dental coverage, etc.).

Line 12. Deferred Compensation Report on line 12, column (a), any compensation expense included in the net income (loss) amount reported on 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 12, column (d), any compensation deductible in the current tax year that wasn't included in the net income (loss) amount reported on Part I, line 11, for the current tax year and that isn't reportable elsewhere on Schedule M-3, including any compensation deductions deferred in a prior tax year. For example, report originations and reversals of deferred compensation subject to section 409A on line 12.

Line 14. Charitable Contribution of Intangible Property Report on line 14 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 15. Organizational Expenses as per Regulations Section 1.709-2(a) Include on line 15, column (a), organizational expenses, as defined in Regulations section 1.709-2(a). Include on line 15, column (d), the amount of organizational expense deducted per section 709(b).

Line 16. Syndication Expenses as per Regulations Section 1.709-2(b) Include on line 16 syndication expenses, as defined in Regulations section 1.709-2(b).

Line 17. Current Year Acquisition/ Reorganization Investment Banking Fees Report on line 17 any investment banking fees paid or incurred in connection with a taxable or tax-free acquisition of property (for example, ownership interests or assets) or a tax-free reorganization not otherwise reportable on Schedule M-3 (for example, line 15 or 16). Report on this line any investment banking 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 or reorganization.

Line 18. Current Year Acquisition/ Reorganization Legal and Accounting Fees Report on line 18 any legal and accounting fees paid or incurred in connection with a taxable or tax-free acquisition of property (for example, ownership interests or assets) or a tax-free reorganization not otherwise reportable on Schedule M-3 (for example, line 15 or 16). Report on this line any legal and accounting 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 or reorganization.

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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 or 195.

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. Reserved 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 Form 1065 filers 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. Intangible Drilling and Development Costs (IDC) Intangible drilling and development costs (IDC) are costs of developing oil, gas, or geothermal wells. Report on line 24, column (a), the total amount of intangible drilling and development costs (or such equivalent costs as classified in the partnership's financial statements) included on Part I, line 11, and report on line 24, column (d), the total amount of IDC paid or incurred during the current tax year under section 263(c) and Regulations section 1.612-4.

Line 25. Depreciation Report on line 25 any depreciation expense/deduction that isn't required to be reported elsewhere on Schedule M-3 (for example, on Part II, line 7, 8, 9, or 15).

Line 26. Bad Debt Expense Report on line 26, 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 27. 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.

An entity 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 line 27, column (a), the total amount of interest expense included on Part I, line 11, and report on line 27, column (d), the total amount of interest deduction included on line 1 of the Analysis of Net Income (Loss) found on Form 1065 that isn't reported elsewhere on Schedule M-3. In column (b) or

(c), as applicable, adjust 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 line 28 should be made in columns (b) and (c), as applicable, of line 27.

Don't report on Form 8916-A and on line 27 amounts reported in accordance with the instructions for (a) Part II, lines 7, 8, and 9, Income (loss) from U.S. partnerships, foreign partnerships, and other pass-through entities; and (b) Part II, line 10, items relating to reportable transactions.

Line 28. Purchase Versus Lease (for Purchasers and/or Lessees) Note. Also see the instructions for Part II, line 16, for sellers and/or lessors.

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 with respect to 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 or deduction amounts for such transactions on line 27, in column (a) or (d), as applicable. Report depreciation expense or deductions for such transactions on line 25, in column (a) or (d), as applicable. Use columns (b) and (c) of lines 25, 27, and 28, as applicable, to report the differences between columns (a) and (d) for such recharacterized transactions.

Example 20. Spruce is a calendar year U.S. partnership that files and entirely completes Schedule M-3 for its 2023 tax year. Spruce acquired property in a transaction that, for financial accounting purposes, Spruce treats as a lease. Because of its terms, the transaction is treated for U.S. income tax purposes as a purchase, and Spruce must treat the periodic payments it makes partially as a payment of principal and partially as a payment of interest. In its financial statements, Spruce treats the difference between the financial accounting and U.S. income tax treatment of this transaction as a temporary difference. During 2023, Spruce 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 2023 Schedule M-3, Spruce must report the following on line 28: column (a), $1,000, its financial accounting gross rental expense; column (b), ($1,000); and column (d), $0. On line 27, Spruce reports $0 in column (a) and $300 in columns (b) and (d) for the interest deduction. On line 25, Spruce reports $0 in column (a) and $1,200 in columns (b) and (d) for the depreciation deduction.

Line 29. Research and Development Costs For tax years beginning after December 31, 2021, for U.S. income tax purposes, research and experimental expenditures paid or incurred by a taxpayer in connection with the taxpayer's trade or business must be amortized. The expenditures must be amortized ratably over the 5-year period (15-year period for

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specified expenditures attributable to foreign research), beginning with the midpoint of the tax year in which the expenses are paid or incurred. See section 174.

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 expenses. Report in column (d) the amount of amortization deductions included in total deductions on page 1 of the return and/or separately reported on Schedule K of the return that are recognized and reported for section 174 research and experimental 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).

Example 21.

1. Partnership Beech is a calendar year taxpayer that files and entirely completes Schedule M-3 for its 2023 tax year. During 2023, Beech incurred $100,000 of research and development costs that Beech recognized as an expense in its financial statements. In compliance with section 174, Beech capitalizes and amortizes research and experimental expenditures for U.S. income tax purposes. Accordingly, Beech must report $100,000 in column (a), $90,000 in column (b), and $10,000 [($100,000/5 years) × 1/2] in column (d).

2. Partnership Flora is a calendar year taxpayer that files and entirely completes Schedule M-3 for its 2023 tax year. During 2023, Flora incurred $10,000 of research and development costs related to social sciences that it recognized as an expense in its financial statements. Flora amortizes research and experimental expenditures for U.S. income tax purposes. Because such costs aren't allowable costs under section 174, Flora 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, Flora must report this item of expense on Part III, line 30.

3. Partnership Basil is a calendar year taxpayer that files and entirely completes Schedule M-3 for its 2023 tax year. During 2023, Basil paid $75,000 to acquire or in-license intangible assets under a collaborative arrangement with another company that Basil recognized as a research and development expense in its financial statements. Because payments made to acquire rights to a product or technology are excluded costs from the definition of research and experimental expenditures, Basil must report $75,000 in column (a), ($75,000) in column (c), and $0 in column (d). Basil must report any amortization otherwise allowable related to the payments on Part III, line 21.

Line 30. Other Expense/ Deduction Items With Differences Separately state and adequately disclose on line 30 all items of expense/deduction that aren't otherwise listed on lines 1 through 29.

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 return for line 30 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 partnership'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. For every item listed on the attached statement for line 30, columns (a) + (b) + (c) must equal column (d). Each item with amounts in columns (a), (b), (c), and (d) will be totaled and included as one line on line 30 of the face of the schedule.

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 30 amounts related to the change in each reserve or contingent liability that isn't required to be reported elsewhere on Schedule M-3. Report on line 30, column (a), expenses included

in net income reported on Part I, line 11, that are related to reserves and contingent liabilities. Report on line 30, column (d), amounts related to liabilities for reserves and contingent liabilities that are deductible in the current tax year for U.S. income tax purposes. Examples of items that must be reported on line 30 include warranty reserves, restructuring reserves, reserves for discontinued operations, and reserves for acquisitions and dispositions. Only report on line 30 items that aren't required to be reported elsewhere on Schedule M-3, Parts II and III. For example, the expense for a reserve for inventory obsolescence must be reported on Part II, line 15.

Example 22. Partnership Quail is a calendar year partnership that files and entirely completes Schedule M-3 for its 2023 tax year. On July 1 of each year, Quail has a fixed liability for its annual insurance premiums that provides a 12-month coverage period beginning July 1 through June 30. In addition, Quail historically prepays 12 months of advertising expense on July 1. On July 1, 2023, Quail prepays its insurance premium of $500,000 and advertising expenses of $800,000. For financial accounting purposes, Quail capitalizes and amortizes the prepaid insurance and advertising over 12 months. For U.S. income tax purposes, Quail deducts the insurance premium when paid and amortizes the advertising over the 12-month period. In its financial statements, Quail treats the differences attributable to the financial statement treatment and U.S. income tax treatment of the prepaid insurance and advertising as temporary differences.

Quail 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 Quail's return for Part III, line 30, must be separately stated and adequately disclosed as follows:

Line 31. Total Expense/ Deduction Items Enter on Part II, line 24, columns (a) through (d), as applicable, positive amounts from line 31 as negative (in parentheses) and negative amounts as positive. For example, if line 31, column (a),

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reflects an amount of $1 million, then report on Part II, line 24, column (a), ($1,000,000). Similarly, if line 31, column (b), reflects an amount of ($50,000), then report on Part II, line 24, column (b), $50,000.