Microsoft Company

In reviewing this example, note the following: The starting point is book income before book tax liability The book tax liability is added back (because this is not deductible for tax) Next, capital losses deducted on the books are added back, since these are not deductible for tax purposes The next section Is for additions, which can be either (1) Income subject to tax but not reflected on the books (e. G. , certain advance payments) or (2) expenses deducted on the books but not allowed for tax purposes (e. G.

Contributions exceeding the 10% limit, 50% of meals and entertainment, etc. ). The next section (lines 7 and 8) report reductions in reconciling book income with taxable income. These can be either (1) income on the books that is not subject to tax (e. G. , tax-exempt interest) or (2) deductions on the turn not reflected on the books (e.

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G. , excess tax depreciation, contributions carried over from prior year) After adjustments, the final Income number on line 10 should agree with taxable Income before special adjustments on line 28 of the Form 1120 4.

Note that the income number reconciled to is before any special deductions such s the dividends received deduction, so this can never be a reconciling item. 5. A common adjustment Item Is for life Insurance on company officers. The premiums paid on such polices, If the corporation Is the beneficiary, are not deductible (though they are deducted on the books).

Proceeds from the policy are not taxable (even though they are included on the books). Finally, the books may reflect as income an increase in the cash surrender value of the policy; this is not income for tax purposes.

Tip – Read each question on reconciliations carefully. It may help to remember the mineral format of the M-1 and plug In the numbers. Always ask yourself two questions: (1) does the item differ in treatment on the books and on the tax return? And (2) if so, does it increase or decrease book income in arriving at taxable income? 6.

Schedule M-3 – On January 8, 2004, the IRS announced a new Schedule M-3, Net Income (Loss) Reconciliation for Corporations With Total Assets of $10 Million or (corporations not meeting the $10 million asset threshold will continue to file Schedule M-1). . The official purpose of the new detailed reconciliation is to “increase the reinsurance of corporate tax return filings,” while the “unofficial” purpose is to make it easier for the IRS to find audit adjustments! The Schedule M-3 is also now required for Partnerships and S corporations. 8. The Schedule M-3 is VERY complex, and requires a listing of numerous book/tax differences in a four-column format; each book-tax difference must also be labeled as temporary (will “turn around” and reverse treatment in the future) or permanent (will never “turn around”).

For example, depreciation is a temporary difference, in that ever the life of the asset the total depreciation will be the same (it is Just a “timing” difference between book and tax reporting numbers each year). On the other hand, municipal bond interest is a permanent difference, in that such amounts are included in book income but will NEVER be included in taxable income. 9. Here is a very brief portion of the format of Schedule M-3. Note that the difference between the book deduction and tax deduction for meals and entertainment expense is a permanent one, since 50% of the meals will never be deductible for tax purposes.