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Department of the Treasury
Internal Revenue Service
2018

Instructions for

Schedule M-3 (Form 1120S)

Net Income (Loss) Reconciliation for S Corporations With Total Assets of
$10 Million or More

Section references are to the Internal Revenue Where To File Schedule M-3, it must either: (i)
Code unless otherwise noted. complete Schedule M-3 entirely; or (ii)
If the corporation is required to file (or
Future Developments voluntarily files) Schedule M-3 (Form complete Schedule M-3 through Part I
1120S), the corporation must file Form and complete Schedule M-1 instead of
For the latest information about 1120S and all attachments, schedules, completing Parts II and III of
developments related to Schedule M-3 including Schedule M-3 (Form 1120S), Schedule M-3.
(Form 1120S) and its instructions, such and statements at the following 2. U.S. corporation C owns U.S.
as legislation enacted after they were address. subsidiary D. For its 2018 tax year, C
published, go to prepares consolidated financial
IRS.gov/Form1120S. Department of the Treasury statements with D, but C and D file
Internal Revenue Service Center separate U.S. income tax returns. The
What’s New Ogden, UT 84201-0013 consolidated accrual basis financial
The Tax Cuts and Jobs Act provides statements for C and D report total
that entertainment expenses are no assets at the end of the tax year of $12
Who Must File
longer deductible if paid or incurred million after intercompany eliminations.
after December 31, 2017. Any corporation required to file Form
C reports separate company total
1120S, U.S. Income Tax Return for an S
year-end assets on its Schedule L of $7
Corporation, that reports on Schedule L
million. D reports separate company
General Instructions of Form 1120S total assets at the end of
total year-end assets on its Schedule L
Applicable schedule and instruc- the corporation's tax year that equal or
of $6 million. Neither C nor D is required
tions. Use the 2018 Schedule M-3 exceed $10 million must file
to file Schedule M-3 for the 2018 tax
(Form 1120S) with these instructions for Schedule M-3 (Form 1120S). A
year. C or D may voluntarily file
tax years ending December 31, 2018, corporation or group of corporations that
Schedule M-3 for the 2018 tax year. If C
through December 30, 2019. For completes Parts II and III of
or D doesn't file Schedule M-3, it must
previous tax years, see the applicable Schedule M-3, isn't required to
file Schedule M-1. If C or D files
Schedule M-3 (Form 1120S) and complete Form 1120S, Schedule M-1,
Schedule M-3, it must either: (i)
instructions. (For example, use the 2017 Reconciliation of Income (Loss) per
complete Schedule M-3 entirely; or (ii)
Schedule M-3 (Form 1120S) with the Books With Income (Loss) per Return.
complete Schedule M-3 through Part I
2017 instructions for tax years ending A U.S. corporation filing Form 1120S and complete Schedule M-1 instead of
December 31, 2017, through December that isn't required to file Schedule M-3 completing Parts II and III of
30, 2018.) may voluntarily file Schedule M-3 Schedule M-3.
instead of Schedule M-1.
Purpose of Schedule Completing Schedule M-3
Schedule M-3, Part I, asks certain Any corporation filing Schedule M-3
questions about the corporation's must check the box on Form 1120S, (Form 1120S)
financial statements and reconciles item C, indicating that Schedule M-3 is A corporation that is required to file
financial statement worldwide net attached (whether required or Schedule M-3 (Form 1120S) and has at
income (loss) for the corporation (or voluntary). least $50 million total assets at the end
of the tax year must complete
consolidated financial statement group, Example 1. Schedule M-3 (Form 1120S) entirely.
if applicable), as reported on Part I, 1. U.S. corporation A owns U.S.
line 4a, to income (loss) per the income subsidiary B and foreign subsidiary F. A corporation that (a) is required to
statement of the corporation for U.S. For its 2018 tax year, A prepares file Schedule M-3 (Form 1120S) and
income tax purposes, as reported on consolidated financial statements with B has less than $50 million total assets at
Part I, line 11. and F that report total assets of $12 the end of the tax year or (b) isn't
Schedule M-3, Parts II and III, million. A files a U.S. income tax return required to file Schedule M-3 (Form
reconcile financial statement net income with B (a corporation that has made a 1120S) and voluntarily files
(loss) for the U.S. tax return (per qualified subchapter S subsidiary Schedule M-3 (Form 1120S) must either
Schedule M-3, Part I, line 11) to total election) and reports total assets on (i) complete Schedule M-3 (Form 1065)
income (loss) on Form 1120S, Schedule L of $8 million. A's U.S. tax entirely or (ii) complete Schedule M-3
Schedule K, line 18. group isn't required to file Schedule M-3 (Form 1120S) through Part I and
for the 2018 tax year. A may voluntarily complete Form 1120S, Schedule M-1
file Schedule M-3 for the 2018 tax year. instead of completing Parts II and III of
If A doesn't file Schedule M-3, it must Schedule M-3 (Form 1120S). If the
file Schedule M-1. If A files corporation chooses to complete Form

Nov 28, 2018 Cat. No. 48245B

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1120S, Schedule M-1 instead of             ending with or within the tax year,        partnership interest. Any liabilities 
completing Parts II and III of             Schedule L must be prepared showing        contributing to such adjusted basis must 
Schedule M-3 (Form 1120S), line 1 of       non-tax-basis amounts. See the             be shown on Schedule L as corporate 
Form 1120S, Schedule M-1 must equal        instructions for Part I, line 1, for a     liabilities. In any event, any investments 
line 11 of Part I of Schedule M-3 (Form    discussion of non-tax-basis income         or other assets reported on Schedule L 
1120S).                                    statements and related non-tax-basis       can never be reported as negative 
                                           balance sheets prepared for any            amounts.
For any part of Schedule M-3 (Form         purpose and the impact on the selection 
1120S) that is completed, all columns      of the income statement used for           Schedule M-1
must be completed, all applicable          Schedule M-3 and the related               A corporation that completes Parts II 
questions must be answered, all            non-tax-basis balance sheet amounts        and III of Schedule M-3 isn't required to 
numerical data asked for must be           that must be used for Schedule L.          complete Form 1120S, Schedule M-1.
provided, any statement required to 
support a line item must be attached       Total assets shown on Schedule L,          Entity Considerations for 
and provide the information required for   line 15, column (d), must equal the total 
that line item.                            assets of the corporation as of the last   Schedule M-3
                                           day of the tax year, and must be the       For purposes of Schedule M-3, 
Any corporation filing Schedule M-3        same total assets reported by the          references to the classification of an 
must check the box on Form 1120S,          corporation in the non-tax-basis           entity (for example, as a corporation, a 
item C, indicating that Schedule M-3 is    financial statements, if any, used for     partnership, or a trust) are references to 
attached (whether required or              Schedule M-3. If the corporation doesn't   the treatment of the entity for U.S. 
voluntary).                                prepare non-tax-basis financial            income tax purposes. An entity that 
                                           statements, Schedule L must be based       generally is disregarded as separate 
Other Issues Affecting                     on the corporation's books and records.    from its owner for U.S. income tax 
Schedule M-3 Filing                        The Schedule L balance sheet can           purposes (disregarded entity) mustn't 
                                           show tax-basis balance sheet amounts       be separately reported on Schedule M-3 
Requirements                               if the corporation is allowed to use       except, if required, on Part I, line 7a, 7b, 
If a corporation was required to file      books and records for Schedule M-3         or 7c. On Schedule M-3, Parts II and III, 
Schedule M-3 for the preceding tax         and the corporation's books and records    any item of income, gain, loss, 
year, but reports on Form 1120S,           reflect only tax-basis amounts.            deduction, or credit of a disregarded 
Schedule L, total assets at the end of                                                entity must be reported as an item of its 
the current tax year of less than $10      Generally, total assets at the             owner. In particular, the income or loss 
million, the corporation isn't required to beginning of the year (Schedule L,         of a disregarded entity mustn't be 
file Schedule M-3 for the current tax      line 15, column (b)) must equal total      reported on Part II, line 7, 8, or 9 as from 
year.                                      assets at the close of the prior year      a separate partnership or other 
                                           (Schedule L, line 15, column (d)). For     pass-through. The financial statement 
For purposes of determining whether        each Schedule L balance sheet item         income or loss of a disregarded entity 
the corporation has total assets at the    reported for which there is a difference   other than a qualified subchapter S 
end of the current tax year of $10 million between the current opening balance        subsidiary (QSub) is included on Part I, 
or more, the corporation's total assets    sheet amount and the prior closing         line 7b, if and only if its financial 
must be determined on an overall           balance sheet amount, attach a             statement income or loss is included on 
accrual method of accounting unless        statement that reports the balance sheet   Part I, line 11, but not on Part I, line 4a. 
both of the following apply: (a) the tax   item, the prior closing amount, the        The financial statement income or loss 
return of the corporation is prepared      current opening amount, and a short        of a QSub is included on Part I, line 7c, if 
using an overall cash method of            explanation of the difference. In          and only if its financial statement 
accounting, and (b) no includible entity   particular, indicate if the differences    income or loss is included on Part I, 
in the U.S. tax return prepares or is      occurred because of acquisitions or        line 11, but not on Part I, line 4a.
included in financial statements           mergers.
prepared on an accrual basis.                                                         Qualified Subchapter S Subsidiaries 
                                           For purposes of measuring total            (QSubs).    Because a QSub is a 
      See the instructions for Part I,     assets at the end of the year, the         disregarded entity, for purposes of 
TIP   line 1, for a discussion of          corporation's assets may not be netted     Schedule M-3, Schedule L, and the tax 
      non-tax-basis income                 or reduced by the corporation's            return in general, the subsidiary is 
statements and related non-tax-basis       liabilities. In addition, total assets may deemed to have liquidated into the 
balance sheets to be used in the           not be reported as a negative amount. If   parent S corporation. As such, all 
preparation of Schedule M-3 and of         Schedule L is prepared on a                QSubs are treated as divisions of the S 
Form 1120S, Schedule L.                    non-tax-basis method, an investment in     corporation parent and they mustn't be 
                                           a partnership may be shown as              separately reported on Schedule M-3 
Other Form 1120S                           appropriate under the corporation's        except, if required, on Part I, line 7c.
                                           non-tax-basis method of accounting, 
Schedules Affected by                      including, if required by the              Reportable Entity Partner 
Schedule M-3                               corporation's reporting methodology,       Reporting Responsibilities
Requirements                               the equity method of accounting for        A reportable entity partner to a 
                                           investments. If Schedule L is prepared     partnership filing Form 1065, U.S. 
Schedule L                                 on a tax-basis method, an investment       Return of Partnership Income, is an 
If a non-tax-basis income statement and    by the corporation in a partnership must   entity that:
related non-tax-basis balance sheet is     be shown as an asset and measured by 
prepared for any purpose for a period      the corporation's adjusted basis in its 

                                                   -2-                   Instructions for Schedule M-3 (Form 1120S) (2018)

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• Owns or is deemed to own, directly or 6. Date on which it first became a corporation filing the U.S. income tax
indirectly, under these instructions, a reportable entity partner. return.
50% or greater interest in the income, 7. Date for which it is reporting a
loss, or capital of the partnership on any change in its ownership interest in the Non-Tax-Basis Financial
day of the tax year; and partnership, if applicable. Statements and Tax-Basis
• Was required to file Schedule M-3 on
its most recently filed U.S. federal 8. The interest in the partnership it Financial Statements
income tax return or return of income owns or is deemed to own in the
A tax-basis income statement is allowed
filed prior to that day. partnership, directly or indirectly (as
for Schedule M-3 and a tax-basis
defined under these instructions) as of
balance sheet for Schedule L only if no
For the purposes of these the date for which it is reporting.
non-tax-basis income statement and no
instructions: 9. Any change in that interest as of non-tax-basis balance sheet was
1. The parent corporation of a the date for which it is reporting. prepared for any purpose and the books
consolidated tax group is deemed to and records of the corporation reflect
own all corporate and partnership The reportable entity partner must
interests owned or deemed to be owned keep copies of required reports it makes only tax-basis amounts. The corporation
under these instructions by any member to partnerships under these instructions. is deemed to have non-tax-basis
of the tax consolidated group; Each partnership must keep copies of income statements and the related
the required reports it receives under non-tax-basis balance sheets for the
2. The owner of a disregarded entity these instructions from reportable entity current tax year for purposes of
is deemed to own all corporate and partners. Schedule M-3 and Schedule L if such
partnership interests owned or deemed non-tax-basis financial statements were
to be owned under these instructions by Example 2. A, a limited liability prepared for and presented to
the disregarded entity; company (LLC) filing a Form 1065 for management, creditors, shareholders,
2018, is owned 50% by U.S. corporation
3. The owner of 50% or more of a government regulators, or any other
Z which files Form 1120S. A owns 50%
corporation by vote on any day of the third parties for a period ending with or
of each of B, C, D, and E, each also an
corporation tax year is deemed to own within the tax year.
LLC filing a Form 1065 for calendar year
all corporate and partnership interests
2018. Z was first required to file
owned or deemed to be owned under If a non-tax-basis income statement
Schedule M-3 (Form 1120S) for its
these instructions by the corporation is prepared that is a certified
corporate tax year ended December 31,
during the corporation tax year; non-tax-basis income statement for the
2017, and filed its Form 1120S with period ending with or within the tax year,
4. The owner of 50% or more of Schedule M-3 for 2017 on September the corporation must check “Yes” for
partnership income, loss, or capital on 15, 2018. As of September 16, 2018, Z Part I, line 1a, and use that income
any day of the partnership tax year is was a reportable entity partner statement for Schedule M-3. If no
deemed to own all corporate and regarding A and, through A, regarding certified non-tax-basis income
partnership interests owned or deemed B, C, D, and E. On October 5, 2018, Z statement is prepared but an unaudited
to be owned under these instructions by reports to A, B, C, D, and E, as it is non-tax-basis income statement is
the partnership during the partnership required to do within 30 days of prepared for the period ending with or
tax year; and September 16, that Z is a reportable within the tax year, the corporation must
5. The beneficial owner of 50% or entity partner directly owning (regarding check “Yes” for Part I, line 1b, and use
more of the beneficial interest of a trust A) or deemed to own indirectly that income statement for
or nominee arrangement on any day of (regarding B, C, D, and E) a 50% Schedule M-3.
the trust or nominee arrangement tax interest. So, because Z was a
year is deemed to own all corporate and reportable entity partner for 2018, each Order of priority in accounting
partnership interests owned or deemed of A, B, C, D, and E is required to file standards. If two or more
to be owned under these instructions by Schedule M-3 (Form 1065) for 2018, non-tax-basis income statements are
the trust or nominee arrangement. regardless of whether they would both certified non-tax-basis income
otherwise be required to file statements for the period, the income
A reportable entity partner to a Schedule M-3 for that year. statement prepared according to the
partnership (as defined above) must following order of priority in accounting
report the following to the partnership standards must be used.
within 30 days of first becoming a Specific Instructions 1. U.S. Generally Accepted
reportable entity partner and, after first for Part I Accounting Principles (GAAP).
reporting to the partnership under these
2. International Financial Reporting
instructions, after that within 30 days of Part I. Financial Standards (IFRS).
the date of any change in the interest it
owns or is deemed to own, directly or Information and Net 3. Any other International
indirectly, under these instructions, in Income (Loss) Accounting Standards (IAS).
the partnership. Reconciliation 4. Other regulatory accrual
1. Name. accounting.
Line 1. Questions Regarding
2. Mailing address. 5. Any other accrual accounting
the Type of Income Statement standard.
3. Taxpayer identification number
(TIN or EIN), if applicable. Prepared 6. Any fair market value standard.
For Part I, lines 1 through 12, use only
4. Entity or organization type. 7. Any cash basis standard.
the financial statements of the U.S.
5. State or country in which it is
organized.

Instructions for Schedule M-3 (Form 1120S) (2018) -3-

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If no non-tax-basis income statement the income statement period differs amounts of income (loss) detailed on
is certified and two or more from the corporation's tax year, the the supporting statement should be
non-tax-basis income statements are income statement period indicated on reported for each separate
prepared, the income statement Part I, line 2, applies for purposes of nonincludible foreign entity without
prepared according to the first listed of Part I, lines 4 through 8. regard to the effect of consolidation or
the accounting standards listed above elimination entries. If there are
must be used. If the corporation doesn't prepare consolidation or elimination entries
non-tax-basis financial statements and relating to nonincludible foreign entities
If no non-tax-basis financial has checked “No” on Part I, line 1b, whose income (loss) is reported on the
statements are prepared for a U.S. enter the net income (loss) per the attached statement that aren't
corporation filing Schedule M-3 (Form books and records of the U.S. reportable on Part I, line 8, the net
1120S), the U.S. corporation must corporation on Part I, line 4a. amounts of all such consolidation and
check “No” on questions 1a and 1b, skip elimination entries must be reported on
Part I, lines 2, 3a, and 3b, and enter the Indicate on Part I, line 4b, which of
net income (loss) per the books and the following accounting standards were a separate line on the attached
records of the U.S. corporation on Part I, used for line 4a. statement, so that the separate financial
accounting income (loss) of each
line 4a. 1. U.S. Generally Accepted nonincludible foreign entity remains
Accounting Principles (GAAP).
Lines 2 and 3. Questions separately stated.
2. International Financial Reporting For example, if the net income (after
Regarding Income Statement Standards (IFRS). consolidation and elimination entries) of
Period and Restatements 3. Tax basis. a nonincludible foreign
Enter the beginning and ending dates 4. Other (Specify). sub-consolidated group is being
on line 2 for the corporation's annual reported on line 5a, the attached
income statement period ending with or Report on Part I, lines 5a through 10, supporting statement should report the
within the current tax year. as instructed below, all adjustment income (loss) of each separate
The questions on Part I, lines 3a and amounts required to adjust worldwide nonincludible foreign legal entity from
3b, regarding income statement net income (loss) reported on this Part I, each such entity's own financial
restatements refer to the worldwide line 4a (whether from financial accounting net income statement or
consolidated income statement issued statements or books and records), to books and records, and any
by the corporation filing the U.S. income net income (loss) of the corporation that consolidation or elimination entries (for
tax return and used to prepare must be reported on Part I, line 11. intercompany dividends, minority
Schedule M-3. Answer “Yes” on lines 3a Report on line 12a the worldwide interests, etc.) not reportable on Part I,
and/or 3b if the corporation's annual consolidated total assets and total line 8, should be reported on the
income statement has been restated for liabilities amounts for the corporation attached supporting statement as a net
any reason. Attach a short explanation using the same financial statements (or amount on a line separate and apart
of the reasons for the restatement in net book and records) used for the from lines that report each nonincludible
income for each annual income worldwide consolidated income (loss) foreign entity's separate net income
statement period that is restated, amount reported on line 4a. (loss).
including the original amount and Line 5. Net Income (Loss) of Line 6. Net Income (Loss) of
restated amount of each annual Nonincludible Foreign Entities Nonincludible U.S. Entities
statement period's net income.
Remove the financial net income Remove the financial net income
Line 4. Worldwide Consolidated (line 5a) or loss (line 5b) of each foreign (line 6a) or loss (line 6b) of each U.S.
Net Income (Loss) per Income entity that is included on line 4a and isn't entity that is included on line 4a and isn't
Statement an includible entity in the U.S. tax return an includible entity in the U.S. tax return
(nonincludible foreign entity). In (nonincludible U.S. entity). In addition,
Report on Part I, line 4a, the worldwide addition, on Part I, line 8, adjust for on Part I, line 8, adjust for consolidation
consolidated net income (loss) per the consolidation eliminations and correct eliminations and correct for minority
income statement (or books and for minority interest and intercompany interest and intercompany dividends
records, if applicable) of the dividends between any nonincludible between any nonincludible U.S. entity
corporation. foreign entity and the entity filing Form and any includible entity. Don't remove
In completing Schedule M-3, the 1120S. Don't remove in Part I the in Part I the financial net income (loss)
corporation must use financial financial net income (loss) of any of any nonincludible U.S. entity
statement amounts from the financial nonincludible foreign entity accounted accounted for on line 4a using the
statement type checked “Yes” on Part I, for on line 4a using the equity method. equity method.
line 1, or from its books and records if
Part I, line 1b, is checked “No.” Attach a supporting statement that Attach a supporting statement that
provides the name, EIN (if applicable), provides the name, EIN, and net income
If a corporation prepares and net income (loss) included on (loss) included on line 4a that is
non-tax-basis financial statements, the line 4a that is removed on this line 5 for removed on this line 6 for each separate
amount on line 4a must equal the each separate nonincludible foreign nonincludible U.S. entity. Also state the
financial statement net income (loss) for entity. Also state the total assets and total assets and total liabilities for each
the income statement period ending total liabilities for each such separate such separate nonincludible U.S. entity
with or within the tax year as indicated nonincludible foreign entity and include and include those assets and liabilities
on Part I, line 2. those assets and liabilities amounts in amounts in the total assets and total
If the corporation prepares the total assets and total liabilities liabilities reported on Part I, line 12c.
non-tax-basis financial statements and reported on Part I, line 12b. The The amounts of income (loss) detailed

-4- Instructions for Schedule M-3 (Form 1120S) (2018)

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on the supporting statement should be          that isn't included in the income          necessary to ensure that transactions 
reported for each separate                     reported on line 4a, but is included on    between includible entities and 
nonincludible U.S. entity without regard       line 11 (other QSub). In addition, on Part nonincludible U.S. or foreign entities 
to the effect of consolidation or              I, line 8, adjust for consolidation        aren't eliminated, in order to report the 
elimination entries. If there are              eliminations and correct for minority      correct total amount on Part I, line 11. 
consolidation or elimination entries           interest and intercompany dividends for    Also, additional consolidation entries 
relating to nonincludible U.S. entities        any other disregarded entity or other      and elimination entries may be 
whose income (loss) is reported on the         QSub.                                      necessary on Part I, line 8, related to 
attached statement that aren't                 Attach a supporting statement that         transactions between includible entities 
reportable on Part I, line 8, the net          provides the name, EIN, and net income     that are in the consolidated financial 
amounts of all such consolidation and          (loss) per the financial statement or      group and other disregarded entities 
elimination entries must be reported on        books and records on this line 7 for       and QSubs that aren't in the 
a separate line on the attached                each separate other disregarded entity     consolidated financial group but that are 
statement, so that the separate financial      or other QSub. Also state the total        reported on Part I, line 7a, 7b, or 7c, in 
accounting income (loss) of each               assets and total liabilities for each such order to report the correct total amount 
nonincludible U.S. entity remains              separate included entity and include       on Part I, line 11.
separately stated. For example, if the         those assets and liabilities amounts in    Include on Part I, line 8, the total of 
net income (after consolidation and            the total assets and total liabilities     the following: (a) amounts of any 
elimination entries) of a nonincludible        reported on Part I, line 12d. The          adjustments to consolidation entries 
U.S. sub-consolidated group is being           amounts of income (loss) detailed on       and elimination entries that are 
reported on line 6a, the attached              the supporting statement should be         contained in the amount reported on 
supporting statement should report the         reported for each separate other           Part I, line 4a, required as a result of 
income (loss) of each separate                 disregarded entity or other QSub           removing amounts on Part I, line 5 or 6; 
nonincludible U.S. legal entity from each      without regard to the effect of            and (b) amounts of any additional 
such entity's own financial accounting         consolidation or elimination entries       consolidation entries and elimination 
net income statement or books and              solely between or among the entities       entries that are required as a result of 
records, and any consolidation or              listed. If there are consolidation or      including amounts on Part I, line 7a, 7b, 
elimination entries (for intercompany          elimination entries relating to such other or 7c. This is necessary in order that the 
dividends, minority interests, etc.) not       disregarded entities or other QSub         consolidation entries and intercompany 
reportable on Part I, line 8, should be        whose income (loss) is reported on the     elimination entries included in the 
reported on the attached supporting            attached statement that aren't             amount reported on Part I, line 11, are 
statement as a net amount on a line            reportable on Part I, line 8, the net      only those applicable to the financial net 
separate and apart from lines that report      amounts of all such consolidation and      income (loss) of includible entities for 
each nonincludible U.S. entity's               elimination entries must be reported on    the financial statement period. For 
separate net income (loss).                    a separate line on the attached            example, adjustments must be reported 
Lines 7a, 7b, and 7c. Net                      statement, so that the separate financial  on line 8 to remove minority interest and 
                                               accounting income (loss) of each other 
Income (Loss) of Other Foreign                                                            to reverse the elimination of 
                                               disregarded entity or other QSub           intercompany dividends included on 
Disregarded Entities, Net                      remains separately stated. For example,    Part I, line 4a, that relate to the net 
Income (Loss) of Other                         if the net income (after consolidation     income of entities removed on Part I, 
Disregarded Entities (Except                   and elimination entries) of a              line 5 or 6, because the income to which 
Qualified Subchapter S                         sub-consolidated group of other            the consolidation or elimination entries 
                                               disregarded entities is being reported     relate has been removed. Also, for 
Subsidiaries), and Net Income                  on line 7b, the attached supporting        example, consolidation or elimination 
(Loss) of Other Qualified                      statement should report the income         entries must be reported on line 8 to 
Subchapter S Subsidiaries                      (loss) of each separate other              eliminate any intercompany dividends 
(QSubs)                                        disregarded entity from each entity's      between entities whose income is 
Include on line 7a the financial income        own financial accounting net income        included on Part I, line 7a, 7b, or 7c, and 
of any foreign disregarded entity that         statement or books and records, and        other entities included in the U.S. 
isn't included on Part I, line 4a, but is      any consolidation or elimination entries   income tax return. See Example 3A 3B,      , 
included in Part I, line 11 (other foreign     (for intercompany dividends, minority      and   in the instructions for line 11.4
disregarded entities). Include on line 7b      interests, etc.) not reportable on Part I, 
                                                                                          If a corporate owner of an interest in 
or 7c the financial net income or (loss)       line 8, should be reported on the 
                                                                                          another entity: (a) accounts for the 
of each disregarded entity in the U.S.         attached supporting statement as a net 
                                                                                          interest in entity in the owner 
tax return that isn't included in the          amount on a line separate and apart 
                                                                                          corporation's separate general ledger 
consolidated financial group and               from lines that report each other 
                                                                                          on the equity method, and (b) fully 
therefore not included in the income           disregarded entity's separate net 
                                                                                          consolidates entity in the owner 
reported on Part I, line 4a. Include on        income (loss).
                                                                                          corporation's consolidated financial 
line 7b the financial income of any U.S.       Line 8. Adjustment to                      statements, but entity isn't includible in 
disregarded entity that isn't a qualified      Eliminations of Transactions               the owner corporation's U.S. income tax 
subchapter S subsidiary (QSub) or a                                                       return, then, as part of reversing all 
foreign disregarded entity and that isn't      Between Includible Entities and            consolidation and elimination entries for 
included in the income reported on Part        Nonincludible Entities                     the nonincludible entity, the corporate 
I, line 4a, but is included in Part I, line 11 Adjustments on Part I, line 8, to reverse  owner must reverse on Schedule M-3, 
(other disregarded entities). Include on       certain financial accounting               Part I, line 8, the elimination of the equity 
line 7c the financial income of any QSub       consolidation or elimination entries are   income inclusion from entity. If the 

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owner corporation doesn't account for amount reported on line 11 includes the entity (P and any QSubs) and the
entity on the equity method on its own net income of entities not includible in nonincludible entities (DS1 through
general ledger, it won't have eliminated the U.S. income tax return. A principal DS75 with no QSub election, DS76
the equity income for consolidated purpose of Schedule M-3 is to report on through DS100 and FS1 through FS50),
financial statement purposes, so it will this Part I, line 11, only the financial including dividends received from
have no elimination of equity income to accounting net income of only the non-QSub DS1 through DS75, DS76
reverse. entities included in the U.S. income tax through DS100, and FS1 through FS50
The attached supporting statement return. and the minority interest's share of the
net income (loss) of DS76 through
for Part I, line 8, must identify the type Whether or not the corporation DS100.
(for example, minority interest, prepares financial statements, Part I,
intercompany dividends, etc.) and line 11, must include all items that P reports on Part I, line 11, the
amount of consolidation or elimination impact the net income (loss) of the consolidated financial statement net
entries reported, as well as the names corporation even if they aren't recorded income (loss) attributable to the
of the entities to which they pertain. It in the profit and loss accounts in the corporation and QSubs. Intercompany
isn't necessary, but it is permitted, to corporation's general ledger, including, transactions between the corporation
report intercompany eliminations that for example, all post-closing adjusting and the QSubs that had been eliminated
net to zero on Part I, line 8, such as entries (including workpaper in the net income amount on line 4a
intercompany interest income and adjustments) and dividend income or remain eliminated in the net income
expense. other income received from amount on line 11. Transactions
Line 9. Adjustment To nonincludible entities. If the corporation between the corporation and the
prepares unconsolidated financial nonincludible entities that are eliminated
Reconcile Income Statement statements using the same accounting in the net income amount on line 4a are
Period to Tax Year method used to determine worldwide included in the net income amount on
Include on line 9 any adjustments consolidated net income (loss) for Part I, line 11 since the elimination of those
necessary to the income (loss) of line 4a, and if it uses the equity method transactions were reversed on line 8.
includible entities to reconcile for investments, the amount reported on Example 3B.
differences between the corporation's Part I, line 11, will equal the amount of 1. U.S. corporation P owns 60% of
income statement period reported on the unconsolidated net income (loss) corporation DS1 which is fully
line 2 and the corporation's tax year. reported on the unconsolidated financial consolidated in P's financial statements.
Attach a statement describing the statements. See items 3 and 4 under P doesn't account for DS1 in P's
adjustment. Example 3B, later. separate general ledger on the equity
Line 10. Other Adjustments To Example 3A. U.S. corporation P method. DS1 has net income of $100
files a Form 1120S U.S. tax return and (before minority interests) and pays
Reconcile to Amount on Line 11 prepares certified audited income dividends of $50, of which P receives
Include on line 10 any other statements for GAAP. P owns 100% of $30. The dividend is eliminated in the
adjustments to reconcile net income the stock of U.S. corporations DS1 consolidated financial statements. In its
(loss) on Part I, line 4a, through Part I, through DS75, between 51% and 99% financial statements, P consolidates
line 9, with net income (loss) on Part I, of the stock of U.S. corporations DS76 DS1 and includes $60 of net income
line 11. through DS100, and 100% of the stock ($100 less the minority interest of $40)
For any adjustments reported on Part of foreign entities FS1 through FS50. P on Part I, line 4a.
I, line 10, attach a supporting statement eliminates all dividend income from DS1 P must remove the $100 net income
with an explanation of each net through DS100 and FS1 through FS50 of DS1 on Part I, line 6a. P must reverse
adjustment included on line 10. in financial statement consolidation on Part I, line 8, the elimination of the
entries. Furthermore, P eliminates the $40 minority interest net income of DS1.
Line 11. Net Income (Loss) per minority interest ownership, if any, of In addition, P reverses its elimination of
Income Statement of the DS76 through DS100 in financial the $30 intercompany dividend in its
Corporation statement consolidation entries. financial statements on Part I, line 8.
Report on line 11 the net income (loss) P must check “Yes” on Part I, line 1a. The net result is that P includes the $30
per the income statement (or books and On Part I, line 4a, P must report the dividend from DS1 at Part I, line 11, and
records, if applicable) of the consolidated net income for the on Part II, line 6, column (a). P's
corporation. Amounts reported in consolidated financial statement group dividend income included on the tax
column (a) of Parts II and III (see later) of P, DS1 through DS100, and FS1 return from DS1 must be reported on
must be reported on the same through FS50. P must remove the net Part II, line 6, column (d).
accounting method used to report the income (loss) of FS1 through FS50 on 2. U.S. corporation C owns 60% of
amount of net income (loss) per income Part I, line 5a or 5b, as applicable, and the capital and profits interests in U.S.
statement of the corporation on Part I, remove on Part I, line 6a or 6b, as LLC N. C doesn't account for N in C's
line 11. applicable, any net income (loss) from separate general ledger on the equity
DS1 through DS75 where a QSub method. N has net income of $100
Don't, in any event, report on this election hasn't been made by P. P must (before minority interests) and makes no
line 11 the net income of entities not remove the net income (loss) before distributions during the tax year. C
included in the U.S. income tax return minority interests of DS76 through treats N as a corporation for financial
for the tax year. For example, it isn't DS100 on Part I, line 6a or 6b, as statement purposes and as a
permissible to remove the income of applicable. P must reverse on Part I, partnership for U.S. income tax
nonincludible entities on lines 5 and/or line 8, the elimination of any purposes. In its financial statements, C
6, above, then to add back such income transactions between the includible consolidates N and includes $60 of net
on lines 7 through 10, such that the

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income ($100 less the minority interest income for N on Part I, line 11, and on through 12d must be reported as
of $40) on Part I, line 4a. Part II, line 7, column (a). C's taxable positive amounts.
C must remove the $100 net income income from N must be reported by C
of N on Part I, line 6a. C must reverse on on Part II, line 7, column (d). On line 12a, enter the worldwide
consolidated total assets and total
Part I, line 8, the elimination of the $40 Example 4. U.S. corporation P liabilities of all of the entities included in
minority interest net income of N. The owns 100% of the stock of QSub computing Part I, line 4a. On line 12b,
result is that C includes no income for N corporation DS1. DS1 is included in P's enter the total assets and total liabilities
either on Part I, line 11, or on Part II, federal income tax return, even though of the entities removed in completing
line 7, column (a). C's taxable income DS1 isn't included in P's consolidated Part I, line 5. On line 12c, enter the total
from N must be reported by C on Part II, financial statements on either a assets and total liabilities removed in
line 7, column (d). consolidated basis or on the equity completing Part I, line 6. On line 12d,
3. U.S. corporation P owns 60% of method. DS1 has current year net enter total assets and total liabilities
corporation DS1, which is fully income of $100 after taking into account included in completing Part I, line 7.
consolidated in P's financial statements. its $40 interest payment to P. P has net
P accounts for DS1 in P's separate income of $1,040 after recognition of the
general ledger on the equity method. interest income from DS1. Because Specific Instructions for
DS1 has net income of $100 (before DS1 is a QSub, 100% of the net income Parts II and III
minority interests) and pays dividends of of both P and DS1 must be reported on
$50, of which P receives $30. The Form 1120S of P's U.S. income tax General Reporting information
dividend reduces P's investment in DS1 return, and the intercompany interest A schedule or statement may be
for equity method reporting on P's income and expense must be removed attached to any line even if none is
separate general ledger where P by consolidation elimination entries. required.
includes its 60% equity share of DS1 P must report its financial statement For each line item in Parts II and III,
income, which is $60. In its financial net income of $1,040 on Part I, line 4a, report in column (a) the amount of net
statements, P eliminates the DS1 equity and reports DS1's net income of $100 income (loss) included in Part I, line 11,
method income of $60 and consolidates on Part I, line 7c. Then, in order to and report in column (d) the amount
DS1, including $60 of net income ($100 reflect the full consolidation of the included in total income (loss) on Form
less the minority interest of $40) on Part financial accounting net income of P 1120S, Schedule K, line 18.
I, line 4a. and DS1 at Part I, line 11, the following
P must remove the $100 net income consolidation and elimination entries are Part II, line 26, column (a) must
of DS1 on Part I, line 6a. P must reverse reported on Part I, line 8: offsetting TIP equal Part I, line 11, and column
on Part I, line 8, the elimination of the entries to remove the $40 of interest (d) must equal the amount on
$40 minority interest net income of DS1 income received from DS1 included by Form 1120S, Schedule K, line 18.
and the elimination of the $60 of DS1 P on line 4a, and to remove the $40 of
equity income. The net result is that P interest expense of DS1 included in For any item of income, gain, loss,
includes the $60 of equity method line 7c for a net change of zero. The expense, or deduction for which there is
income from DS1 at Part I, line 11, and result is that Part I, line 11, reports a difference between columns (a) and
on Part II, line 5, column (a). P's $1,140: $1,040 from line 4a, and $100 (d), the portion of the difference that is
dividend income included on the tax from line 7c. Stated another way, Part I, temporary must be entered in column
return from its investment in DS1 must line 11, includes the entire $1,000 net (b) and the portion of the difference that
be reported on Part II, line 6, column (d). income of P, measured before is permanent must be entered in column
4. U.S. corporation C owns 60% of recognition of the intercompany interest (c).
the capital and profits interests in U.S. income from DS1 and the consolidation If financial statements are prepared
LLC N. C accounts for N in C's separate of DS1 operations, plus the entire $140 by the corporation under with generally
general ledger on the equity method. N net income of DS1, measured before accepted accounting principles (GAAP),
has net income of $100 (before minority interest expense to P. P's U.S. income differences that are treated as
interests) and makes no distributions tax group isn't required to include on the temporary under GAAP must be
during the tax year. C treats N as a attached supporting statement for Part I, reported in column (b) and differences
corporation for financial statement line 8, the offsetting adjustment to the that are permanent (that is, not
purposes and as a partnership for U.S. intercompany elimination of interest temporary) for GAAP must be reported
income tax purposes. For equity method income and interest expense (though it in column (c). Generally, under to
reporting on C's separate general is permitted to do so). GAAP, a temporary difference affects
ledger, C includes its 60% equity share Line 12. Total Assets and (creates, increases, or decreases) a
of N income, which is $60. In its deferred tax asset or liability.
financial statements, C eliminates the Liabilities of Entities Included
$60 of N net income ($100 less the or Removed on Part I, Lines 4, If the corporation doesn't prepare
minority interest of $40) on Part I, 5, 6, and 7 financial statements, or the financial
statements aren't prepared under
line 4a. Line 12 must be completed by all
GAAP, report in column (b) any
C must remove the $100 net income corporations that file Schedule M-3.
difference that the corporation believes
of N on Part I, line 6a. C must reverse on Report on lines 12a, 12b, 12c, and 12d
will reverse in a future tax year (that is,
Part I, line 8, the elimination of the $40 the total amount (not just the
have an opposite effect on total income
minority interest net income of N and the corporation's share) of assets and
(loss) in a future tax year (or years) due
elimination of the $60 of N equity liabilities of entities included or removed
to the difference in timing of recognition
method income. The result is that C on Part I, lines 4, 5, 6, and 7. All assets
for financial accounting and U.S.
includes the $60 of equity method and liabilities reported on lines 12a
income tax purposes) or is the reversal

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of such a difference that arose in a prior  permanent difference of ($5,000) in         If a corporation would be required to 
tax year. Report in column (c) any          column (c), and $0 in column (d).           report in column (a) of Parts II and III the 
difference that the corporation believes                                                amount of any item specifically listed on 
won't reverse in a future tax year (and     Reporting Requirements                      Schedule M-3 in accordance with the 
isn't the reversal of such a difference     for Parts II and III                        preceding paragraph, except that the 
that arose in a prior tax year).                                                        corporation has capitalized the item of 
                                            General Reporting                           income or expense and reports the 
If the corporation is unable to                                                         amount in its financial statement 
determine whether a difference between      Requirements
                                                                                        balance sheet or in asset and liability 
column (a) and column (d) for an item       If an amount is attributable to a 
                                                                                        accounts maintained in the 
will reverse in a future tax year or is the reportable transaction described in 
                                                                                        corporation's books and records, the 
reversal of a difference that arose in a    Regulations section 1.6011-4(b), the 
                                                                                        corporation must report the proper tax 
prior tax year, report the difference for   amount must be reported in columns 
                                                                                        treatment of the item in columns (b), (c), 
that item in column (c).                    (a), (b), (c), and (d), as applicable, of 
                                                                                        and (d), as applicable.
Example 5.        At the end of             Part II, line 10, regardless of whether the 
Corporation A's first tax year, December    amount would otherwise be reported on       Furthermore, in applying the two 
31, 2018, it wasn't required to file        Schedule M, Part II or Part III. So, if a   preceding paragraphs, a corporation is 
Schedule M-3 for any reason.                taxpayer is required to file Form 8886,     required to report in column (a) of Parts 
                                            Reportable Transaction Disclosure           II and III the amount of any item 
A may elect to file Schedule M-3            Statement, the amounts attributable to      specifically listed on Schedule M-3 that 
instead of completing Schedule M-1.         that reportable transaction must be         is included in the corporation's financial 
If A elects to file schedule M-3, it        reported on Part II, line 10.               statements or exists in the corporation's 
must either (i) complete Schedule M-3                                                   books and records, regardless of the 
entirely or (ii) complete Schedule M-3      A corporation is required to report in      nomenclature associated with that item 
through Part I and complete                 column (a) of Parts II and III the amount   in the financial statements or books and 
Schedule M-1 instead of completing          of any item specifically listed on          records. Accurate completion of 
Parts II and III of Schedule M-3.           Schedule M-3 that is in any manner          Schedule M-3 requires reporting 
                                            included in the corporation's current       amounts according to the substantive 
If A elects to complete Schedule M-3        year financial statement net income         nature of the specific line items included 
entirely, it must complete all columns of   (loss) or in an income or expense           in Schedule M-3 and consistent 
Parts II and III.                           account maintained in the corporation's     reporting of all transactions of like 
If A completes Schedule M-3 through         books and records, even if there is no      substantive nature that occurred during 
Part I and completes Schedule M-1           difference between that amount and the      the tax year. For example, all expense 
instead of completing Parts II and III of   amount included in total income (loss)      amounts that are included in the 
Schedule M-3, line 11 of Part I of          unless ( ) otherwise provided in these a    financial statements or exist in the 
Schedule M-3 must equal line 1 of           instructions or ( ) the amount is b         books and records that represent some 
Schedule M-1.                               attributable to a reportable transaction    form of “Bad debt expense,” must be 
Example 6.        Corporation B is a U.S.   described in Regulations section            reported on Part III, line 25, in column 
corporation that files a U.S. tax return    1.6011-4(b) so it is reported on Part II,   (a), regardless of whether the amounts 
and prepares GAAP financial                 line 10. For example, with the exception    are recorded or stated under different 
statements. In prior years, B acquired      of interest income reflected on a           nomenclature in the financial 
intellectual property (IP) and goodwill.    Schedule K-1 received by a corporation      statements or the books and records 
The IP is amortizable for both U.S.         as a result of the corporation's            such as: “Provision for doubtful 
income tax and financial statement          investment in a partnership or other        accounts”; “Expense for uncollectible 
purposes. In the current year, B's annual   pass-through entity, all interest income    notes receivable”; or “Impairment of 
amortization expense for IP is $9,000 for   included on Part I, line 11, whether from   trade accounts receivable.” Likewise, as 
U.S. income tax purposes and $6,000         affiliated companies, third parties,        stated in the preceding paragraph, all 
for financial statement purposes. In its    banks, or other entities, whether from      fines and penalties must be included on 
financial statements, B treats the          foreign or domestic sources, whether        Part III, line 9, column (a), regardless of 
difference in IP amortization as a          taxable or exempt from tax, and whether     the terminology or nomenclature 
temporary difference. The goodwill isn't    classified as some other type of income     attached to them by the corporation in 
amortizable for U.S. income tax             for U.S. income tax purposes (such as       its books and records or financial 
purposes and is subject to impairment       dividends), must be included on Part II,    statements.
for financial statement purposes. In the    line 11, column (a). Likewise, all fines 
current year, B records an impairment       and penalties included in Part I, line 11,  With limited exceptions, Part II 
charge on the goodwill of $5,000. In its    paid to a government or other authority     includes lines for specific items of 
financial statements, B treats the          for the violation of any law for which      income, gain, or loss (income items). 
goodwill impairment as a permanent          fines or penalties are assessed must be     (See Part II, lines 1 through 21.) If an 
difference. B must report the               included on Part III, line 9, column (a),   income item is described in Part II, lines 
amortization attributable to the IP on      regardless of the government authority      1 through 21, report the amount of the 
Part III, line 21, and report $6,000 in     that imposed the fines or penalties,        item on the applicable line, regardless of 
column (a), a temporary difference of       regardless of whether the fines or          whether there is a difference for the 
$3,000 in column (b), and $9,000 in         penalties are civil or criminal, regardless item. If there is a difference for the 
column (d). B must report the goodwill      of the classification, nomenclature, or     income item, or only a portion of the 
impairment on Part III, line 19, and        terminology attached to the fines or        income item has a difference and a 
report $5,000 in column (a), a              penalties by the imposing authority in its  portion of the item doesn't have a 
                                            actions or documents.                       difference, and the item isn't described 
                                                                                        in Part II, lines 1 through 21, report and 

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describe the entire amount of the item Schedule M-3, or any statement 2018 tax year. On December 31, 2018,
on Part II, line 22. required to be attached, even if the D establishes three reserve accounts in
amounts are below a certain dollar the amount of $100,000 for each
With limited exceptions, Part III amount. account. One reserve account is an
includes lines for specific items of allowance for accounts receivable that
expense or deduction (expense items). Required statements for Part II,
are estimated to be uncollectible. The
(See Part III, lines 1 through 28.) If an line 22, and Part III, line 31. A
second reserve is an estimate of
expense item is described on Part III, separate statement must be attached to
coupons outstanding that may have to
lines 1 through 28, report the amount of Schedule M-3 (Form 1120S) that
be paid. The third reserve is an estimate
the item on the applicable line, includes a detailed description of each
of future warranty expenses. In its
regardless of whether there is a item and adjustment entered on Part II,
financial statements, D treats the three
difference for the item. If there is a line 22, and Part III, line 31.
reserve accounts as giving rise to
difference for the expense item, or only The description for each amount temporary differences that will reverse
a portion of the expense item has a entered in column (a) must be readily in future years. The three reserves are
difference and a portion of the item identifiable to the name of the account expenses in D's 2018 financial
doesn't have a difference and the item in the financial statements or books and statements but aren't deductions for
isn't described in Part III, lines 1 through records of the taxpayer, under which the U.S. income tax purposes in 2018. D
28, report and describe the entire amount in column (a) was recorded in mustn't combine the Schedule M-3
amount of the item on Part III, line 31. the accounting records. Also, the differences for the three reserve
If there is no difference between the description for each amount entered in accounts. D must report the amounts
financial accounting amount and the column (a) must include detailed attributable to the allowance for
taxable amount of an entire item of information supporting each adjustment uncollectible accounts receivable on
income, loss, expense, or deduction reported in columns (b) and (c), Part III, line 25, and must separately
and the item isn't described or included including how the adjustment is state and adequately disclose the
in Part II, lines 1 through 21, or Part III, identified in the accounting records. The amounts attributable to each of the
lines 1 through 28, report the entire entire description is considered the tax other two reserves, coupons
amount of the item in columns (a) and description for the amount reported in outstanding and warranty costs, on a
(d) of Part II, line 25. column (d) for each item reported on required, attached statement that
Part II, line 22, or Part III, line 31. supports the amounts at Part III, line 31.
Separately stated and adequately
Each description should adequately
disclosed. Each difference reported in D must also provide a description for
describe all four columns of Part II,
Parts II and III must be separately stated each reserve that meets the
line 22, or Part III, line 31. If additional
and adequately disclosed. In general, a requirements for Part III, line 31,
information is required to provide an
difference is adequately disclosed if the discussed earlier under Required
acceptable description, provide a
difference is labeled in a manner that statements for Part II, line 22, and Part
supporting statement.
clearly identifies the item or transaction III, line 31. In this example, an
from which the difference arises. For Example 7. Corporation C is a acceptable description would be
further guidance about adequate calendar year taxpayer that files and "Coupon Issue Reserves - Rewards
disclosure, see Regulations section entirely completes Schedule M-3 for its Expense" and "Future Warranty
1.6662-4(f). If a specific item of income, 2018 tax year. C placed in service 10 Expense Reserve."
gain, loss, expense, or deduction is depreciable fixed assets in a previous There is no need to add the title
described on Part II, lines 7 through 21, year. C's total depreciation expense for TIP of the reserve account to the
or Part III, lines 1 through 28, and the its 2018 tax year for five of the assets is description if the account name
line doesn't indicate to “attach $50,000 for income statement purposes for the amount in column (a) is already
statement,” and the specific instructions and $70,000 for U.S. income tax part of the adjustment description.
for the line don't call for an attachment purposes. C's total annual depreciation
of a statement, then the item is expense for its 2018 tax year for the Example 9. Corporation E is a
considered separately stated and other five assets is $40,000 for income calendar year taxpayer that files and
adequately disclosed if the item is statement purposes and $30,000 for entirely completes Schedule M-3 for its
reported on the applicable line and the U.S. income tax purposes. In its 2018 tax year. On January 2, 2018, E
amount(s) of the item(s) are reported in financial statements, C treats the establishes an allowance for
the applicable columns of the applicable differences between financial statement uncollectible accounts receivable (bad
line. See the instructions for Part II, lines and U.S. income tax depreciation debt reserve) of $100,000. During 2018,
1 through 6, for specific additional expense as giving rise to temporary E increased the reserve by $250,000 for
information required to be provided for differences that will reverse in future additional accounts receivable that may
these particular lines. years. C must combine all of its become uncollectible. Additionally,
Except as otherwise provided, depreciation adjustments. Accordingly, during 2018 E decreases the reserve by
differences for the same item must be C must report on Part III, line 24, for its $75,000 for accounts receivable that
combined or netted together and 2018 tax year income statement were discharged in bankruptcy during
reported as one amount on the depreciation expense of $90,000 in 2018. The balance in the reserve
applicable line of Schedule M-3. column (a), a temporary difference of account on December 31, 2018, is
However, differences for separate items $10,000 in column (b), and U.S. income $275,000. The $100,000 amount to
mustn't be combined or netted together. tax depreciation expense of $100,000 in establish the reserve account and the
Each item (and corresponding amount column (d). $250,000 to increase the reserve
attributable to that item) must be Example 8. Corporation D is a account are expenses on E's 2018
separately stated and adequately calendar year taxpayer that files and financial statements but aren't
disclosed on the applicable line of entirely completes Schedule M-3 for its deductible for U.S. income tax purposes

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in 2018. However, the $75,000 Line 1. Income (Loss) From Forms 5471, Information Return of U.S.
decrease to the reserve is deductible for Equity Method Foreign Persons With Respect To Certain
U.S. income tax purposes in 2018. In its Foreign Corporations. The amount of
financial statements, E treats the Corporations QEF income corresponds to the total of
reserve account as giving rise to a Report on line 1, column (a), the the amounts reported by the corporation
temporary difference that will reverse in financial income (loss) included in Part I, on all Forms 8621, Information Return
future tax years. E must report on Part line 11, for any foreign corporation by a Shareholder of a Passive Foreign
III, line 25, for its 2018 tax year income accounted for on the equity method and Investment Company or Qualified
statement bad debt expense of remove such amount in column (b) or Electing Fund. See Form 8621 and the
$350,000 in column (a), a temporary (c), as applicable. Report the amount of Instructions for Form 8621.
difference of ($275,000) in column (b), dividends received and other taxable
and U.S. income tax bad debt expense amounts received or includible from Also include on line 3 passive foreign
of $75,000 in column (d). foreign corporations on Part II, lines 2 investment company (PFIC)
through 4, as applicable. mark-to-market gains and losses under
Example 10. Corporation F is a section 1296. Don't report such gains
calendar year taxpayer that files and Line 2. Gross Foreign and losses on Part II, line 14.
entirely completes Schedule M-3 for its Dividends Not Previously
2018 tax year. During 2018, F incurs Line 4. Gross Foreign
Taxed
$200 in meal expenses and $100 in Distributions Previously Taxed
entertainment expenses that F deducts Except as otherwise provided in this
in computing net income per the income paragraph, report on line 2, column (d), Report on line 4, column (a), any
statement. All of the $200 meal expense the amount (before any withholding tax) distributions received from foreign
is subject to the 50% limitation under of any foreign dividends included in corporations that were included in Part I,
section 274(n). The $100 of current year total income (loss) on Form line 11, and that were previously taxed
entertainment expenses is disallowed 1120S, Schedule K, line 18, and report for U.S. income tax purposes. For
as a deduction under section 274(a). In on line 2, column (a), the amount of example, include in column (a) amounts
its financial statements, F treats the dividends from any foreign corporation that are excluded from income under
limitation on deductions for meals and included in Part I, line 11. Don't report sections 959 and 1293(c). Remove
entertainment as a permanent on line 2 any amounts that must be such amount in column (b) or (c), as
difference. Because meal and reported on Part II, line 3, or dividends applicable. Report the full amount of the
entertainment expenses are specifically that were previously taxed and must be distribution before any withholding tax.
described in Part III, line 8, F must reported on Part II, line 4. (See the Report withholding taxes on Part III,
report all of its meal and entertainment instructions below for Part II, lines 3 and line 31, or Part II, line 25, as applicable.
expenses on this line, regardless of 4.) Report withholding taxes on Part III, Since previously taxed foreign
whether there is a difference. line 31, or Part II, line 25, as applicable. distributions aren't currently taxable,
line 4, column (d), is shaded. Also, see
Accordingly, F must report $300 in For any dividends reported on Part II, the instructions above for Part II, line 2.
column (a), $200 in column (c), and line 2, that are received on a class of
$100 in column (d). F must report all voting stock of which the corporation Line 5. Income (Loss) From
meal and entertainment expenses, directly or indirectly owned 10% or more Equity Method U.S.
whether allowed fully or subject to of the outstanding shares of that class at Corporations
limitations, on Part III, line 8. No amount any time during the tax year, report on Report on line 5, column (a), the
should be reflected on Part II, line 25. an attached supporting statement: (1) financial income (loss) included in Part I,
the name of the dividend payer, (2) the line 11, for any U.S. corporation
Part II. Reconciliation of payer's EIN (if applicable), (3) the class accounted for on the equity method and
Net Income (Loss) per of voting stock on which the dividend remove such amount in column (b) or
Income Statement of the was paid, (4) the percentage of the (c), as applicable. Report on Part II,
class directly or indirectly owned, and line 6, dividends received from any U.S.
Corporation With Total (5) the amounts for columns (a) through corporation accounted for on the equity
Income (Loss) per Return (d). method.
Lines 1 Through 9. Additional Line 3. Subpart F, QEF, and Line 6. U.S. Dividends Not
Information for Each Entity Similar Income Inclusions Eliminated in Tax Consolidation
For any item reported on Part II, lines 1, Report on line 3, column (d), the amount Report on line 6, column (a), the amount
and 3 through 5, attach a supporting included in income under section 951 of dividends included in Part I, line 11,
statement that provides the name of the (relating to Subpart F), the amount that were received from any U.S.
entity for which the item is reported, the included in income under section 951A corporation. Report on line 6, column
entity's EIN (if applicable), the type of (relating to global intangible low-taxed (d), the amount of any U.S. dividends
entity (corporation, partnership, etc.), income (GILTI)), gains or other income included in total income (loss) on Form
and the item amounts for columns (a) inclusions resulting from elections under 1120S, Schedule K, line 18.
through (d). See the instructions for Part sections 1291(d)(2) and 1298(b)(1), and
II, lines 2 and 6 through 9, for the any amount included in income For any dividends included on Part II,
specific information required for those pursuant to section 1293 (relating to line 6, that are received on classes of
particular lines. qualified electing funds (QEFs)). The voting stock in which the corporation
amount of Subpart F income directly or indirectly owned 10% or more
corresponds to the total of the amounts of the outstanding shares of that class at
reported by the corporation on any time during the tax year, report on
Schedule I, lines 1 through 4, of all an attached supporting statement for

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Part II, line 6: (1) the name of the of ordinary income, $7,000 of long-term separately stated and adequately
dividend payer, (2) the payer's EIN (if capital gains, $4,000 of charitable disclosed. A corporation will be
applicable), (3) the class of voting stock contributions, and $200 of section 179 considered to have separately stated
on which the dividend was paid, (4) the expense. H must report on Part II, line 7, and adequately disclosed a reportable
percentage of the class directly or $10,000 in column (a), a permanent transaction on line 10 if the corporation
indirectly owned, and (5) the item difference of ($2,200) in column (c), and sequentially numbers each Form 8886
amounts for columns (a) through (d). $7,800 in column (d). and lists by identifying number on the
supporting statement for Part II, line 10,
Line 7. Income (Loss) From Line 9. Income (Loss) From each sequentially numbered reportable
U.S. Partnerships and Line 8. Other Pass-Through Entities transaction and the amounts required
Income (Loss) From Foreign For any interest in a pass-through entity for Part II, line 10, columns (a) through
Partnerships (other than an interest in a partnership (d).
For any interest owned by the reportable on Part II, line 7 or 8, as
corporation that is treated as an applicable) owned by the corporation In lieu of the requirements of the
investment in a partnership for U.S. (other than an interest in a disregarded preceding paragraph, a corporation will
income tax purposes (other than an entity), report the following on line 9. be considered to have separately stated
and adequately disclosed a reportable
interest in a disregarded entity), report 1. In column (a), the sum of the
transaction if the corporation attaches a
amounts on Part II, line 7 or 8, as corporation's distributive share of
supporting statement that provides the
described below. income or loss from the pass-through
following for each reportable
1. In column (a), the sum of the entity that is included in Part I, line 11.
transaction.
corporation's distributive share of 2. In column (b) or (c), as
1. A description of the reportable
income or loss from a U.S. or foreign applicable, the sum of all differences, if
transaction disclosed on Form 8886 for
partnership that is included in Part I, any, attributable to the pass-through
which amounts are reported on Part II,
line 11. entity.
line 10.
2. In column (b) or (c), as 3. In column (d), the sum of all
2. The name and reportable
applicable, the sum of all differences, if taxable amounts of income, gain, loss,
transaction or tax shelter registration
any, attributable to the corporation's or deduction reportable on the
number, if applicable, as reported on
distributive share of income or loss from corporation's Schedules K-1 received
lines 1a and 1c, respectively, of Form
a U.S. or foreign partnership. from the pass-through entity (if
8886.
3. In column (d), the sum of all applicable).
3. The type of reportable transaction
amounts of income, gain, loss, or For each pass-through entity (that is, listed transaction, confidential
deduction attributable to the reported on line 9, attach a supporting transaction, transaction with contractual
corporation's distributive share of statement that provides that entity's protection, etc.) as reported on line 2 of
income or loss from a U.S. or foreign name, EIN (if applicable), the Form 8886.
partnership (that is, the sum of all corporation's end of year profit-sharing
amounts reportable on the corporation's percentage (if applicable), the If a transaction is a listed transaction
Schedule(s) K-1 received from the corporation's end of year loss-sharing described in Regulations section
partnership (if applicable)), without percentage (if applicable), and the 1.6011-4(b)(2), the description also
regard to any limitations computed at amounts reported by the corporation in must include the description provided
the partner level. column (a), (b), (c), or (d) of line 9, as on line 3 of Form 8886. In addition, if the
For each partnership reported on applicable. reportable transaction involves an
investment in the transaction through
line 7 or 8, attach a supporting Line 10. Items Relating to another entity such as a partnership, the
statement that provides the name, EIN Reportable Transactions description must include the name and
(if applicable), end of year profit-sharing EIN (if applicable) of that entity as
percentage (if applicable), end of year Any amounts attributable to any
loss-sharing percentage (if applicable), reportable transactions (as described in reported on line 5 of Form 8886.
and the amount reported in column (a), Regulations section 1.6011-4(b)) must Example 12. Corporation J is a
(b), (c), or (d) of lines 7 or 8, as be included on Part II, line 10, calendar year taxpayer that files and
applicable. regardless of whether the difference, or entirely completes Schedule M-3 for its
differences, would otherwise be 2018 tax year. J incurred seven different
Example 11. U.S. corporation H is a reported elsewhere in Part II or Part III. abandonment losses during its 2018 tax
calendar year taxpayer that files and So, if a taxpayer is required to file Form year. One loss of $12 million results
entirely completes Schedule M-3 for its 8886 for any reportable transaction from a reportable transaction described
2018 tax year. H has an investment in a described in Regulations section in Regulations section 1.6011-4(b)(5),
U.S. partnership USP. H prepares 1.6011-4(b), the amounts attributable to another loss of $5 million results from a
financial statements in accordance with that reportable transaction must be reportable transaction described in
GAAP. In its financial statements, H reported on Part II, line 10. In addition, Regulations section 1.6011-4(b)(4), and
treats the difference between financial all income and expense amounts the remaining five abandonment losses
statement net income and taxable attributable to a reportable transaction aren't reportable transactions. J
income from its investment in USP as a must be reported on Part II, line 10, discloses the reportable transactions
permanent difference. For its 2018 tax columns (a) and (d), even if there is no giving rise to the $12 million and $5
year, H's financial statement net income difference between the financial million losses on separate Forms 8886
includes $10,000 of income attributable amounts and the taxable amounts. and sequentially numbers them X1 and
to its share of USP's net income. H's X2, respectively. J must separately state
Schedule K-1 from USP reports $5,000 Each difference attributable to a
reportable transaction must be and adequately disclose the $12 million

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and $5 million losses on Part II, line 10. Any corporation that files Form statements in accordance with GAAP
The $12 million loss and the $5 million TIP 1120S that (a) is required to file using an overall accrual method of
loss will be adequately disclosed if J a Schedule M-3 and has less accounting. L uses an overall cash
attaches a supporting statement for than $50 million in total assets at the method of accounting for U.S. income
line 10 that lists each of the sequentially end of the tax year or (b) isn't required tax purposes. L's financial statements
numbered forms, Form 8886-X1 and to file a Schedule M-3 and voluntarily for the year ending December 31, 2018,
Form 8886-X2, and for each reportable files a Schedule M-3, isn't required to report accounts receivable of $35,000,
transaction reports the appropriate file Form 8916-A but may voluntarily do an allowance for bad debts of $10,000,
amounts required for Part II, line 10, so. and accounts payable of $17,000
columns (a) through (d). Alternatively, related to current year acquisition and
J's disclosures will be adequate if the Report on Part II, line 11, column (a), reorganization legal and accounting
description provided for each loss on the total amount of interest income fees. In addition, for L's year ending
the supporting statement includes the included on Part I, line 11, and report on December 31, 2018, L reported financial
names and reportable transaction or tax Part II, line 11, column (d), the total statement depreciation expense of
shelter registration numbers, if any, amount of interest income included on $15,000 and depreciation for U.S.
disclosed on the applicable Form 8886, Form 1120S, Schedule K, line 18, that income tax purposes of $25,000. For L's
identifies the type of reportable isn't required to be reported elsewhere 2018 tax year using an overall cash
transaction for the loss, and reports the on Schedule M-3. In columns (b) or (c), method of accounting, L doesn't
appropriate amounts required for Part II, as applicable, adjust for any amounts recognize the $35,000 of revenue
line 10, columns (a) through (d). J must treated for U.S. income tax purposes as attributable to the accounts receivable,
report the losses attributable to the interest income that are treated as some can't deduct the $10,000 allowance for
other five abandonment losses on Part other form of income for financial bad debt, and can't deduct the $17,000
II, line 21e, regardless of whether a accounting purposes, or vice versa. For of accounts payable. In its financial
difference exists for any or all of those example, adjustments to interest statements, L treats both the difference
abandonment losses. income resulting from adjustments in overall accounting methods used for
Example 13. Corporation K is a made in accordance with the financial statement and U.S. income tax
calendar year taxpayer that files and instructions for Part II, line 16, should be purposes and the difference in
entirely completes Schedule M-3 for its made in columns (b) and (c) of this depreciation expense as temporary
2018 tax year. K enters into a line 11. differences. L must combine all
transaction with contractual protection Don't report on this line 11 or include adjustments attributable to the
that is a reportable transaction on Form 8916-A amounts reported in differences related to the overall
described in Regulations section accordance with instructions for Part II, accounting methods on Part II, line 12.
1.6011-4(b)(4). This reportable lines 7, 8, 9, 10, and 20. As a result, L must report on Part II,
transaction is the only reportable line 12, $8,000 in column (a) ($35,000 –
transaction for K's 2018 tax year and Line 12. Total Accrual to Cash $10,000 – $17,000), ($8,000) in column
results in a $7 million capital loss for Adjustment (b), and zero in column (d). L mustn't
both financial accounting purposes and This line is completed by a corporation report the accrual to cash adjustment
U.S. income tax purposes. Although the that prepares financial statements (or attributable to the legal and accounting
transaction doesn't result in a books and records, if permitted) using fees on Part III, line 17. Because the
difference, K is required to report on an overall accrual method of accounting difference in depreciation expense
Part II, line 10, the following amounts: and uses an overall cash method of doesn't relate to the use of the cash or
($7 million) in column (a), zero in accounting for U.S. income tax accrual method of accounting, L must
columns (b) and (c), and ($7 million) in purposes (or vice versa). With the report the depreciation difference on
column (d). The transaction will be exception of amounts required to be Part III, line 24, and report $15,000 in
adequately disclosed if K attaches a reported on Part II, line 10, the column (a), $10,000 in column (b), and
supporting statement for line 10 that (a) corporation must report on Part II, $25,000 in column (d).
sequentially numbers the Form 8886 line 12, a single amount net of all Line 13. Hedging Transactions
and refers to the sequentially-numbered adjustments attributable solely to the Report on line 13, column (a), the net
Form 8886-X1 and (b) reports the use of the different overall methods of gain or loss from hedging transactions
applicable amounts required for line 10, accounting (for example, adjustments included on Part I, line 11. Report in
columns (a) through (d). Alternatively, related to accounts receivable, column (d) the amount of income (loss)
the transaction will be adequately accounts payable, compensation, from hedging transactions as defined in
disclosed if the supporting statement for accrued liabilities, etc.), regardless of section 1221(b)(2). Use columns (b)
line 10 includes a description of the whether a separate line on and (c) to report all differences caused
transaction, the name and tax shelter Schedule M-3 corresponds to an item by treating hedging transactions
registration number, if any, and the type within the accrual to cash reconciliation. differently for financial accounting
of reportable transaction disclosed on Differences not attributable to the use of purposes and for U.S. income tax
Form 8886. the different overall methods of purposes. For example, if a portion of a
accounting must be reported on the hedge is considered ineffective under
Line 11. Interest Income appropriate lines of Schedule M-3 (for GAAP but still is a valid hedge under
Attach Form 8916-A, Supplemental example, a depreciation difference must section 1221(b)(2), the difference must
Attachment to Schedule M-3. Complete be reported on Part III, line 24). be reported on line 13. The hedge of a
Part II and enter the amounts shown on
line 6, columns (a) through (d), on Example 14. Corporation L is a capital asset, which isn't a valid hedge
Schedule M-3, line 11, columns (a) calendar year taxpayer that files and for U.S. income tax purposes but may
through (d), as applicable. entirely completes Schedule M-3 for its
2018 tax year. L prepares financial

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be considered a hedge for GAAP Examples of amounts that must be is $50,000 for financial accounting
purposes, must also be reported here. included as cost of goods sold items are purposes and $70,000 for U.S. income
amounts attributable to inventory tax purposes. C's total annual
Report hedging gains and losses
valuation, such as amounts attributable depreciation expense for its 2018 tax
computed under the mark-to-market
to cost-flow assumptions, additional year for the other five assets is $40,000
method of accounting on line 13 and not
costs required to be capitalized for financial accounting purposes and
on Part II, line 14.
(including depreciation) such as section $30,000 for U.S. income tax purposes.
Report any gain or loss from 263A costs, inventory shrinkage In addition, C incurs $200 of meal
inventory hedging transactions on accruals, inventory obsolescence expenses that C deducts in computing
line 13 and not on Part II, line 15. reserves, and lower of cost or market net income for financial accounting
(LCM) write-downs. purposes. All $200 of the meal
Line 14. Mark-to-Market Income expenses is subject to the 50%
(Loss) Complete Part I of Form 8916-A.
Enter the amounts from line 8, columns limitation under section 274(n). In its
Report on line 14 any amount (a) through (d) of Form 8916-A, on financial statements, C treats the
representing the mark-to-market income Schedule M-3, Part II, line 15, columns $50,000 depreciation and $100 of the
or loss for any securities held by a (a) through (d), as applicable. Attach meals as other costs in computing cost
dealer in securities, a dealer in Form 8916-A. of goods sold. C must include on
commodities having made a valid Schedule M-3, Part II, line 15, in column
election under section 475(e), or a The entries in columns (a) and (a), the $50,000 of depreciation and
trader in securities or commodities TIP (d) of Schedule M-3, line 15, are $100 of meals. C must also include a
having made a valid election under negative amounts. temporary difference of $20,000 in
section 475(f). “Securities” for these column (b), a permanent difference of
purposes are securities described in Don't report the following on line 15 ($50) in column (c), and $70,050 in
section 475(c)(2) and “commodities” are or on Form 8916-A. column (d) ($70,000 depreciation and
described in section 475(e)(2). • Amounts reportable on Part II, line 10. $50 meal expenses). In addition, C must
“Securities” don't include any items • Any gain or loss from inventory report on Part III, line 24, for its 2018 tax
specifically excluded from sections hedging transactions reportable on Part year income statement, depreciation
475(c)(2) and 475(e)(2), such as certain II, line 13. expense of $40,000 in column (a), a
contracts to which section 1256(a) • Amounts reportable on Part II, line 16. temporary difference of ($10,000) in
applies. • Amounts reportable on Part II, line 19. column (b), and $30,000 in column (d);
• Mark-to-market income or (loss) and on Part III, line 8, meals and
Report hedging gains and losses associated with the inventories of entertainment expense of $100 in
computed under the mark-to-market dealers in securities under section 475 column (a), a permanent difference of
method of accounting on Part II, line 13, reportable on Part II, line 14. ($50) in column (c), and $50 in column
and not on line 14. • Section 481(a) adjustments related to (d). All other cost of goods sold items
Traders in securities and commodi- cost of goods sold or inventory valuation would be added to the amounts
ties. For a trader in securities or reportable on Part II, line 17. included on Part II, line 15, detailed in
commodities that made a valid election • Fines and penalties reportable on this example and reported on Part II,
under section 475(f) to use the Part III, line 9. line 15, in the appropriate columns.
mark-to-market method to account for • Judgments, damages, awards, and
securities or commodities held in similar costs, reportable on Part III, Line 16. Sale Versus Lease (for
connection with a trading business that line 10. Sellers and/or Lessors)
files Form 4797, Sales of Business • Amounts included on Part III, line 28.
Also see the instructions at Part
Property, any Schedule M-3 entries Form 8916-A. Any corporation filing TIP III, line 28.
required as a result of marking to market Form 1120S that (a) is required to file a
these securities or commodities are Schedule M-3 and has less than $50 Asset transfer transactions with periodic
reported as follows: (a) mark-to-market million in total assets at the end of the payments characterized for financial
gains and losses from Form 4797, tax year or (b) isn't required to file a accounting purposes as either a sale or
line 10, are included on Schedule M-3 Schedule M-3 and voluntarily files a a lease may, under some
(Form 1120S), Part II, line 14; (b) any Schedule M-3, isn't required to file Form circumstances, be characterized as the
other Schedule M-3 entries required 8916-A but may voluntarily do so. opposite for tax purposes. If the
based on other results (non
If you are required to (or voluntarily)
mark-to-market gains and losses) transaction is treated as a lease, the
file Form 8916-A, complete Part I to
included in the total reported on Form seller/lessor reports the periodic
provide a detailed schedule of cost of
4797, line 17, should be reported on payments as gross rental income and
goods sold. Enter the amounts from
Schedule M-3 (Form 1120S), Part II, also reports depreciation expense or
line 8, columns (a) through (d) of Form
line 21d, unless the instructions for deduction. If the transaction is treated
8916-A, on Schedule M-3, Part II,
Schedule M-3 require the amounts to be as a sale, the seller/lessor reports gross
line 15, columns (a) through (d), as
reported on another line. profit (sale price less cost of goods sold)
applicable. Attach Form 8916-A. from the sale of assets and reports the
Line 15. Cost of Goods Sold Example 15. Corporation C is a periodic payments as payments of
Report on line 15 any amounts calendar year taxpayer that files and principal and interest income.
deducted as part of cost of goods sold entirely completes Schedule M-3 for its On Part II, line 16, column (a), report
during the tax year, regardless of 2018 tax year. C placed in service 10 the gross profit or gross rental income
whether the amounts would otherwise depreciable fixed assets in a previous for financial accounting purposes for all
be reported elsewhere in Part II or Part tax year. C's total depreciation expense sale or lease transactions that must be
III. for its 2018 tax year for five of the assets

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given the opposite characterization for adjustment must be reported on Part II, Line 20. Original Issue Discount
U.S. income tax purposes. On Part II, line 17, regardless of whether a and Other Imputed Interest
line 16, column (d), report the gross separate line for that income or expense
profit or gross rental income for federal item exists in Part II or Part III. Report on line 20 any amounts of
original issue discount (OID) and other
income tax purposes. Interest income Example 17. Corporation N is a imputed interest. The term “original
amounts for such transactions must be calendar year taxpayer that files and issue discount and other imputed
reported on Part II, line 11, in column (a) entirely completes Schedule M-3 for its interest” includes, but isn't limited to:
or (d), as applicable. Depreciation 2018 tax year. N was depreciating
1. The excess of a debt instrument's
expense for such transactions must be certain fixed assets over an erroneous
stated redemption price at maturity over
reported on Part III, line 24, in column recovery period and, effective for its
its issue price, as determined under
(a) or (d), as applicable. Use columns 2018 tax year, N receives IRS consent
section 1273;
(b) and (c) of Part II, lines 11 and 16, to change its method of accounting for
and Part III, line 24, as applicable to the depreciable fixed assets and begins 2. Amounts that are imputed interest
report the differences between column using the proper recovery period. The on a deferred sales contract under
(a) and (d). change in method of accounting results section 483;
Example 16. Corporation M is a in a positive section 481(a) adjustment 3. Amounts treated as interest or
calendar year taxpayer that files and of $100,000 that is required to be OID under the stripped bond rules under
entirely completes Schedule M-3 for its spread over four tax years, beginning section 1286; and
2018 tax year. M sells and leases with the 2018 tax year. In its financial 4. Amounts treated as OID under
property to customers. For financial statements, N treats the section 481(a) the below-market interest rate rules
accounting purposes, M accounts for adjustment as a temporary difference. N under section 7872.
each transaction as a sale. For U.S. must report on Part II, line 17, $25,000
income tax purposes, each of M's in columns (b) and (d) for its 2018 tax Line 21a. Income Statement
transactions must be treated as a lease. year and each of the subsequent three Gain/Loss on Sale, Exchange,
In its financial statements, M treats the tax years (unless N is otherwise
Abandonment, Worthlessness,
difference in the financial accounting required to recognize the remainder of
and the U.S. income tax treatment of the 481(a) adjustment earlier). N mustn't or Other Disposition of Assets
these transactions as temporary. During report the section 481(a) adjustment on Other Than Inventory and
2018, M reports in its financial Part III, line 24. Pass-Through Entities
statements $1,000 of sales and $700 of Report on line 21a, column (a), all gains
cost of goods sold regarding 2018 lease Line 18. Unearned/Deferred
transactions. M receives periodic Revenue and losses on the disposition of assets
except for (a) gains and losses on the
payments of $500 in 2018 for these Report on line 18, column (a), amounts disposition of inventory, and (b) gains
2018 transactions and similar of revenues included in Part I, line 11, and losses allocated to the corporation
transactions from prior years and treats that were deferred from a prior financial from a pass-through entity (for example,
$400 as principal and $100 as interest accounting year. Report on line 18, on Schedule K-1) that are included in
income. For financial accounting column (d), amounts of revenues the net income (loss) of the corporation
purposes, M reports gross profit of $300 recognizable for U.S. income tax reported on Part I, line 11. Reverse the
($1,000 – $700) and interest income of purposes in the current tax year that are amount reported in column (a) in
$100 from these transactions. For U.S. recognized for financial accounting column (b) or (c), as applicable. The
income tax purposes, M reports $500 of purposes in a different year. Also report corresponding gains and losses for U.S.
gross rental income (the periodic on line 18, column (d), any amount of income tax purposes are reported on
payments) and (based on other facts) revenues reported on line 18, column Part II, lines 21b through 21g, as
$200 of depreciation deduction on the (a), that are recognizable for U.S. applicable.
property. On its 2018 Schedule M-3, M income tax purposes in the current tax
must report on Part II, line 11, $100 in year. Use columns (b) and (c) of line 18, Line 21b. Gross Capital Gains
column (a), ($100) in column (b), and as applicable, to report the differences From Schedule D, Excluding
zero in column (d). In addition, M must between columns (a) and (d). Amounts From Pass-Through
report on Part II, line 16, $300 of gross
profit in column (a), $200 in column (b), Line 18 mustn't be used to report Entities
and $500 of gross rental income in income recognized from long-term Report on line 21b gross capital gains
column (d). Lastly, M must report on contracts. Instead, use line 19. reported on Schedule D (Form 1120S),
Part III, line 24, $200 in column (b) and Line 19. Income Recognition Capital Gains and Losses and Built-in
Gains, or Form 8949, Sales and Other
(d). From Long-Term Contracts Dispositions of Capital Assets,
Line 17. Section 481(a) Report on line 19 the amount of net excluding capital gains from
Adjustments income or loss for financial statement pass-through entities, which must be
With the exception of a section 481(a) purposes (or books and records, if reported on Part II, lines 7, 8, or 9, as
adjustment that is required to be applicable) or U.S. income tax purposes applicable.
reported on Part II, line 10, for for any contract accounted for under a
reportable transactions, any difference long-term contract method of
between an income or expense item accounting.
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)

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Line 21c. Gross Capital Losses Line 21g. Other Gain/Loss on Line 24. Total Expense/
From Schedule D, Excluding Disposition of Assets Other Deduction Items
Amounts From Pass-Through Than Inventory Report on Part II, line 24, columns (a)
Entities, Abandonment Losses, Report on line 21g any gains or losses through (d), as applicable, the negative
and Worthless Stock Losses from the sale or exchange of property of the amounts reported on Part III,
Report on line 21c gross capital losses other than inventory that aren't reported line 32, columns (a) through (d). For
reported on Schedule D (Form 1120S) on lines 21b through 21f. example, if Part III, line 32, column (a),
reflects an amount of $1 million, then
or Form 8949, excluding capital losses Line 22. Other Income (Loss) report on Part II, line 24, column (a), ($1
from (a) pass-through entities, which Items With Differences million). Similarly, if Part III, line 32,
must be reported on Part II, lines 7, 8, or column (b), reflects an amount of
9, as applicable; (b) abandonment Separately state and adequately
losses, which must be reported on Part disclose on Part II, line 22, all items of ($50,000), then report on Part II, line 24,
II, line 21e; and (c) worthless stock income (loss) with differences that aren't column (b), $50,000.
losses, which must be reported on Part otherwise listed on Part II, lines 1 Line 25. Other Items With No
II, line 21f. through 21. Attach a statement that
itemizes the type of income (loss) and Differences
Line 21d. Net Gain/Loss the amount of each item and provides a If there is no difference between the
Reported on Form 4797, description that states the income (loss) financial accounting amount and the
Line 17, Excluding Amounts name for book purposes for the amount taxable amount of an entire item of
recorded in column (a) and describes income, gain, loss, expense, or
From Pass-Through Entities, the adjustment being recorded in deduction and the item isn't described
Abandonment Losses, and column (b) or (c). The entire description or included in Part II, lines 1 through 22,
Worthless Stock Losses completes the tax description for the or Part III, lines 1 through 31, report the
Report on line 21d the net gain or loss amount included in column (d) for each entire amount of the item in columns (a)
reported on line 17 of Form 4797, item separately stated on this line. and (d) of line 25. If a portion of an item
of income, loss, expense, or deduction
excluding amounts from (a) The attached statement should have has a difference and a portion of the
pass-through entities, which must be five columns. The first column has the item doesn't have a difference, don't
reported on Part II, lines 7, 8, or 9, as description for the next four columns. report any portion of the item on line 25.
applicable; (b) abandonment losses, The second column is column (a) Instead, report the entire amount of the
which must be reported on Part II, income (loss) per income statement, item (that is, both the portion with a
line 21e; and (c) worthless stock losses, third column is column (b) temporary difference and the portion without a
which must be reported on Part II, difference, the fourth column is column difference) on the applicable line of Part
line 21f. The amount reported on (c) permanent difference, and the fifth II, lines 1 through 22, or Part III, lines 1
line 21d is the amount that would have column is column (d) income (loss) per through 31. See Example 10, earlier.
been carried to line 17 of Form 4797 in tax return. Every item listed on the
the case of a corporation that isn't an S attached statement for line 22 must Part III. Reconciliation of
corporation. always have columns (a) + (b) + (c) =
Traders in securities or (d). Each item with amounts in columns Net Income (Loss) per
TIP commodities that have made a (a), (b), (c), and (d) will be totaled and Income Statement of the
valid election under section included as one line on line 22. Corporation With Total
475(f) to use the mark-to-market If any “comprehensive income” as Income (Loss) per
method to account for securities or defined by Statement of Financial Return—Expense/
commodities, see the instructions for Accounting Standards (SFAS) No. 130
Part II, line 14. is reported on this line, describe the Deduction Items
item(s) in detail. Examples of sufficiently Expense amounts that reduce
Line 21e. Abandonment Losses detailed descriptions include “Foreign TIP financial accounting income
Report on line 21e any abandonment currency translation must be reported on Part III,
losses, regardless of whether the loss is adjustments—comprehensive income” column (a), as positive amounts.
characterized as an ordinary loss or a and “Gains and losses on Deduction amounts that reduce taxable
capital loss. available-for-sale income must be reported on Part III,
securities—comprehensive income.”
Line 21f. Worthless Stock column (d), as positive amounts.
Amounts reported on Part II, line 24,
Losses Line 23. Total Income (Loss)
must be the negative of the amounts
Report on line 21f any worthless stock Items reported on Part III, line 32.
loss, regardless of whether the loss is Combine lines 1 through 22 and enter
characterized as an ordinary loss or a the total on line 23. Lines 1 Through 6. Income Tax
capital loss. Attach a statement that Expense
separately states and adequately Line 15, Cost of goods sold,
discloses each transaction that gives TIP columns (a) and (d), are If the corporation doesn't distinguish
rise to a worthless stock loss and the negative amounts which will between current and deferred income
amount of each loss. affect the totals entered on line 23. 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.

Instructions for Schedule M-3 (Form 1120S) (2018) -15-

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Line 7. Equity-Based                        of any overaccrual of any amount           Line 12. Other Post-Retirement 
Compensation                                described in this paragraph. See section   Benefits
                                            162(f) for additional guidance.
Report on line 7 any amounts for                                                       Report on line 12 any amounts 
equity-based compensation or                Report on line 9, column (d), any          attributable to other post-retirement 
consideration that are reflected as         such amounts as described in the           benefits not otherwise includible on Part 
expense for financial accounting            preceding paragraph that are includible    III, line 11 (for example, retiree health 
purposes (column (a)) or deducted in        in taxable income, regardless of the       and life insurance coverage, dental 
the U.S. income tax return (column (d))     financial accounting period in which       coverage, etc.).
other than amounts reportable               such amounts were or are included in       Line 13. Deferred 
elsewhere on Schedule M-3, Parts II         financial accounting net income. 
and III. Examples of amounts reportable     Complete columns (b) and (c) as            Compensation
on line 7 include payments attributable     appropriate.                               Report on line 13, column (a), any 
to stock options (including incentive                                                  compensation expense included in the 
stock options and nonqualified stock        Don't report on this Part III, line 9,     net income (loss) amount reported in 
options), employee stock purchase           amounts required to be reported in         Part I, line 11, that isn't deductible for 
plans (ESPPs), phantom stock options,       accordance with instructions for Part III, U.S. income tax purposes in the current 
phantom stock units, stock warrants,        line 10.                                   tax year and that wasn't reported 
stock appreciation rights, and restricted                                              elsewhere on Schedule M-3, column 
stock, regardless of whether such           Don't report on this Part III, line 9,     (a). Report on line 13, column (d), any 
payments are made to employees or           amounts recovered from insurers or any     compensation deductible in the current 
non-employees, or as payment for            other indemnitors for any fines and        tax year that wasn't included in the net 
property or compensation for services.      penalties described above.                 income (loss) amount reported in Part I, 
Line 8. Meals and                           Line 10. Judgments, Damages,               line 11, for the current tax year and that 
                                                                                       isn't reportable elsewhere on 
Entertainment                               Awards, and Similar Costs                  Schedule M-3. For example, report 
Report on line 8, column (a), any           Report on line 10, column (a), the         originations and reversals of deferred 
amounts paid or accrued by the              amount of any estimated or actual          compensation subject to section 409A 
corporation during the tax year for         judgments, damages, awards,                on line 13.
meals, beverages, and entertainment         settlements, and similar costs, however 
that are accounted for in financial         named or classified, included in           Line 15. Charitable 
accounting income, regardless of the        financial accounting income, regardless    Contribution of Intangible 
classification, nomenclature, or            of whether the amount deducted was         Property
terminology used for such amounts, and      attributable to an estimate of future      Report on line 15 any charitable 
regardless of how or where such             anticipated payments or actual             contribution of intangible property, for 
amounts are classified in the               payments. Also report on line 10,          example, contributions of:
corporation's financial income statement    column (a), the reversal of any            • Intellectual property, patents 
or the income and expense accounts          overaccrual of any amount described in     (including any amounts of additional 
maintained in the corporation's books       this paragraph.                            contributions allowable by virtue of 
and records. Report only amounts not                                                   income earned by donees subsequent 
otherwise reportable elsewhere on           Report on line 10, column (d), any 
                                                                                       to the year of donation), copyrights, 
Schedule M-3, Parts II and III (for         such amounts as are described in the 
                                                                                       trademarks;
example, Part II, line 15).                 preceding paragraph that are includible 
                                            in taxable income, regardless of the       • Securities (including stocks and their 
                                                                                       derivatives, stock options, and bonds);
Line 9. Fines and Penalties                 financial accounting period in which 
Report on line 9 any fines or similar       such amounts were or are included in       • Conservation easements (including 
                                                                                       scenic easements or air rights);
penalties paid to a government or other     financial accounting net income. 
authority for the violation of any law for  Complete columns (b) and (c) as            • Railroad rights of way;
which fines or penalties are assessed.      appropriate.                               • Mineral rights; and
                                                                                       • Other intangible property.
All fines and penalties expensed in 
financial accounting income (paid or        Don't report on this Part III, line 10,    Line 16. Current Year 
accrued) must be included on this line 9,   amounts required to be reported in 
                                                                                       Acquisition or Reorganization 
column (a), regardless of the               accordance with instructions for Part III, 
government or other authority that          line 9.                                    Investment Banking Fees
imposed the fines or penalties,                                                        Report on line 16 any investment 
regardless of whether the fines and         Don't report on this Part III, line 10,    banking fees paid or incurred in 
penalties are civil or criminal, regardless amounts recovered from insurers or any     connection with a taxable or tax-free 
of the classification, nomenclature, or     other indemnitors for any judgments,       acquisition of property (for example, 
terminology used for the fines or           damages, awards, or similar costs          stock or assets) or a tax-free 
penalties by the imposing authority in its  described above.                           reorganization. Report on this line any 
                                                                                       investment banking fees incurred at any 
actions or documents, and regardless of     Line 11. Pension and 
                                                                                       stage of the acquisition or 
how or where the fines or penalties are     Profit-Sharing                             reorganization process including, for 
classified in the corporation's financial 
income statement or the income and          Report on line 11 any amounts              example, fees paid or incurred to 
expense accounts maintained in the          attributable to the corporation's pension  evaluate whether to investigate an 
corporation's books and records. Also       plans, profit-sharing plans, and any       acquisition, fees to conduct an actual 
report on line 9, column (a), the reversal  other retirement plans.                    investigation, and fees to consummate 

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the acquisition. Also include on this and (d), include amounts amortizable elsewhere on Schedule M-3. In columns
line 16 investment banking fees incurred under section 167, 195, or 248. (b) or (c), as applicable, include any
in connection with the liquidation of a adjustments for any amounts treated for
subsidiary, a spin-off of a subsidiary, or Line 21. Other Amortization or U.S. income tax purposes as interest
an initial public stock offering. Impairment Write-Offs deduction that are treated as some
Report on line 21 any amortization or other form of expense for financial
Line 17. Current Year impairment write-offs not otherwise accounting purposes, or vice versa. For
Acquisition or Reorganization includible on Schedule M-3. example, adjustments to interest
Legal and Accounting Fees expense/deduction resulting from
Line 22.
Report on line 17 any legal and adjustments made in accordance with
accounting fees paid or incurred in When using this line to figure amounts the instructions for Part III, line 28,
connection with a taxable or tax-free on other tax forms or worksheets, this should be made in columns (b) and (c),
acquisition of property (for example, line should be considered to be zero. as applicable, of this line 26.
stock or assets) or tax-free Line 23a. Depletion—Oil & Gas Don't report on Form 8916-A and on
reorganization. Report on this line any line 26 amounts reported in accordance
Report on line 23a, column (a), any oil
legal and accounting fees incurred at with the instructions for Part II, lines 7, 8,
and gas depletion included on Part I,
any stage of the acquisition or 9, and 10.
line 11.
reorganization process including, for
example, fees paid or incurred to Line 23b. Depletion—Other Line 27. Corporate Owned Life
evaluate whether to investigate an than Oil & Gas Insurance Premiums
acquisition, fees to conduct an actual Report on line 27 all amounts of
investigation, and fees to consummate Report on line 23b any depletion
the acquisition. Also include on this line expense/deduction other than oil and insurance premiums attributable to any
legal and accounting fees incurred in gas that isn't required to be reported life insurance policy if the corporation is
connection with the liquidation of a elsewhere on Schedule M-3 (for directly or indirectly a beneficiary under
subsidiary, a spin-off of a subsidiary, or example, on Part II, line 7, 8, 9, or 15). the policy or if the policy has a cash
value. Report in column (d) the amount
an initial public stock offering. Line 24. Depreciation of the premiums that are deductible for
Line 18. Current Year Report on line 24 any depreciation federal income tax purposes.
Acquisition/Reorganization expense that isn't required to be
reported elsewhere on Schedule M-3 Line 28. Purchase Versus
Other Costs (for example, on Part II, line 7, 8, 9, or Lease (for Purchasers and/or
Report on line 18 any other fees paid or 15). Lessees)
incurred in connection with a taxable or
tax-free acquisition of property (for Line 25. Bad Debt Expense Also see the instructions for
example, stock or assets) or a tax-free Report on line 25, column (a), any TIP sellers and/or lessors in the
reorganization not otherwise reportable amounts attributable to an allowance for instructions for Part II, line 16.
on Schedule M-3 (for example, Part III, uncollectible accounts receivable or Asset transfer transactions with periodic
line 16 or 17). Report on this line any actual write-offs of accounts receivable payments characterized for financial
fees paid or incurred at any stage of the included on Part I, line 11. Report in accounting purposes as either a
acquisition or reorganization process column (d) the amount of bad debt purchase or a lease may, under some
including, for example, fees paid or expense deductible for federal income circumstances, be characterized as the
incurred to evaluate whether to tax purposes under section 166. opposite for tax purposes.
investigate an acquisition, fees to
conduct an actual investigation, and Line 26. Interest Expense If a transaction is treated as a lease,
fees to consummate the acquisition. Attach Form 8916-A. Complete Part III the purchaser/lessee reports the
Also include on this line other and enter the amounts shown on line 5, periodic payments as gross rental
acquisition/reorganization costs columns (a) through (d), on expense. If the transaction is treated as
incurred in connection with the Schedule M-3, line 27, columns (a) a purchase, the purchaser/lessee
liquidation of a subsidiary, a spin-off of a through (d), as applicable. reports the periodic payments as
payments of principal and interest and
subsidiary, or an initial public stock Any corporation that files Form
also reports depreciation expense or
offering. TIP 1120S that (a) is required to file
deduction regarding the purchased
Line 19. Amortization/ a Schedule M-3 and has less
asset.
than $50 million in total assets at the
Impairment of Goodwill end of the tax year or (b) isn't required Report in column (a) gross rent
Report on line 19 amortization of to file a Schedule M-3 and voluntarily expense for a transaction treated as a
goodwill or amounts attributable to the files a Schedule M-3, isn't required to lease for financial accounting purposes
impairment of goodwill. file Form 8916-A but may voluntarily do but as a sale for U.S. income tax
Line 20. Amortization of so. purposes. Report in column (d), gross
rental deductions for a transaction
Acquisition, Reorganization, Report on Part III, line 26, column (a), treated as a lease for U.S. income tax
and Start-Up Costs the total amount of interest expense purposes but as a purchase for financial
Report on line 20 amortization of included on Part I, line 11, and report on accounting purposes. Report interest
acquisition, reorganization, and start-up Part III, line 26, column (d), the total expense for such transactions on Part
costs. For purposes of columns (b), (c), amount of interest deduction included III, line 26, in column (a) or (d), as
on Form 1120S, Schedule K, line 18, applicable. Report depreciation
that isn't required to be reported expense or deductions for such

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transactions on Part III, line 24, in otherwise, column (b) adjustments Also, X undertook to develop a new
column (a) or (d), as applicable. Use include adjustments for timing machine for its business. X expended
columns (b) and (c) of Part III, lines 24, differences between financial and tax $30,000 on the project of which $10,000
26, and 28, as applicable, to report the accounting for: (1) deferral and represents actual costs of material,
differences between column (a) and (d) amortization of research expenditures, labor, and component cost to construct
for such recharacterized transactions. (2) reduction of section 174 the machine, and $20,000 represents
Example 18. U.S. Corporation X is a expenditures under section 280C or research costs not attributable to the
calendar-year taxpayer that files and section 482, (3) costs attributable to machine itself. X capitalized all costs of
entirely completes Schedule M-3 for its obtaining a patent, (4) research in social $30,000 related to the machine and
2018 tax year. X acquired property in a sciences, and (5) cost elements for recognized $6,000 of depreciation
transaction that, for financial accounting property of a character subject to expense in its financial statements. X’s
purposes, X treats as a lease. Because depreciation. depreciation expense on the $10,000 of
costs related to the machine itself was
of its terms, the transaction is treated for Section 174 provides two methods $2,000 for U.S. income tax purposes.
U.S. income tax purposes as a for the treatment of research and Accordingly, X must report $50,000 in
purchase and X must treat the periodic experimental expenditures paid or column (a), $20,000 (research costs
payments it makes partially as payment incurred by a taxpayer in connection which aren't attributable to the machine
of principal and partially as payment of with the taxpayer’s trade or business. itself) in column (b), and $70,000 in
interest. In its financial statements, X These expenditures may be treated as column (d). X must also report $6,000 in
treats the difference between the expenses not chargeable to a capital column (a), ($4,000) in column (b), and
financial accounting and U.S. income account and deducted in the year in $2,000 in column (d) on Part III, line 24.
tax treatment of this transaction as a which they are paid or incurred, or they
temporary difference. During 2018, X may be deferred and amortized. Example 22. Corporation X is a
reports in its financial statements $1,000 calendar year taxpayer that files and
of gross rental expense that, for U.S. Example 19. Corporation X is a entirely completes Schedule M-3 for its
income tax purposes, is recharacterized calendar year taxpayer that files and 2018 tax year. During 2018, X incurred
as a $700 payment of principal and a entirely completes Schedule M-3 for its $10,000 of research and development
$300 payment of interest, accompanied 2018 tax year. During 2018, X incurred costs related to social sciences that it
by a depreciation deduction of $1,200 $100,000 of research and development recognized as an expense in its
(based on other facts). On its 2018 costs that X recognized as an expense financial statements. X adopted the
Schedule M-3, X must report the in its financial statements. Also, X current expense method for research
following on Part III, line 28: column (a), incurred $20,000 in attorney fees in and experimental expenditures for U.S.
$1,000, its financial accounting gross obtaining a patent application that X income tax purposes. Because such
rental expense; column (b), ($1,000); capitalized and amortized in its financial costs aren't allowable costs under
and column (d), zero. On Part III, line 26, statements. X recognized a $2,000 section 174, X must report $10,000 in
X reports zero in column (a) and $300 in amortization deduction. In compliance column (a), permanent difference
columns (b) and (d) for the interest with its adopted method of accounting ($10,000) in column (c), and $0 in
deduction. On Part III, line 24, X reports under section 174, X deducts research column (d). If such costs are otherwise
zero in column (a) and $1,200 in and experimental expenditures for U.S. deductible for U.S. income tax
columns (b) and (d) for the depreciation income tax purposes. Accordingly, X purposes, X must report this item of
deduction. must report $100,000 in column (a), expense on Part III, line 31.
$20,000 in column (b), and $120,000 in
Line 29. Research and column (d). X must also report $2,000 in Example 23. Corporation X is a
Development Costs column (a), ($2,000) in column (b), and calendar year taxpayer that files and
Report in column (a) the amount of $0 in column (d) on Part III, line 21. entirely completes Schedule M-3 for its
2018 tax year. During 2018, X paid
expenses included in net income Example 20. Assume the same $75,000 to acquire or in-license
reported on Part I, line 11, that are facts as Example 19 except Corporation intangible assets under a collaborative
related to research and development X elected to capitalize and amortize its arrangement with another company that
expense. Report in column (d) the research and expenditures over 60 X recognized as a research and
amount of deductions included in Form months for all its research programs for development expense in its financial
1120S, line 21, and/or separately U.S. tax purposes. X first realized statements. X adopted the current
reported on Form 1120S, Schedule K, benefits from such expenditures on expense method for research and
that are recognized and reported as August 1. Accordingly, X must report experimental expenditures for U.S.
Section 174 research and experimental $100,000 in column (a), a temporary income tax purposes. Because
expenditures consistent with the difference of ($90,000) ($20,000 less payments made to acquire rights to a
corporation’s adopted method of ($120,000/60 months X 55 months)) in product or technology are excluded
accounting for such expenditures. In column (b), and $10,000 in column (d). costs from the definition of research and
column (c), as applicable, include any Example 21. Corporation X is a experimental expenditures, X must
adjustments for any amounts treated for calendar year taxpayer that files and report $75,000 in column (a), ($75,000)
U.S. income tax purposes as research entirely completes Schedule M-3 for its in column (c), and $0 in column (d). X
or experimental expenditures that are 2018 tax year. X adopted the current must report any amortization otherwise
treated as some other form of expense expense method for research and allowable related to the payments on
for financial accounting purposes, or experimental expenditures for U.S. Part III, line 21.
vice versa. Report any difference in income tax purposes. During 2018, X
timing recognition in column (b). For incurred $50,000 of research and Line 30. Section 118 Exclusion
example, if the taxpayer's financial development costs that X recognized as Report on line 30 any inducements
accounting method doesn't specify an expense in its financial statements. received in the current year and treated

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as contributions to the capital of a of disclosure depends upon each as prepaid subscriptions and license
corporation by a non-shareholder. The taxpayer’s operational activity and the fees, prepaid insurance, etc.
following non-shareholder contributions nature of its accounting records. For Report on line 31, column (a),
to capital are not eligible for exclusion example, if a corporation’s net income expenses included in net income
under section 118. amount reported in the income reported on Part I, line 11, that are
• Any contribution in aid of construction statement includes anticipated related to reserves and contingent
or any other contribution as a customer expenses for a discontinued operation liabilities. Report on line 31, column (d),
or potential customer. as a single amount, and its general amounts related to liabilities for reserves
• Any contribution by any civic group. ledger or other books, records, and and contingent liabilities that are
• Any contribution by any governmental work papers provide details for the deductible in the current tax year for
entity, except any contribution made anticipated expenses under more U.S. income tax purposes. Examples of
after December 22, 2017, and made explanatory and defined categories, reserves that are allowed for book
pursuant to a master development plan such as employee termination costs, purposes, but not for tax purposes,
that was approved prior to December lease cancellation costs, loss on sale of include warranty reserves, restructuring
22, 2017, by a governmental entity. equipment, etc., a supporting statement reserves, reserves for discontinued
that lists those categories of expenses operations, and reserves for
Report in column (a) any income and their details will satisfy the acquisitions and dispositions. Only
amount as a negative number and any requirement to separately state and report on line 31 items that aren't
expense amount as a positive number. adequately disclose. In order to required to be reported elsewhere on
Corporations must identify on an separately state and adequately Schedule M-3, Parts II and III.
accompanying statement referencing disclose the employee termination
line 36 the fair market value of land or costs, it isn't required that an anticipated Example 24. Corporation Q is a
other property (including cash) provided termination cost amount be listed for calendar year taxpayer that files and
to the corporation by any each employee, or that each asset (or entirely completes Schedule M-3 for its
non-shareholder, including a category of asset) be listed along with 2018 tax year. On July 1 of each year, Q
governmental unit as an inducement, or the anticipated loss on disposition. has a fixed liability for its annual
insurance premiums on its home office
for any other purpose. The attached statement should have building that provides a 12-month
On the accompanying statement, five columns. The first column has the coverage period beginning July 1
also identify any inducements that description for the next four columns. through June 30. In addition, Q
include refundable or transferable tax The second column is column (a) historically prepays 12 months of
credits, including transferable credits expense per income statement, the third advertising expense on July 1. On July
that were sold. column is column (b) temporary 1, 2018, Q prepays its insurance
difference, the fourth column is column premium of $500,000 and advertising
The statement must separately state, (c) permanent difference, and the fifth expenses of $800,000. For financial
adequately disclose, and identify all of column is column (d) deduction per tax accounting purposes, Q capitalizes and
the dollar amounts summarized by this return. Every item listed on the attached amortizes the prepaid insurance and
line. An accompanying statement is statement for line 31 must always have advertising over 12 months. For U.S.
required even if there are no dollar columns (a) + (b) + (c) = (d). Each item income tax purposes, Q deducts the
amounts reported on line 30. with amounts in columns (a), (b), (c), insurance premium when paid and
Line 31. Other Expense/ and (d) will be totaled and included as amortizes the advertising over the
one line on line 31. 12-month period. In its financial
Deduction Items With statements, Q treats the differences
Differences Comprehensive income. If any
“comprehensive income” as defined by attributable to the financial statement
Separately state and adequately SFAS No. 130 is reported on this line, treatment and U.S. income tax
disclose on Part III, line 31, all items of describe the item(s) in detail as, for treatment of the prepaid insurance and
expense/deduction that aren't otherwise example, “Foreign currency translation advertising as temporary differences.
listed on Part III, lines 1 through 30. adjustments—comprehensive income” Q also has a legal expense reserve
Attach a statement that describes and “Gains and losses on where $300,000 was expensed for
and itemizes the type of expense/ available-for-sale financial accounting purposes and a
deduction and the amount of each item, securities—comprehensive income.” ($100,000) temporary difference was
calculated to arrive at the income tax
and provides a description that states Reserves and contingent liabilities. deduction of $200,000. The statement
the expense/deduction name for book Report on line 31 amounts related to the attached to Q's return for Part III, line 31,
purposes for the amount recorded in change in each reserve or contingent must be separately stated and
column (a) and describes the liability that isn't required to be reported adequately disclosed as shown below.
adjustment being recorded in column elsewhere on Schedule M-3. For
(b) or (c). The entire description example: (1) amounts relating to Line 32. Total Expense/
completes the tax description for the changes in reserves for litigation must
Deduction Items
amount included in column (d) for each be reported on Part III, line 10; and (2)
item separately stated on this line. amounts relating to changes in reserves Report on Part II, line 24, columns (a)
The statement of details attached to for uncollectible accounts receivable though (d), as applicable, the negative
the Schedule M-3 for line 31 must must be reported on Part III, line 25. See of the amounts reported on Part III,
separately state and adequately Example 8 and Example 9, earlier; and line 32, columns (a) through (d), as
disclose the nature and amount of the Example 24, later. applicable. Report positive amounts as
negative and negative amounts as
expense related to each reserve and/or Report on line 31, the amortization of positive. For example, if Part III, line 32,
contingent liability. The appropriate level various items of prepaid expense, such

Instructions for Schedule M-3 (Form 1120S) (2018) -19-

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Line 31—Example 24
Statement Concerning Other Expense/Deduction Items With Differences

                          Column (a) Expense       Column (b) Temporary                Column (c)    Column (d) Deduction 
Description               per Income Statement     Difference                   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

column (a), reflects an amount of $1      column (a), ($1 million). Similarly, if Part amount of ($50,000), then report on Part 
million, then report on Part II, line 24, III, line 32, column (b), reflects an        II, line 24, column (b), $50,000.

                                                   -20-       Instructions for Schedule M-3 (Form 1120S) (2018)

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