Reporting Requirements for Parts II and III

Except for mixed group consolidation, the number of Parts II must equal the number of Parts III filed by the corporation. Mixed groups should see Schedule M-3 Consolidation for Mixed Groups (1120/L/PC) , earlier.

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 Part II, line 12, columns (a), (b), (c), and (d), as applicable, 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 entered on Part II, line 12.

A corporation is required to report in Parts II and III, column (a) 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 taxable income 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) and is therefore reported on Part II, line 12. 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 unconsolidated 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 in Part II, line 13, 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 which fines or penalties are assessed must be included in Part III, line 12, 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 corporation would be required to report in Parts II and III, column (a), 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.

Furthermore, in applying the two preceding paragraphs, a corporation is required to report in Parts II and III, column (a), 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 on 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 in Part III, line 32, 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 in Part III, line 12, 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 24. If an income item is described on Part II,

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lines 1 through 24, 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 does not have a difference, and the item is not described on Part II, lines 1 through 24, report and describe the entire amount of the item on Part II, line 25.

With limited exceptions, Part III includes lines for specific items of expense or deduction (expense items). See Part III, lines 1 through 37. If an expense item is described on Part III, lines 1 through 37, 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 does not have a difference and the item is not described in Part III, lines 1 through 37, report and describe the entire amount of the item on Part III, line 38.

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 is not described or included on Part II, lines 1 through 25, or Part III, lines 1 through 38, report the entire amount of the item in Part II, line 28, columns (a) and (d).

Special instructions for Part II, lines 25 and 28, and Part III, line 38. Whether a given income (loss) item is reported on Part II, line 25, or on Part II, line 28, or a given expense/ deduction item on Part III, line 38, or on Part II, line 28, is determined separately by each member of the U.S. consolidated tax group and not at the U.S. consolidated tax group level. For example, U.S. corporation P has two subsidiaries, A and B, that are included in P's consolidated financial statements and in P's consolidated U.S. income tax return. For financial statement purposes, P, A, and B recognize real estate tax expense when accrued. For U.S. income tax purposes, P and A recognize such expense consistent with the method used for financial statement purposes, whereas B recognizes such deduction based on a method different from that used for financial statement purposes. P and A must report this expense/deduction in columns (a) and (d) on Part II, line 28. B must report the following on Part III, line 38: in column (a), B's expense recognized in the financial statements when accrued; in column (d), B's real estate tax expense recognized for U.S. income tax purposes; and in column (b) or (c), as applicable, the difference between B's real estate tax expense in its financial statements and its real estate tax deduction recognized for U.S. taxable income purposes.

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. See Regulations section 1.6662-4(f). If a specific item of income, gain, loss, expense, or deduction is described on Part II, lines 9 through 24, or Part III, lines 1 through 38, and the line does not indicate to “attach statement” and the specific instructions for the line do not call for an attachment of a statement, then the item is considered separately stated and adequately disclosed if the item is entered on the applicable line and the amount(s) of the item(s) is entered in the applicable columns of the applicable line. See the instructions for Part II, lines 1 through 8, for specific additional information required to be provided for these particular lines.

Note. A statement or explanation may be attached to any line even if none is required.

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 25, and Part III, line 38. A separate statement must be attached to Schedule M-3 (Form 1120) that includes a detailed description of each item and adjustment entered on Part II, line 25, and Part III, line 38.

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 25, or Part III, line 38.

Each description should adequately describe all four columns of Part II, line 25, or Part III, line 38. If additional information is required to provide an acceptable description, provide a supporting statement.

Example 8. Corporation C is a calendar year taxpayer that placed in service 10 depreciable fixed assets in a previous tax year. C files and entirely completes Schedule M-3 for its current tax 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 31, 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 9. Corporation D is a calendar year taxpayer that files and entirely completes Schedule M-3 for its current tax year. On December 31, 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 reserves are expenses in D's current financial statements but are not deductions for U.S. income tax purposes in the current year. D must not combine the Schedule M-3 differences for the three reserve accounts. D must report the amounts attributable to the

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allowance for uncollectible accounts receivable on Part III, line 32, 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 38. D must also provide a description for each reserve that meets the requirements for Part III, line 38, discussed earlier under Required statements for Part II, line 25, and Part III, line 38 . In this example, an acceptable description would be “Coupon Issue Reserves—Rewards Expense” and “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. Corporation E is a calendar year taxpayer that files and entirely completes Schedule M-3 for its current tax year. On January 2 of the current tax year, E establishes an allowance for uncollectible accounts receivable (bad debt reserve) of $100,000. During the current tax year, E increased the reserve by $250,000 for additional accounts receivable that may become uncollectible. Additionally, during the current tax year, E decreases the reserve by $75,000 for accounts receivable that were discharged in bankruptcy during the current tax year. The balance in the reserve account on December 31 of the 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 year financial statements but are not deductible for U.S. income tax purposes in the current tax year. However, the $75,000 decrease to the reserve is deductible for U.S. income tax purposes in the 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 32, 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 11. Corporation F is a calendar year taxpayer that files and entirely completes Schedule M-3 for its current tax year. F incurs $200 of meal expenses and $100 of entertainment expenses that F deducts in computing net income per the income statement. All of the $200 of meal expenses are subject to the 50% limitation under section 274(n). The $100 of entertainment expenses are nondeductible under section 274(a). In its financial statements, F treats the limitation on deductions for meals and entertainment as a permanent difference. Because meals and entertainment expenses are specifically described in Part III, line 11, F must report all of its meals 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). All meals and entertainment expenses, whether allowed fully or subject to limitations, must be reported on Part III, line 11. No amounts should be reported on Part II, line 28.