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 on Part I, line 11, and report in column (d) the amount included on line 1 of the Analysis of Net Income (Loss) found on Form 1065.

Note. Part II, line 26, column (a), must equal Part I, line 11, and column (d) must equal line 1 of the Analysis of Net Income (Loss) found on Form 1065. Thus, column (d) on Part II and Part III must include certain of the separately stated items on Schedule K.

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 partnership in accordance 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 GAAP, a temporary difference affects (creates, increases, or decreases) a deferred tax asset or liability.

If the partnership doesn't prepare financial statements, or the financial statements aren't prepared under GAAP, report in column (b) any difference that the partnership believes will reverse in a future tax year (that is, have an opposite effect on taxable income 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 partnership 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 partnership 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 6. At the end of Partnership Sycamore’s first tax year, December 31, 2023, it wasn't required to file Schedule M-3 for any reason.

Sycamore may elect to file Schedule M-3 instead of completing Schedule M-1.

If Sycamore 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 Sycamore elects to complete Schedule M-3 entirely, it must complete all columns of Parts II and III.

If Sycamore 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.

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, items relating to reportable transactions, regardless of whether the amount would otherwise be reported on Schedule M-3, Part II or Part III. Thus, if a taxpayer files Form 8886, Reportable Transaction Disclosure Statement, the amounts attributable to that reportable transaction must be reported on Part II, line 10.

A partnership 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 partnership's current year financial statement net income (loss) or in an income or expense account maintained in the partnership's books and records, even if there is no difference between that amount and the amount included in net income (loss) for tax purposes unless (a) otherwise instructed in these instructions, or (b) the amount is attributable to a reportable transaction described in Regulations section 1.6011-4(b) and is therefore reported on Part II, line 10. For example, with the exception of interest income reflected on a Schedule K-1 received by the partnership as a result of the partnership's investment in a partnership or other pass-through entity, all interest income included on Part I, line 11, whether from unconsolidated affiliated entities, 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 on Part I, line 11, paid to a government or other authority for the violation of any law for

-9-

which fines or penalties are assessed must be included on Part III, line 7, column (a), regardless of the government authority that imposed the fines or penalties, regardless of whether the fines or penalties are civil or criminal, and regardless of the classification, nomenclature, or terminology attached to the fines or penalties by the imposing authority in its actions or documents.

If a partnership 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 partnership 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 partnership's books and records, the partnership must report the proper tax treatment of the item in columns (b), (c), and (d), as applicable.

Furthermore, in applying the two preceding paragraphs, a partnership 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 partnership's financial statements or exists in the partnership'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 26, 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 7, column (a), regardless of the terminology or nomenclature attached to them by the partnership 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 lines 1 through 21.) If an income item is described on 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 on lines 1 through 21, report and describe the entire amount of the item on line 22.

With limited exceptions, Part III includes lines for specific items of expense or deduction (expense items). (See lines 1 through 29.) If an expense item is described on lines 1 through 29, 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 doesn't have a difference and the item isn't described on lines 1 through 29, report and describe the entire amount of the item on line 30.

If there is no difference between the financial accounting amount and the amount reported for tax purposes of an entire item of income, loss, expense, or deduction and the item isn't described or included on Part II, lines 1 through 22, or Part III, lines 1 through 30, 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

-10-

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 29, and the line doesn't indicate to “attach schedule” or “attach details,” and the specific instructions for the line don't call for an attachment of a schedule or explanation, 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) is reported in the applicable columns of the applicable line. See the instructions for Part II, lines 1 through 9, 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 must not 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 30. A separate statement must be attached to Schedule M-3 (Form 1065) that includes a detailed description of each item and adjustment entered on Part II, line 22, and Part III, line 30.

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 30.

Each description should adequately describe all four columns of Part II, line 22, or Part III, line 30. If additional information is required to provide an acceptable description, provide a supporting statement.

Example 7. Partnership Tulip prepares GAAP financial statements. In prior years, Tulip acquired intellectual property (IP) and goodwill. The IP is amortizable for both U.S. income tax and financial statement purposes. In 2023, Tulip's annual amortization expense for IP is $9,000 for U.S. income tax purposes and $6,000 for financial statement purposes. The goodwill isn't amortizable for U.S. income tax purposes and is subject to impairment for financial statement purposes. In 2023, Tulip records an impairment charge on the goodwill of $5,000. Tulip 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). Tulip 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).

Example 8. Partnership Willow is a calendar year partnership that files and entirely completes Schedule M-3 for its 2023 tax year. Willow placed in service 10 depreciable fixed assets in a previous tax year. Willow's total depreciation expense for its 2023 tax year for five of the assets is $50,000 for income statement purposes and $70,000 for U.S. income tax purposes. Willow's total annual depreciation expense for its 2023 tax year for the other five assets is $40,000 for income statement purposes and $30,000 for U.S. income tax purposes. Willow

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. Willow must combine all of its depreciation adjustments. Accordingly, Willow must report on Part III, line 25, for its 2023 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 9. Partnership Derry is a calendar year partnership that files and entirely completes Schedule M-3 for its 2023 tax year. On December 31, 2023, Derry 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, Derry treats the three reserve accounts as giving rise to temporary differences that will reverse in future years. The three reserves are expenses in Derry's 2023 financial statements but aren't deductions for U.S. income tax purposes in 2023. Derry must not combine the Schedule M-3 differences for the three reserve accounts. Derry must report the amounts attributable to the allowance for uncollectible accounts receivable on Part III, line 26, Bad debt expense, 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 on Part III, line 30. Derry must also provide a description for each reserve that meets the requirements for Part III, line 30, discussed earlier under Required statements for Part II, line 22, and Part III, line 30 . In this example, an acceptable description for warranty costs would be “Future Warranty Expense Reserve.”

Note. There is no need to add the title 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 10. Partnership Elm is a calendar year partnership that files and entirely completes Schedule M-3 for its 2023 tax year. On January 2, 2023, Elm establishes an allowance for uncollectible accounts receivable (bad debt reserve) of $100,000. During 2023, Elm increases the reserve by $250,000 for additional accounts receivable that may become uncollectible. Additionally, during 2023, Elm decreases the reserve by $75,000 for accounts receivable that were discharged in bankruptcy during 2023. The balance in the reserve account on December 31, 2023, is $275,000. The $100,000 amount to establish the reserve account and the $250,000 to increase the reserve account are expenses on Elm's 2023 financial statements but aren't deductible for U.S. income tax purposes in 2023. However, the $75,000 decrease to the reserve is deductible for U.S. income tax purposes in 2023. In its financial statements, Elm treats the reserve account as giving rise to a temporary difference that will reverse in future tax years. Elm must report on Part III, line 26, Bad debt expense, for its 2023 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 11. During 2023, partnership Fig had $100 of meals expenses, $100 of entertainment expenses, and therefore deducted $200 on its income statement. For federal income tax purposes, the $100 of meals expenses is subject to section 274(n) (50% allowance) and the $100 of entertainment expenses is subject to section 274(a) (0% allowance). Fig must report on Part III, line 6: $200 in column (a), $150 in column (c), and $50 in column (d). Fig must report all of its meals and entertainment expenses only on this line whether there is a difference or not because meals and entertainment expenses are specifically described.

-11-