April 30, 2004
Ms. Susan Blake
Internal Revenue Service
Office of Pre-Filing and Technical Guidance
1111 Constitution Ave., NW
Mint Bldg M3-353 LM:PFT
Washington, DC 20224
Re: I.R. 2004-14, Proposed Schedule M-3
Dear Ms. Blake:
The American Institute of Certified Public Accountants (AICPA) respectfully offers the
enclosed comments, pursuant to the request in IR 2004-14, on the Proposed Schedule M-3 in
general and, specifically, ways that taxpayer burden can be minimized. The AICPA is the
largest professional association of certified public accountants in the United States, with more
than 350,000 members in business, industry, public practice, government, and education.
The enclosed comments were developed by members of our Tax Accounting Technical
Resource Panel and approved by the Tax Executive Committee. We would be pleased to
discuss these comments with you or a member of your staff at any time. If you have any
questions, please contact either Barry Tovig, Chair of the Tax Accounting Technical
Resource Panel, at (202) 327-8821 or barry.tovig@ey.com; or George White, AICPA
Technical Manager, at (202) 434-9268 or gwhite@aicpa.org.
Sincerely,
Robert A. Zarzar
Chair, Tax Executive Committee
Enclosure
cc:
Helen M. Hubbard, Tax Legislative Counsel
George Manousos, Tax Specialist
Robert M. Brown, Associate Chief Counsel (IT&A)
AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS
Comments on the Proposed Form 1120 Schedule M-3
April 30, 2004
Developed by the
Proposed Schedule M-3 Task Force
Robert Kilinskis, Chair
John Bennecke
Michelle Carlone
Paul Chameli
Rhonda Heddins
Mark Schmitz
Cristy Turgeon
George White, AICPA Technical Manager
AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS
Comments on the Proposed Form 1120 Schedule M-3
A.
Summary of Comments
This submission responds to IR 2004-14, which requests comments on the Proposed Form 1120
Schedule M-3, including comments on significant difficulties that taxpayers may encounter if the
use of Schedule M-3 is required for a tax year that begins before Schedule M-3 is finalized, as
well as comments on methods to minimize burden to taxpayers.
The AICPA fully supports the Treasury and IRS goals to increase transparency in return filing,
reduce the time required to examine tax returns and examine most recent tax returns filed.
However, the AICPA does not believe that taxpayers and tax return preparers have sufficient
time to establish the systems to support the process of gathering the required information and
accurately complete the Schedule M-3 for the targeted effective date of tax years ending on or
after December 31, 2004. Therefore, the AICPA recommends the following:

The effective date for Schedule M-3 should be tax years ending on or after December 31,
2005 or (preferably) on or after December 31, 2006.

For the initial year of compliance, the threshold for taxpayer’s required to use the
Schedule M-3 should be increased to taxpayers with assets of $250 million or more. In
this case, consider deferring the effective date for other taxpayers until tax years ending
on or after December 31, 2006.

For the first two years of required compliance, do not require the completion of Columns
(A) and (D) of Parts III and IV. This will provide taxpayers additional time to complete
the necessary system changes to accurately comply with the reporting requirements
imposed by these columns.
These recommendations, more fully explained below, are followed by additional comments and
recommendations and specific line comments on the proposed Schedule M-3 and instructions.
B.
Proposed Schedule M-3
In an effort to increase the transparency of corporate tax return filings, the Treasury and IRS
released in proposed draft form, Schedule M-3, “Net Income (Loss) Reconciliation for
Corporations with Total Assets of $10 Million or More,” for use by certain corporate taxpayers
filing Form 1120, U.S. Corporation Income Tax Return (herein, “Proposed Schedule M-3” ,
“Schedule M-3” or “proposed form”). This new form is proposed for corporations with assets of
$10 million or more and is proposed to be required for tax years ending on or after December 31,
2004.
Treasury and IRS also announced that other federal tax returns that require the
completion of Schedule M-1, for example, Form 1065, U.S. Partnership Return of Income, and
Form 1120S, U.S. Income Tax Return of an S Corporation, may incorporate Schedule M-3 in the
future. Draft instructions for Schedule M-3 were released on March 11, 2004.
AICPA
Proposed Schedule M-3 Comments
C.
April 30, 2004
Page 2
Recommendation: Delay the Effective Date of Schedule M-3
The AICPA respectfully requests a delay in the effective date of the utilization of the Schedule
M-3 until the first taxable year ending on or after December 31, 2005, or (preferably) on or after
December 31, 2006. This recommendation is based on the Proposed Schedule’s extensive
change in fundamental tax preparation methodology, the inability for accounting software
vendors to accommodate the changes by the proposed compliance date, the hardship involved in
tracking the current year transactions, and the training burden the proposed deadline places on
corporate tax departments.
1. Changes Required in Fundamental Tax Preparation Methodology
The Proposed Schedule M-3 requires taxpayers to abandon and replace their core
methodology for calculating book-tax differences. The most common approach to prepare
the Schedule M-1 is the balance sheet approach. Through years of repetition, taxpayers have
become effective and efficient at reporting book-tax differences by this method. In a number
of cases, the book-tax difference reported on the Schedule M-1 is simply the change in a
year-end balance sheet amount. The Proposed Schedule M-3 requires a transaction by
transaction approach to accumulating and identifying book-tax differences. In addition, book
income and expense must be reported in categories defined by tax law. Most of these tax law
categories do not exist for book purposes. Most corporate tax departments will be illprepared to make the transition to this type of methodology without significant investment in
their compliance process.
In addition to the burden associated with the departure from a balance sheet approach, the
proposed transactional approach to capturing book-tax differences eliminates the checks and
balances inherent in the balance sheet approach. Under a transactional approach, the only
way to determine that all book-tax differences are captured is to recode and examine every
accounting transaction.
For example, assume Taxpayer uses a balance-sheet approach method to compute certain
book-tax differences items under the current Form 1120 Schedule M-1 requirements. Further
assume that Taxpayer has an inventory reserve for market write-downs for financial reporting
purposes that are not deductible for federal income tax purposes until there is a charge to the
reserve reflecting a disposition of the inventory. For many companies there may be a
separate or combined reserve for excess and obsolete inventory.
The reserve activity may include a monthly standard addition to the reserve reflecting the
book reserve expense, which would not be deductible for tax. The reserve may also include
an adjustment at each quarter or year end to increase or decrease the reserve to the projected
requirements with a corresponding adjustment to the income statement, which would not be
deductible for tax. Finally, the reserve may be charged for dispositions or alternatively
charges may be made to cost-of-goods-sold, which would be deductible for tax. Under a
balance-sheet approach, the current book-tax difference is the change in the reserve from
year to year. This change in reserve includes an add-back for the reserve expenses, a tax
deduction for the charge-offs, and a reversal of any book adjustments. It is likely that most
AICPA
Proposed Schedule M-3 Comments
April 30, 2004
Page 3
automated Form 1120 preparation systems compute the necessary Schedule M-1 adjustment
from the balance sheet accounts. The book-tax difference is then easily verified by
comparing reserve balances.
Under an approach necessary to prepare the Proposed Schedule M-3, expense per income
statement required by Part IV, line 34, Column (A) would be the amount of reserve additions
net of adjustments as reflected in the income statement. The Temporary Difference included
in Column (B) would be the difference between either the charge-offs in the reserve or costof-goods sold as compared to the income statement expenses. In future years cumulative
amounts of both income statement deductions and balance sheet charge-offs must be
maintained to preserve the integrity of the information the Proposed Schedule M-3 requires.
If separate accounts exist for the book expenses and the reserve, then total amounts for the
year may be used for the calculations. However, if amounts are combined in the financial
statements, for example restructuring reserves, the ability to compute the amounts that the
new Schedule M-3 requires becomes imprecise. For example, the monthly reserve additions
for book purposes may not be allocated to specific costs expected to be incurred. If these
costs represent different specific lines on Part III or Part IV on Schedule M-3, the expense
per income statement (Column (A) on Parts III and IV of the Schedule M-3) will likely be an
estimate. The reserve expense will likely occur in a month or quarter different than the tax
amount, and the tax deduction may need to incorporate the rules for the recurring item
exception (so-called 8-½ month rule), rules for determining deferred compensation (so-called
2-½ month rule) or other tax rules. The difficulty is that separate transactions on a monthly
basis must be analyzed to compute the amounts Schedule M-3 requires. It is likely numerous
sub-accounts must be created to automate the process.
2. Inability of Software and Accounting Processes to Accommodate the Proposed
Compliance Date
It is the understanding of the AICPA that certain software vendors have stated they may be
able to deliver a product in time to incorporate the Schedule M-3 for the 2004 tax return.
However, the more significant burden is the change required to the internal information
gathering systems and internal accounting processes of corporate tax departments, including
the following:

Identifying and mapping trial balance amounts on a transaction by transaction basis to
appropriate lines in Column A of the Proposed Schedule M-3 and Page 1 of the Form
1120

Identifying and mapping Schedule M-3 amounts to different line items on Page 1 of
Form 1120

Creating new trial balance sub-accounts necessary to meet the new, detailed tax
reporting requirements

Determining baseline data for the initial year of implementation

Inability to use multiple sources of data
AICPA
Proposed Schedule M-3 Comments

April 30, 2004
Page 4
Inability to convert non-U.S. currency into the system
3. Four or More Months of Transactions Posted for Current Year
At the time of the submission of this comment letter, calendar year taxpayers are four full
months into the tax year of proposed implementation. Required compliance for tax years
ending on or after December 31, 2004 would place a significant burden on accounting
departments to revisit transactions from the beginning of the year. This would require a
cumbersome process of recoding prior transactions and/or performing manual adjustments
and reconciliations to identify book-tax differences. Further, software modifications are not
likely to be complete for some time, increasing the number of manual accounting entries and
re-work. This places a significant burden on taxpayers and creates substantial risk that
accuracy is compromised.
4. Training
The proposed Schedule M-3 will place a burden on corporate tax departments, accounting
departments, and other functions with responsibility for information reported on the tax
return to train their employees on the requirements of the new form and the processes and
documentation necessary to achieve efficient and effective compliance, including new
software applications and coding requirements.
D.
Recommendation: Increase the Asset Threshold to $250 Million or More for First
Year Use Is Required
The AICPA respectfully requests that the threshold for compliance with the Proposed Schedule
M-3 be increased to apply to corporate taxpayers with assets in excess of $250 million to be
consistent with the tax shelter reporting threshold and to allow the IRS time to monitor
information for the first year of implementation.
1.
Consistency with Tax Shelter Reporting Threshold
The $250 million threshold corresponds to the threshold utilized for the requirement to
disclose transactions with a significant book-tax difference under reg. section 1.6011-4,
Requirement of Statement Disclosing Participation in Certain Transactions by Taxpayers.
These taxpayers have already begun to gather information for the reporting of book-tax
differences to comply with the tax shelter disclosure requirements and have gained
information and experience that will assist them at gathering the required information for the
Schedule M-3.
2.
Allows IRS to Monitor and Adjust Before Full Compliance
Increasing the threshold to taxpayers with $250 million of assets would provide that
approximately 10,000 taxpayers would utilize the Schedule M-3 in its initial year. This
would allow the IRS and Treasury to review the Schedules M-3 filed by these taxpayers,
better understand the impact of the Schedule M-3, and adjust the form or procedure as
AICPA
Proposed Schedule M-3 Comments
April 30, 2004
Page 5
necessary before requiring more taxpayers to utilize the Schedule M-3. In order for the IRS
and Treasury to complete their assessment of the Schedule M-3, the effective date for all
other taxpayers should be deferred until tax years ending on or after December 31, 2006.
E.
Recommendation: Do Not Require Parts III and IV, Columns (A) or (D) During First
Two Compliance Years
The AICPA respectfully requests that the IRS and Treasury defer the requirement that Columns
(A) and (D) of Parts III and IV be completed for the first two years of required compliance. By
adopting this change, the IRS would still receive more consistency and comparability by
standardized reporting of book to tax adjustments reported in Columns (B) and (C). This
deferral would provide taxpayers additional time to implement the necessary system changes to
comply with the requirements of Columns (A) and (D).
F.
Impacts Outside Federal Income Tax
1. Cost of Tax Preparation and Effect on Smaller Taxpayers
The proposed Schedule M-3 will increase the cost of tax compliance. The accounting
systems and processes necessary to provide the transaction by transaction detail will require
full systems revisions from those currently utilized. The additional internal cost coupled with
the additional cost of modifying compliance software, or purchasing new software will fall
disproportionately on smaller business. This result occurs because the $10 million asset
threshold will require systems changes for smaller taxpayers even though they may not have
the same number of transactions required to be separately stated on Schedule M-3.
2. State Reporting
State reporting will likely add additional burden to implementation of the Proposed Schedule
M-3 as certain states do not follow Federal book-tax adjustment processing. The new
proposed schedule will present issues for state taxing authorities who will be forced to adapt
their internal systems to process the new schedule. In the event that the states decide not to
follow the Federal Schedule, taxpayers will be forced to track book-tax differences from both
a balance sheet and a transactional perspective.
G.
Additional Recommendations
1. Replace Form 8886
To the extent that the Proposed Schedule M-3 creates duplicate disclosures, the IRS and
Treasury should consider eliminating the necessity of disclosure of book-tax differences on
Form 8886. This would reduce the tax preparation burden on taxpayers of reporting the same
items on multiple forms when filing their tax returns. This disclosure may also replace the
required disclosure filed with the Office of Tax Shelter Analysis.
AICPA
Proposed Schedule M-3 Comments
April 30, 2004
Page 6
2. Limit the Frequency of Updates
Treasury has indicated a desire to update the form on a regular basis. These seemingly
minor changes are likely to create significant software system and processing
methodology changes, both of which increase the overall cost and burden of compliance.
Limiting the frequency of updates to the Schedule M-3 and providing taxpayers ample
time to review the proposed changes to the Schedule M-3 will help relieve the burden to
taxpayers and assist in their compliance efforts.
3. Clarify Scope
Please clarify which taxpayers are required to utilize the Schedule M-3. The instructions
state that “[a]ny domestic corporation or U.S. consolidated tax group” must use Schedule
M-3. Clarify whether this does or does not include taxpayers filing Forms 1120L,
1120PC, and 1120F.
4. Shading
It would be helpful to taxpayers if spaces that are not required to be completed are shaded
as this would reduce potential confusion in complying with the Schedule M-3. For
example, Column (A) (income statement amount) could be shaded for section 481(a)
adjustments.
5. Use a Second Comment Period If Schedule M-3 Is Extended to Other Returns
When a new Schedule M-3 is drafted for other taxpayers (e.g., Forms 1065 and 1120S),
provide a comment period prior to finalizing those Schedules M-3.
Example of comment for Schedule M-3 for Form 1065 – Many partnerships
maintain Schedule L on a tax basis so that the capital accounts presented on the
Schedules K-1 are on a tax basis. Consider relaxing the Schedule L requirements
in the “Other Form 1120 Schedules Affected by Schedule M-3 Requirements” on
page 1 of the instructions when/if Schedule M-3 is expanded to include
partnerships.
H.
Specific Line Recommendations for Proposed Schedule M-3 and Instructions
The following modifications will increase taxpayer comprehension of the purpose behind
Proposed Schedule M-3 and increase the clarity of its instructions.
1. Part I
a.
Line 1 – State on the face of the form that the choices are hierarchal. Change
“income statement” to “financial statements” in b through d on face of form.
b.
Line 3 – Replace “(If yes, attach details)” on the form with “(If yes, attach
explanation and amount of any item restated)”.
AICPA
Proposed Schedule M-3 Comments
c.
April 30, 2004
Page 7
Lines 3, 4, and 5 – Change “corporation’s” to “U.S. corporate taxpayer’s” on face
of the form (if that is the intent).
2. Part II
a.
Line 1 – Clarify form by adding “Taxpayer’s worldwide consolidated” before “Net
income (loss) per income statement” and after add “from source provided in Part I,
Line 1.”
b.
Line 2 – Delete “and on line 8” from the 2nd paragraph of the instructions.
c.
Lines 2 and 3 – Clarify form by changing “corporations” to “entities” since these
lines also apply to non-corporate entities.
d.
Line 3
i.
If equity income (loss) related to nonincludible foreign entities should not be
reversed on this line (inferred by existence of Part III, lines 1 and 10), the
instructions should clearly state so by adding a sentence to the end of the 1st
paragraph such as: “Do not remove the financial statement net income (loss)
of any equity method nonincludible foreign entity in Part II.”
ii.
If equity income (loss) related to nonincludible U.S. entities should not be
reversed on this line (inferred by existence of Part III, lines 6 and 9), the
instructions should clearly state so by adding a sentence to the end of the 1st
paragraph such as: “Do not remove the financial statement net income (loss)
of any equity method nonincludible U.S. entity in Part II.”
iii.
Delete “on line 8 and” from the 2nd paragraph of the instructions.
e.
Line 4 – Delete “on line 1 and” from the 2nd paragraph of the instructions.
f.
Line 5 – Change reference in instructions from Part III to “Part II.”
g.
Example 2 – the answer is no different if Foreign Corporation F, which owns 100
percent of FS2-50 in addition to P, files a Form 10-K with the SEC since its
American Depository Shares are listed on a U.S. stock exchange. We recommend
the following revisions to Example 2:
Foreign Corporation F owns 100 percent of the stock of foreign subsidiaries
FS1-49 and of U.S. Corporation P. P owns 100 percent of the stock of DS1, 60
percent of the stock of DS2, and 100 percent of the stock of FS50. F files a
Form 10-K with the SEC since its American Depository Shares are listed on a
U.S. stock exchange. P, DS1-2, and FS1-50 individually submit to F financial
reporting packages prepared in accordance with International Accounting
Standards (IAS). P files a U.S. consolidated tax return with DS1.
AICPA
Proposed Schedule M-3 Comments
April 30, 2004
Page 8
Please clarify that the answer is the same as the current Example 2 due to the fact
that sub-consolidated financial statements of the P/DS1-2/FS50 group do not exist.
Please describe the effect that F’s filing of a Form 10-K has on the answer to
Schedule M-3, Part I, line 1(a). Based on the intent, inbound taxpayers (i.e.,
subsidiaries) will have severe difficulties gathering the information necessary for
Part II.
3. Instructions to Parts III and IV
a.
To increase clarity regarding adequate disclosure, consider changing the second
sentence on page 3 of the instructions under “Reporting Differences in Parts III and
IV” to: “In general, a difference is adequately disclosed if the difference is reported
on a specific line or, if on an other line, is labeled in a manner.”
b.
To increase clarity regarding adequate disclosure of an “item or transaction from
which the difference arises,” we recommend that the instructions include the
parenthetical provided in reg. section 1.6662-4(f) “Disclosure is adequate with
respect to an item (or group of similar items, such as amounts paid or incurred for
supplies by a taxpayer engaged in business).”
c.
Example 5 – Note that goodwill is no longer amortizable for book purposes.
4. Part III
a.
Line 7 – U.S. dividends not eliminated in tax consolidated - Modify instructions to
“Report on line 7 the amount of any dividends received from any U.S. corporation
that is not included in the U.S. consolidated tax group.”
b.
Lines 9 and 10, Partnerships income/ (loss) – clarify that the partner’s distributive
share of partnership income/ (loss) should be reported on this line. Furthermore,
separately stated items reported to the partner on the Schedule K-1 should be
reported in their respective locations on the Schedule M-3 (e.g., Net capital gain
from flow- through entities reported on line 27).
c.
Line 16 – Provide instructions for this line.
d.
Line 18 – The instructions to this line should clarify the types of costs that should
be included, including cost-flow assumption, uniform capitalization, shrinkage
accruals, lower of cost or market write-downs, and capitalizable depreciation.
Please indicate why this is listed in both Part III line 18 and Part IV line 34.
Confirm that the use of the sections depends on whether there is an increase or
decrease in the balance.
e.
Line 20 – Move to line 32 immediately before the other “Other” lines, shifting
current lines 21-32 up, consistent with Part IV. Add instructions for this line to
AICPA
Proposed Schedule M-3 Comments
April 30, 2004
Page 9
clarify that “reportable transactions” are transactions requiring disclosure under reg.
section 1.6011-4.
f.
Lines 18 and 22 – Clarify whether mark to market income related to inventory
should be included on the mark-to-market line 22 or on the inventory line 18.
g.
Line 24 – Provide instructions to clarify what is required to be included on Line 24.
h.
Lines 35 and 36 – If appropriate, clarify that Column D of lines 35 and 36 should
equal lines 11 and 27 on page 1 of Form 1120, respectively.
5. Part IV
a.
Lines 1 through 6 – Tax expense is not usually segregated by jurisdiction and
between current/deferred on trial balances. Further, these amounts are not usually
allocated to subsidiary companies. Manual calculations and adjustments will be
required to break out tax expense into Form 10-K format for the Includible
Corporations only.
b.
Line 7 – Consider whether this should mirror line 2, requiring dividends from
domestic corporations that are included in Part II, line 8, to be reported in Column
(A).
c.
Lines 8 through 10 – Provide guidance regarding where other compensation items
(e.g., ESPP, phantom stock, warrants) should be reported on the Schedule M-3.
d.
Line 22 – Instructions for this line are necessary to determine whether or not this
line is intended to include restructuring costs, such as severance and leases.
e.
Lines 23 and 24 – these line items could be combined similar to line 25.
f.
Line 31 – Add instructions for this line. Further, this line could include the reserve
for pending litigation and the warranty reserve in Example 7. If this line is intended
to only include accrued liabilities that will never be deductible for tax purposes, we
suggest shading out the temporary column for this item and clarifying that in the
instructions.
g.
Line 35 – Add instructions for this line to clarify that “reportable transactions” are
transactions requiring disclosure under reg. section 1.6011-4.