Schedule M Guidance

Schedule M Guidance

Caution: While every effort is made to ensure that this document contains the most current and accurate information available, the user is advised that items contained herein may be outdated. The user continues to be personally responsible for meeting all applicable professional standards (including those applicable standards set forth in the Tax Practice Manual), including the obligations to: ensure the current accuracy and applicability of the document; collaborate with colleagues who possess the relevant skills and knowledge pertinent to the area of inquiry; and obtain all required approvals.

FOR INTERNAL USE ONLY Updated: November 14, 2011

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Table of Contents Overview .................................................................................................................................... 1

Introduction to Schedule M......................................................................................................... 1

LD100A Master Trial Balance ................................................................................................. 3

LD100C Amount Subject to Book Reclass Summary .............................................................. 3

LD400 Book to Tax Reconciliation .......................................................................................... 3

LD450 Schedule K Workpaper ................................................................................................ 4

LD500 Equity Rollforward ........................................................................................................ 4

LD600 Sec. 444 Election of Taxable Year other than Required Taxable Year .......................... 4

Sch E Officers Compensation ................................................................................................. 4

Schedule Ms .............................................................................................................................. 5 MP100A Federal Income Tax* ......................................................................................................... 5 MP100B State and City Income Taxes* ........................................................................................... 6 MP100C Foreign Income Taxes ...................................................................................................... 7 MP100D Foreign Withholding Tax ................................................................................................... 8 MP200 Club Dues ............................................................................................................................ 9 MP210A Other Interest Expense ................................................................................................... 10 MP201B Other Interest Income ...................................................................................................... 11 MP220 Lobbying Expense ............................................................................................................. 12 MP230 Meals and Entertainment* ................................................................................................. 13 MP230A Skybox Rental Expense .................................................................................................. 15 MP240 Business Gifts .................................................................................................................... 16 MP250 Key Man Life Insurance ................................................................................................... 17 MP260 Fines and Penalties* .......................................................................................................... 18 MP270 Punitive Damages .............................................................................................................. 19 MP300 - Tax Exempt Interest* .......................................................................................................... 20 MP300A Tax Exempt Dividends .................................................................................................... 21 MP300B Other Tax-Exempt Interest Income ................................................................................. 22 MP310 Section 965(F) DRD .......................................................................................................... 23 MP400 Outstanding Stock-Issuance, Repurchase and Refinancing Redemption ........................ 24 MP410 Stock Options .................................................................................................................... 25 MP420 Nondeductible Compensation ........................................................................................... 26 MP430 Parachute Payments ......................................................................................................... 27 MP500 Goodwill Amortization* ....................................................................................................... 28 MP510 Exchange Gain/Loss .......................................................................................................... 29 MP520 Leased Inclusion Costs* .................................................................................................... 30 MP600 - Credit Expense Addback .................................................................................................... 31 MP610 Domestic Production Activity Deduction ............................................................................ 32 MP700 Environmental Remediation Costs .................................................................................... 33 MP800 or MT110 Acquisition/Reorganization Costs ..................................................................... 34 MPB25A Bank Life Insurance ........................................................................................................ 35 MPB25B Bank-Owned Life Insurance Income ............................................................................... 36 MPB30A Sec 291 Interest Expense Disallowance ........................................................................ 37 MPB30B Sec 265 Interest Expense Disallowance ........................................................................ 38 MPX100 Deemed Inclusions .......................................................................................................... 39 MPX200 Distribution of PTI ............................................................................................................ 40 MPX210 PTI Exchange Gain/Loss................................................................................................. 41 MPX300 - Branch Remittance Gain/Loss ......................................................................................... 42 MPX400 Section 78 Gross-Up ....................................................................................................... 43

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MPX500 Reverse Section 901 Taxes ............................................................................................ 44 MPX600 FSC Commission ............................................................................................................ 45 MPX700 Section 965 DASTM Gain/Loss ...................................................................................... 46 MPX800 Gross Foreign Dividend Not Previously Taxed ............................................................... 47 MPX900 Excess Distribution 2 ....................................................................................................... 48 MTA10A Accrued Bonus* .............................................................................................................. 49 MTA10B Accrued Payroll ............................................................................................................... 51 MTA10C Accrued Deferred Compensation ................................................................................... 52 MTA10D Accrued Rabbi Trust ....................................................................................................... 53 MTA10E Accrued Benefits ............................................................................................................. 54 MTA10F Accrued Vacation* ........................................................................................................... 55 MTA10G Accrued ASC 715 (formerly FASB 106) ......................................................................... 56 MTA10H Accrued Severance ......................................................................................................... 57 MTA10I Accrued Commissions ...................................................................................................... 58 MTA10J or MT120 - Accrued Professional Fees* ............................................................................. 59 MTA10K Accrued Directors Fees................................................................................................... 61 MTA10L Accrued Related Party Compensation ............................................................................ 62 MTA10M Accrued Retirement ........................................................................................................ 63 MTA10Q Accrued Related Party Bonus ........................................................................................ 64 MTA10R Accrued Related Party Vacation ..................................................................................... 65 MTA10S Accrued Pension/Profit-Sharing ...................................................................................... 66 MTA10T Accrued 401(k) ................................................................................................................ 67 MTA20A Accrued Workers Compensation .................................................................................... 68 MTA20B Accrued Charitable Contribution ..................................................................................... 69 MTA20C Accrued Coupons ........................................................................................................... 70 MTA20D Accrued Discounts .......................................................................................................... 71 MTA20E Accrued Environmental Clean-Up ................................................................................... 72 MTA20F Accrued Promotions ........................................................................................................ 73 MTA20G Accrued Rebates ............................................................................................................ 74 MTA20H Accrued Insurance .......................................................................................................... 75 MTA20I Accrued Self-Insurance .................................................................................................... 76 MTA20J Accrued Advertising ......................................................................................................... 77 MTA20K Co-Op Advertising ........................................................................................................... 78 MTA20L - Accrued Interest ............................................................................................................... 79 MTA20M Accrued Management Fees ........................................................................................... 80 MTA20N Accrued Personal Property Taxes .................................................................................. 81 MTA20O Accrued Payroll Taxes .................................................................................................... 82 MTA20P Accrued Royalties ........................................................................................................... 83 MTA20Q Related Party Accrued Interest ....................................................................................... 84 MTA20R Accrued Development Costs .......................................................................................... 85 MTA20S Accrued Sales Tax .......................................................................................................... 86 MTA300 Accrued Real Property .................................................................................................... 87 MTB10A FHLB Stock Dividend ...................................................................................................... 88 MTB10B FHLB Stock Redemption Gain Of Sale ........................................................................... 89 MTB200 Non-Accrual Interest ........................................................................................................ 90 MTB30A Bad Debt Provision ......................................................................................................... 91 MTB30B Tax Loan Loss Reserve Method .................................................................................. 92 MTB30C Tax Loan Loss Spec Charge Off ................................................................................. 93 MTB30D - Tax Reserve Recap 481(A) .......................................................................................... 94 MTB400 - Accrued SIP Adjustment .................................................................................................. 95 MTB450 SERP Expense ................................................................................................................ 96 MTB500 Loan Costs ...................................................................................................................... 97 MTB510 Tax Loan Fees ................................................................................................................. 98 MTD10A Deferred Rent Expense .................................................................................................. 99 MTD20A Deferred Revenue ......................................................................................................... 100 MTD20B Unearned Rent Income* ............................................................................................... 101

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MTD20C Unearned License Fee ................................................................................................. 102 MTD20D Unearned Income ......................................................................................................... 103 MTD20E Unearned Interest ......................................................................................................... 104 MTD300 Deferred Intercompany Profit ........................................................................................ 105 MTD400 or MT280 Unrealized Book Gain(Loss) ......................................................................... 106 MTF100 Amortization* ................................................................................................................. 107 MTF110 Intangible Assets Roll-Forward ...................................................................................... 109 MTF200 Intangible Basis Difference ............................................................................................ 110 MTF30A Book Depreciation* ........................................................................................................ 111 MTF30B_4562 Tax Depreciation* ................................................................................................ 112 MTF30B_4626 Alternative Minimum Tax and ACE Data Entry ................................................... 115 MTF310 Fixed Assets Roll-Forward............................................................................................. 116 MTF35A Book Depletion .............................................................................................................. 117 MTF35B Tax Depletion ................................................................................................................ 118 MTF400 - Fixed Asset Basis Difference ......................................................................................... 119 MTF410 Imp of Long Lived Assets ASC 360 (formerly FAS 144) ............................................ 120 MTF420 - Other Impairment of Assets ............................................................................................ 121 MTF50A Book Gain/(Loss) on Sale of Fixed Assets* .................................................................. 122 MTF50B_4684 Casualties and Thefts ......................................................................................... 123 MTF50B_4797 Tax Gain/(Loss) on Sale of Fixed Assets* .......................................................... 124 MTF60A Book Gain/(Loss) on Sale of Capital Assets ................................................................. 125 MTF60B_Sch D Tax Gain/(Loss) on Sale of Capital Assets ....................................................... 126 MTI100 LIFO ................................................................................................................................ 127 MTI200 263A UNICAP Adjustment* ............................................................................................ 128 MTI300 Capitalized Interest ......................................................................................................... 130 MTI400 Lower of Cost/Market Write-Downs ................................................................................ 131 MTM100 IRC Section 481(a) Adjustment* ................................................................................... 132 MTM20D Income/Loss from Domestic Schedules K-1 ................................................................ 133 MTM20F Income/Loss from Foreign Schedule K-1 ..................................................................... 134 MTM20Z Income/Loss from Other Schedules K-1 ....................................................................... 135 MTM300 Installment Sales* ......................................................................................................... 136 MTM400 Equity Earnings of Subsidiary ....................................................................................... 137 MTM500 Minority Interest ............................................................................................................ 138 MTM600 Hedging Transactions ................................................................................................... 139 MTM610 - OID & Other Imputed Interest ........................................................................................ 140 MTM620 - Mark to Marked Income/(Loss) ...................................................................................... 141 MTM700 Inc Recognition from LT Contracts ............................................................................... 142 MTM71A Sale versus Lease ........................................................................................................ 143 MTM71B Purchase versus Lease ................................................................................................ 144 MTM800 Accrual to Cash Adjustment ......................................................................................... 145 MTP10A Prepaid Advertising* ...................................................................................................... 146 MTP10B - Prepaid Insurance* ........................................................................................................ 148 MTP10C Prepaid Supplies ........................................................................................................... 149 MTP10D Prepaid Rent Expense .................................................................................................. 150 MTP10E Prepaid Legal Fees* ...................................................................................................... 151 MTP10F Prepaid VEBA ............................................................................................................... 152 MTR10A Bad Debt Reserve* ....................................................................................................... 153 MTR10B Inventory Reserve ......................................................................................................... 155 MTR10C Obsolescence Reserve ................................................................................................. 156 MTR10D Sales Returns & Allowance Reserve ............................................................................ 157 MTR10E Warranty Reserve* ........................................................................................................ 158 MTR10F Contingency Reserve* .................................................................................................. 160 MTR10G - Restructuring Reserve* ................................................................................................. 161 MTR10H Litigation Reserve* ........................................................................................................ 162 MTS100 Stock Options ................................................................................................................ 163 MTT100 State Taxes* .................................................................................................................. 164

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MTT200 Capitalized Real Estate Taxes ...................................................................................... 165 OT100 Federal Tax Payments ..................................................................................................... 166

Additional Hedge Fund Partnership Schedule Ms .................................................................... 167 MP100 Federal Tax Exempt Interest and Income ....................................................................... 167 MP110 Syndication Fees ............................................................................................................. 168

Additional Partnership Schedule Ms ......................................................................................... 169 Sch B Other Partnership Information ........................................................................................... 169 KP100 Partner Information ........................................................................................................... 170 KP200 Partner Contributions ....................................................................................................... 171 KP300 Partner Distributions ......................................................................................................... 172 KP400 Transfer of Interest ........................................................................................................... 173 KP500 Partnership Liabilities ....................................................................................................... 174 KP600 Guaranteed Payments Detail ........................................................................................... 175 KP700 Foreign Partner Withholding ............................................................................................ 176 MP440 or MP120 Guaranteed Payments .................................................................................... 177 MP450 Syndication Costs ............................................................................................................ 178

Additional S Corporation Schedule Ms ..................................................................................... 179 LD550 AAA Reconciliation (S Corporation) ................................................................................. 179 Sch B Other S Corporation Information ....................................................................................... 180 KS100 Shareholder Information ................................................................................................... 181 KS200 Shareholder Contributions................................................................................................ 182 KS300 Shareholder Distributions ................................................................................................. 183 KS350 Taxability of Distributions to Shareholders ....................................................................... 184 KS400 Ownership and Transfers ................................................................................................. 185 KS500 Schedule K Allocations ..................................................................................................... 186 KS600 Shareholder Foreign Withholding ..................................................................................... 187 MP450 Shareholder Fringe Benefits ............................................................................................ 188 OT200 Composite Tax Payments ................................................................................................ 189

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Overview This document was compiled from two legacy data sources:

o The Hows and Whys of Calculating Some Common Schedule M Adjustments o The DCW Tax Law

This document does not cover every situation, but is a tool for gaining a general understanding of Schedule Ms that are often encountered in business compliance. Specialists should always be consulted when appropriate. The rules discussed in the document are generally applicable, but are not intended to cover all exceptions.

Introduction to Schedule M Form 1120 Schedule M-3 Schedule M-3 reconciles financial statement net income (loss) for the consolidated financial group to taxable income on Form 1120, page 1, line 28. Corporations with consolidated assets that equal or exceed $10 million are required to file Schedule M-3. Partnerships with assets that equal or exceed $10 million, adjusted total assets that equal or exceed $10 million, or have gross revenues equal or greater to $35 million are required to file Schedule M-3. All other corporations and partnerships must still use Schedule M-1. Schedule M-3 requires the reporting of much more detail about book-tax differences than Schedule M-1.

The current Schedule M-1 has remained virtually unchanged for decades. In that time, large and midsize corporations have made dramatic changes in the ways they are structured and conduct business, and in their corresponding financial and tax accounting. Schedule M-1 and the related instructions do not provide a uniform reporting requirement for net income per books on line 1 of Schedule M-1. As a result, taxpayers may provide information for (i) the worldwide group, (ii) the U.S. consolidated tax group, or (iii) something in between. Similarly, Schedule M-1 and the related instructions do not provide uniform disclosure requirements for reporting differences between financial accounting net income and taxable income. The lack of requirements prevents efficient comparisons being made among taxpayers and prevents comparisons from year-to-year for the same taxpayer, thus making it more difficult to assess the risk of noncompliance associated with an issue or a taxpayer.

Objectives of Schedule M-3 According to the IRS, Schedule M-3:

Increases transparency while minimizing overall taxpayer burden;

Reduces the time required to examine tax returns and ensure IRS is in a position to examine the most recent tax returns filed;

Provides consistent reporting among taxpayers and, from year-to-year, for each taxpayer;

Provides a method of presentation to obtain more useful, descriptive information at the time the federal income tax return is filed to assist the IRS in the identification of tax returns that should or should not be selected for audit, identification of issues that should or should not be audited, and identification of trends and areas of greater compliance risk;

Will be modified periodically to highlight emerging issues, identify trends, and adapt to future changes encountered by large and midsize corporations;

Facilitates tax return selection and issue identification through electronic filing;

Facilitates the use of Limited Issue Focused Examination (LIFE) audits through greater transparency.

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Illustration: Excerpt from 2010 Corporate Form Schedule M-3

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What Is a Schedule M-1 Adjustment? Schedule M-1 is located on page 4 of Form 1120 Corporate and Form 1065 Partnership Federal Tax Return. M-1 adjustments arise when the GAAP (a.k.a., the book/financial statement) rules for certain income or expense items differ from the tax treatment as promulgated by the Internal Revenue Code.

Illustration: Page 4 of the 1120 and 1120S Schedule M-1

LD100A Master Trial Balance Potentially Applicable TCC Sections

1.05 Trial Balance Review 2.01 Accounting Methods 2.02 Accounting Method Changes 2.03 Book Accounting Changes 2.05 Adopting an Accounting Method 2.06 Initial Tax Year 2.07 Change of Tax Year 2.93 Determination of Accounting Method Following a Transaction 2.96 Accounting for Investments 4.26 Financial Accounting 14.00 Controlled Groups and Consolidated Returns 25.06 Debt Considered a Second Class of Stock

LD100C Amount Subject to Book Reclass Summary Potentially Applicable TCC Sections

1.03 Recordkeeping 2.03 Book Accounting Changes 14.00 Controlled Groups and Consolidated Returns

LD400 Book to Tax Reconciliation Potentially Applicable TCC Sections

1.02 Impact of Prior Year Events 1.03 Recordkeeping

Book Income per Financial Statements (GAAP)

Taxable Income per IRC

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1.05 Trial Balance Review 1.07 Schedule M-3/M-1 and M-2 Reconciliation 1.08 Provision to Return Reconciliation 1.09 Schedules M-3/M-1 and M-2 Analysis 2.00 Accounting Periods and Methods 2.01 Accounting Methods 2.02 Accounting Method Changes 2.04 Effecting a Method Change by Amending an NOL 2.05 Adopting an Accounting Method 2.06 Initial Tax Year 2.07 Change of Tax Year 2.93 Determination of Accounting Method Following a Transaction 2.94 Net Operating Loss Carryback 2.96 Accounting for Investments

LD450 Schedule K Workpaper Potentially Applicable TCC Sections

26.01 Items that Pass Through to Shareholders 26.02 Separately Stated Income and Gains(Losses) 26.03 Separately Stated Deductions 26.04 Other Separately Stated Items 26.05 Separately Stated AMT Items 27.02 Income and Credits of Partner 27.03 Partnership Computations (IRC 703)

LD500 Equity Rollforward Potentially Applicable TCC Sections

1.02 Impact of Prior Year Events 1.03 Recordkeeping 1.08 Provision to Return Reconciliation 1.09 Schedules M-3/M-1 and M-2 Analysis

LD600 Sec. 444 Election of Taxable Year other than Required Taxable Year Potentially Applicable TCC Sections

26.52 Calendar Year-End 26.53 Year-End Other Than Calendar Year

Sch E Officers Compensation Potentially Applicable TCC Sections

6.18 Compensation Paid to Top Executives

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Schedule Ms

MP100A Federal Income Tax* GAAP (Financial Statement) Treatment

Book net income or loss is presented net of income tax expense or benefit. ASC 740, Income Taxes, addresses financial accounting and reporting for the effects of all income taxes that result from an enterprises activities during the current year and preceding years.

Tax Treatment

As provided in IRC 275, federal income tax expense is not an allowable deduction for tax purposes. These costs must be added back in order to arrive at taxable income.

Note: The deduction of these expenses is never allowed for tax purposes and therefore produces permanent differences.

Where Do I Get the Information?

Source documents: Tax provision workpapers, post-provision adjusted trial balance, financial statement footnote, and income statement.

In taxable entities, federal income tax will be clearly identifiable in both the income statement and the expense portion of the trial balance. The account that contains federal income tax expense should be properly coded in the tax trial balance as Federal Income Taxes. Note, a company may have an accounting policy to include interest and/or penalties in the Income Taxes line in the income statement. It is important to confirm that only the amount related to federal income taxes (and not related interest and penalties) is included in this schedule M adjustment.

How Do I Calculate the Schedule M Adjustment?

The entire amount of the expense is disallowed in calculating taxable income. This amount is added back to book income as an unfavorable addback on the schedule.

Potentially Applicable TCC Sections

2.72 Disallowed Deductions 2.73 Federal Income Tax

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MP100B State and City Income Taxes* GAAP (Financial Statement) Treatment

Book net income or loss is presented net of income tax expense or benefit, including state income taxes. Through the process of calculating the tax provision, an estimate of the current years state income tax expense is included in the financial statements and deducted from book income.

Tax Treatment

IRC 164(a) provides that the following taxes shall be allowed as deductions for the taxable year within which they were paid or accrued subject to IRC 461(h) economic performance rules:

State and local, foreign, and real property taxes State and local personal property taxes State and local, foreign, income, war profits, and excess profits taxes

Note: See IRC 461(d). For example, California accrual of state taxes not deductible until subsequent year to which franchise tax relates.


Source documents: Post-provision adjusted trial balance, tax provision, financial statement footnote.

The estimated amount for state income/franchise taxes can be found in both the trial balance and the income statement section of the financial statements. Note, a company may have an accounting policy to include interest and/or penalties in the Income Taxes line in the income statement. It is important to confirm that only the amount related to state income taxes (and not related interest and penalties) is included in this schedule M adjustment.


The Schedule M adjustment amount is the difference between the book expense and the tax expense. If the book amount is larger than the tax amount, the difference will be treated as an unfavorable adjustment and will be added back to the book income. If the tax amount is larger than the book amount, the difference will be treated as a favorable adjustment and will be subtracted from the book income in arriving at taxable income.

Accrued state tax expense per books $20,000

Accrued state tax expense per tax 25,000

Schedule M favorable reduction ($5,000)


2.74 Deductibility of State and Local Tax Accruals 8.02 Filing Obligations 8.03 Nexus Issues 8.04 State Filing Methods 8.06 Law Changes 8.07 Alternate Measures of Tax 8.08 Federal-To-State Adjustments 8.09 Loss Carryovers and Carrybacks 8.11 Federal Consolidated Return Regulations

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MP100C Foreign Income Taxes Tax Law

Companies can elect to either deduct foreign income taxes, under IRC 164, or apply them as a credit against US-income tax. A book/tax difference arises with respect to foreign taxes when such taxes are deducted for book purposes but not for tax purposes. Often, companies will claim credit for foreign taxes on Form 1118 rather than claim a tax deduction.


10.21 AMT Foreign Tax Credit 12.22 Information Reporting and Withholding 12.42 Foreign Bank Account Reporting (FBAR) 16.07 Foreign Tax Credits 26.60 Foreign Subsidiaries Classified as Corporations for U.S. Tax

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MP100D Foreign Withholding Tax Tax Law

Companies can elect to either deduct foreign income taxes or apply them as a credit against US-income tax. A book/tax difference arises with respect to foreign taxes when such taxes are deducted for book purposes but not for tax purposes. Often, companies will claim credit for foreign taxes on Form 1118 rather than claim a tax deduction.


12.22 Information Reporting and Withholding 12.42 Foreign Bank Account Reporting (FBAR) 16.14 U.S. Effectively Connected Income ("ECI") 16.17 Withholding on Outbound Payments

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MP200 Club Dues Tax Law

Per IRC 274(a), a deduction is not allowed for membership dues in any club organized for business, pleasure, recreation, or other social purpose.


2.72 Disallowed Deductions

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MP210A Other Interest Expense Tax Law

This adjustment only applies when the interest paid or received has not been reflected in the income statement. This adjustment is usually only necessary in unusual circumstances.


1.06 IRS Interest Expense/Income 2.31 Economic Performance [including Accrual Method Liability Quick Reference Sheet] 2.40 Capitalization of Interest, Taxes 2.80 Related Party Debt Acquisition 4.02 Deferred Payment Obligations/Nontraded Debt 4.03 Variable or Stepped Interest Payments 4.04 Multiple Debt Instruments Issued in the Same Transaction 4.05 Contingent Payment Debt Obligations 4.06 Interest Not Due Currently (Including "Payment in Kind" Debt) 4.07 Debt Issued with Warrants or Other Property 4.08 Short-Term Debt Instruments 4.09 Applicable High-Yield Debt Obligations (AHYDOs) 4.10 Acquisition Indebtedness 4.11 Debt Exchanges or Modifications 4.12 Retirements or Prepayments of Debt 4.13 Issuance of Convertible Debt 4.14 Issuance of Debt Payable In (or Indexed to) Portfolio Stock 4.15 Issuance of Convertible Debt with Contingent Interest 4.18 Low Interest Loans 4.21 Hedges of Issuers Debt Obligations: Synthetic Debt Treatment 4.22 Hedges of Issuers Convertible Debt Obligations 4.23 Equity-Linked Securities 4.24 Investment Units Consisting of Debt and a Forward Contract 4.25 Interest Capitalization 4.27 Prepaid Interest 4.28 Treatment as Debt 4.29 Interest on Related Party Debt 4.30 Related-Party Debt Acquisitions 5.06 Market Discount 5.08 Short-term Investments 5.17 Hedging Ordinary Property or Liabilities 5.22 Tax Straddle Transactions 5.32 Repurchase Agreements 7.05 Interest Income on Finance Leases 7.06 Finance Lease v. Sale 15.16 Contingent Stock Payments

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MP201B Other Interest Income Potentially Applicable TCC Sections

1.06 IRS Interest Expense/Income 2.31 Economic Performance [including Accrual Method Liability Quick Reference Sheet] 2.40 Capitalization of Interest, Taxes 4.18 Low Interest Loans 4.30 Related-Party Debt Acquisitions 5.01 Original Issue Discount (corporate obligations) 5.02 Original Issue Discount (non-corporate obligations) 5.03 Stripped Obligations 5.05 Deferred Payment Sales 5.06 Market Discount 5.07 Bond premium 5.08 Short-term Investments 5.17 Hedging Ordinary Property or Liabilities 5.32 Repurchase Agreements 7.05 Interest Income on Finance Leases 7.07 Lessee Default 7.06 Finance Lease v. Sale 10.12 Private Activity Bonds

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MP220 Lobbying Expense Tax Law

Under IRC 162(e), deductible business expenses generally do not include amounts paid or incurred in influencing legislation. Nondeductible lobbying expenses include amounts incurred while participating in political campaigns, influencing the general public with respect to legislation, or while communicating directly with certain executive branch officials on official matters.

Nondeductible lobbying also includes dues paid to exempt organizations allocable to lobbying. When payments are made to an organization that incurs lobbying expenses the entity will generally provide the payor with the percentage of total expenses that are directly attributable to the lobbying activity on an invoice or in some instances an annual statement. Traditionally lobbying expenses are recorded in various accounts.

Some of these accounts could include dues and subscriptions, contribution accounts, donations, lobbying expenses, political contributions, and organization expenses.

See also Treas. Reg. 1.162-28 and 29.


2.60 Political Contributions 2.61 Lobbying Costs 2.72 Disallowed Deductions

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MP230 Meals and Entertainment* GAAP (Financial Statement) Treatment

These expenditures are expensed as incurred for GAAP purposes.

Tax Treatment

IRC 274(n) states that for certain meal and entertainment (M&E) expenses, only 50% of the total expense is allowed as a deduction. However, some M&E expenses are fully deductible for tax purposes. In general, M&E expenses related to entertaining clients (nonemployees) and travel are subject to the 50% disallowance.

In particular circumstances, the following types of M&E expenses are fully deductible (not subject to the 50% limitation):

Recreational or social employee activities. However, such activities cannot discriminate in favor of highly compensated employees (IRC 414(q)) (e.g., a company picnic or holiday party)

Cost of ticket package to a sporting event if the benefit is organized to benefit a tax-exempt organization all net proceeds of the event are contributed to such origination and volunteers

Overtime meal allowances. Certain limitations are placed on the deductibility of such expenses due to frequency and value issues

An employee's meal expenses incurred while moving that are reimbursed by the employer and includable in the employee's gross income

Food and beverages provided to employees on certain vessels and oil or gas platforms and drilling rigs

Expenses incurred by an employer and reimbursed by their client (common in the services industry). Very specific document substantiation requirements must be met before reimbursed expenses may qualify for a full deduction (see IRC 274(d) and Rev. Rul. 2008-23)

De minimis fringe benefits (IRC 132). Certain prohibitions and limitations are placed on the deductibility of such expenses due to frequency, value, and accountable plan issues

Goods, services or facilities that are treated as compensation

Goods, services or facilities made available to the public or sold to customers for adequate consideration

Reimbursed expenses for services performed by employees but only if these expenses are not treated as wages

A portion of the per diem rates up to the federal M&E rate (see Rev. Proc. 2010-39)

Additionally, as part of your review of the clients travel, meals, and entertainment accounts, particular attention should be paid to expenses that are either 50% or 100% nondeductible, that may have been inadvertently treated as fully deductible. For example, to the extent that hotel meals are charged to a hotel room invoice that was captured in a fully deductible general ledger account, such meals charges should be identified and subjected to the 50% limitation on deductibility. Further, exposure may exist if the clients expenses include entertainment costs associated with luxury boxes that are used for entertaining.

You should consult with your senior or manager to determine whether your clients facts meet the terms and conditions listed above. There is potential for a substantial consulting opportunity in performing a study of your clients M&E expense to review either opportunity items, exposure items, or both. See your senior, manager, or partner if you feel there is potential for such a review.

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The nature of the M&E expense should be established before any adjustments are calculated. If you are not sure that the expenses are 100%, 50% deductible, or 100% nondeductible, you must find this out from the client or another member of the engagement team before proceeding.


The adjustment is calculated by multiplying the 50% deductible expenses by 50%. The adjustment is then added back to book income as an unfavorable permanent Schedule M adjustment.

M&E (subject to 50% disallowance) $5,000

50%

Schedule M unfavorable addback $2,500

Practice Tips and Techniques

Many companies have misclassified exempted meals and entertainment expenditures as deductions subject to the 50% limitation on deductibility. These misclassifications result in an overpayment of federal and state income tax. In addition, ordinary and necessary expenses (i.e., hotel charges, office supplies, advertising, charitable contributions, etc.) are being erroneously included in the meals and entertainment accounts. Significant tax savings and improved financial statement earnings may result from a comprehensive analysis of the general ledger accounts to which the 50% limitation is currently being applied. Misclassifications may be reversed to restore full deductibility. Because these misclassifications do not constitute a method of accounting, taxpayers may amend open years to claim tax refunds. Prospectively, we may assist clients with their general ledger classification of expenses to ensure that full deductions are obtained on expenditures that meet the various exceptions to the 50% limitation.


2.43 Travel, Meals, & Entertainment Costs [including M&E Quick Reference Sheet] 2.72 Disallowed Deductions [including Meals & Entertainment Quick Reference Sheet] 6.21 Company Cars & Aircraft 6.24 Fringe Benefits 6.25 Eating Facilities 6.29 Travel and Entertainment Expenses 8.27 Meals for Employees

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MP230A Skybox Rental Expense Tax Law

The cost of the skybox lease must be reduced to the cost of non-luxury box seats, per IRC 274(I)(2), for the same number of seats in the box covered by the lease, before computing the limitation. The total cost of the non-luxury box seats must also be reduced by 50%, the general limitation for entertainment costs.


2.72 Disallowed Deductions

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MP240 Business Gifts Tax Law

Generally, a company is not allowed a business deduction for gifts to an employee to the extent that the total cost of all gifts of cash, tangible personal property, and other items to the same individual during the taxable year exceed $25. A $400 limitation applies to gifts of tangible personal property awarded to an employee for length of service, safety achievement, or productivity.


2.72 Disallowed Deductions 6.20 Employee Gifts

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MP250 Key Man Life Insurance Tax Law

Per IRC 264, premiums paid by an employer for insurance on the life of any individual are deductible only if it can be shown that payments are 1) in the nature of additional compensation, 2) total compensation including premiums is not unreasonable, and 3) the employer is not directly or indirectly a beneficiary under the policy. Generally, premiums paid under split-dollar life insurance arrangements are not deductible. Premiums on group-term life insurance covering the lives of employees are deductible by the employer unless the employer is a direct or indirect beneficiary. The payment of such premiums may result in income to the employee if coverage exceeds $50,000 or if the plan is discriminatory in favor of key employees. In general interest on debt incurred or continued to purchase or carry a life insurance policy is not deductible. However interest on pre-June 21, 1986 policies and policy loans of up to $50,000 on a limited group of key persons.


2.65 Life Insurance Loans 2.66 Life Insurance Premiums 6.17 Life Insurance

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MP260 Fines and Penalties* GAAP (Financial Statement) Treatment

Generally, fines and penalties are expensed as incurred for GAAP purposes.

Tax Treatment

IRC 162(f) states that no deduction shall be allowed for a fine or similar penalty imposed by a federal, state, or local government for the violation of any law.

Note: Fines and penalties imposed by vendors, such as those for airline ticket changes and hotel cancellations, are fully deductible for tax purposes.


Source documents: Clients trial balance or completed client information request.

Any account that contains fines and/or penalties should be investigated to determine what kind of fines or penalties are included in that account. Check the treatment of these accounts in prior years or ask the client about the nature of the accounts if this is the first year that they are present. If the accounts are expenses due to fines and/or penalties paid to governmental organizations, they cannot be deducted for federal income tax purposes. Note, companies may have an accounting policy for financial statement purposes to report penalties in the income tax expense line.


Nondeductible fines and penalties are added back to book income as an unfavorable permanent Schedule M addback.


Perform a detailed analysis of the account for the following examples of fines and penalties, which are fully deductible and do not have to be added back to book income in determining taxable income.

Hotel cancellation penalties Airline ticket change penalties Other similar vendor fines or penalties Fines or penalties that are compensatory in nature


2.59 Fines and Penalties 2.68 Department of Justice Settlements 2.72 Disallowed Deductions 9.09 Tax Liability and Tax Payments 12.32 Penalties

Schedule M Guidance

19

MP270 Punitive Damages Tax Law

Punitive damages paid under IRC 104(a)(2) that are includible in gross income by the recipient are deductible to the payer. There are cases where punitive damages paid are excluded from gross income by the recipient if received in a civil action for wrongful death and the applicable state law, in effect on September 13, 1995, provides that only punitive damages may be awarded (IRC 104(c)). Beginning in 2005, attorney's fees and court costs incurred in prosecuting claims based on unlawful discrimination and certain other federal claims, including but not limited to whistleblower actions, are deductible from gross income (IRC 62(a)(20), as added by the American Jobs Creation Act of 2004. Only punitive damages paid pursuant to a wrongful death claim are excluded from the recipient's income per IRC 104(c) and are thus not deductible to the payer corporation.


2.24 Recoveries for Damage

Schedule M Guidance

20

MP300 - Tax Exempt Interest* GAAP (Financial Statement) Treatment

For GAAP purposes, there is no distinction made (as to inclusion in income) between the interest income generated by different types of debt instruments (i.e., municipal bonds vs. corporate bonds). Generally, all interest for GAAP purposes is included in income.

Tax Treatment

IRC 103(a) states that interest income derived from bonds insured by state and local governments is generally not included in gross income for federal tax purposes.

However, interest derived from certain state and local private activity bonds (within the meaning of IRC 141), arbitrage bonds (within the meaning of IRC 148), and bonds not in registered form (not meeting the requirements of IRC 149), are included in taxable income.

Note: IRC 265(a)(2) provides that no deduction shall be allowed for interest on indebtedness incurred to purchase or carry obligations, the interest of which is wholly exempt from tax. Therefore, a separate adjustment may be required to disallow interest expense attributable to the generation of the tax-exempt interest income.


Source documents: Trial balance, audit workpapers, or completed client information request. In most cases, tax-exempt interest will be assigned its own trial balance account. If the description is vague, or you question the nature of the interest income, document your questions on the open items list, and follow up with the senior or manager on the engagement.


Any interest income amounts that are deemed to be tax-exempt have been included in the book income amount and need to be removed in arriving at taxable income. The total tax-exempt interest amount should be subtracted from book income as a favorable permanent adjustment.

Tax-exempt interest income per books $2,000

Tax-exempt interest income per tax 0

Schedule M favorable reduction ($2,000)


5.24 Tax-Exempt Interest 8.08 Federal-To-State Adjustments

Schedule M Guidance

21

MP300A Tax Exempt Dividends Tax Law

IRC 103(a) provides that gross income does not generally include dividend income derived from any state or local bond. However, dividends derived from certain state and local private activity bonds (within the meaning of IRC 141), arbitrage bonds (within the meaning of IRC 148), and bonds not in registered form (not meeting the requirements of IRC 149), are included in taxable income.


15.02 Distributions

Schedule M Guidance

22

MP300B Other Tax-Exempt Interest Income Potentially Applicable TCC Sections

5.24 Tax-Exempt Interest

Schedule M Guidance

23

MP310 Section 965(F) DRD Potentially Applicable TCC Sections

5.09 Dividends 5.25 Dividends Received Deduction 8.08 Federal-To-State Adjustments 8.12 Foreign Source Dividends and IRC 78 Gross-Up 16.23 IRC 965

Schedule M Guidance

24

MP400 Outstanding Stock-Issuance, Repurchase and Refinancing Redemption Tax Law

Pursuant to IRC 162(k), no deduction is allowed for any amount paid or incurred by a corporation in connection with reacquisition of its stock or of the stock of any related person (as defined in IRC 465(b)(3)(C)). Note that there are exceptions to the general rule.


2.72 Disallowed Deductions 5.04 Redemption Premiums on Preferred Stock 15.03 Redemptions 15.04 Related Party Stock Sales Treated as Redemptions 26.57 Compensation: Employee Stock Option Plans 26.58 Shareholders Receiving Little to no Compensation

26.59 Limit on Deductibility of Business Expenses by the Corporation

Schedule M Guidance

25

MP410 Stock Options Tax Law

In general, IRC 421(a) prevents tax income recognition to the employee and consequently a tax deduction to the employer of the value of a qualified stock option if the stock is held for two years after the date of the grant of the option and the share of stock is not sold within one year of the option being exercised. Qualified stock options include incentive stock options (ISO) as provided in IRC 422 and employee stock purchase plans as provided in IRC 423. If the employee does not hold the stock for the two year holding period or the one year grant to exercise period, then IRC 421 does not apply to the option, the employee recognizes income on the value of the stock option when the stock is sold, and the employer is allowed a deduction for the value of the option included in income of the employee.


2.63 Compensation to Executives 6.01 Nonqualified and Qualified Plans 6.13 Nonqualified Stock Options 6.14 Incentive Stock Options 6.15 Employee Stock Purchase Plans 6.18 Compensation Paid to Top Executives 26.57 Compensation: Employee Stock Option Plans 26.58 Shareholders Receiving Little to no Compensation 26.59 Limit on Deductibility of Business Expenses by the Corporation

Schedule M Guidance

26

MP420 Nondeductible Compensation Tax Law

IRC 162(m)(1). Publicly held corporations are generally not able to deduct compensation paid to certain covered employees to the extent that such compensation exceeds $1 million per tax year. Treas. Reg. 1.162-27. The $1 million limit does not apply to certain "performance based compensation" (IRC 162(m)(4)(C)).


2.63 Compensation to Executives 6.18 Compensation Paid to Top Executives 26.57 Compensation: Employee Stock Option Plans 26.58 Shareholders Receiving Little to no Compensation 26.59 Limit on Deductibility of Business Expenses by the Corporation

Schedule M Guidance

27

MP430 Parachute Payments Tax Law

Per IRC 280G, a corporation that enters into a contract whereby it agrees to pay an employee amounts in excess of the employee's usual compensation in the event that control or ownership of the corporation changes is barred from taking a deduction for an 'excess parachute payment' made to a 'disqualified individual. See IRC 280G for definitions and calculation of 'excess parachute payment.'


6.19 Golden Parachutes

Schedule M Guidance

28

MP500 Goodwill Amortization* GAAP (Financial Statement) Treatment

Goodwill is not amortized for GAAP purposes. Goodwill is tested for impairment on an annual basis and in between annual tests in certain circumstances. After a goodwill impairment loss is recognized, the adjusted carrying amount of goodwill is its new accounting basis.

Tax Treatment

IRC 197 states that a taxpayer shall be entitled to an amortization deduction with respect to certain intangibles. The amount of such deduction shall be determined by amortizing the adjusted basis (for determining gain) of such intangible ratably over the 15-year period beginning with the month in which such intangible was acquired. To qualify as a 197 intangible, the acquisition must have been made after 8-11-93 (or 7-25-91 if an election was made). The asset must be held in connection with the conduct of a trade or business or held for the production of income. (See IRC 212 for a more complete description).

Amortization of goodwill on acquisitions prior to IRC 197 is not deductible (permanent difference).


Source documents: Prior-year tax analysis and audit workpapers. Goodwill is separately stated in the financial statements and, generally, is easily identifiable in the asset section of the trial balance and/or audit workpapers.

Goodwill impairment, if any, may be found in the income and expense section of the trial balance. The other number used in the calculation is the tax amortization expense amount and will be found in fixed asset system (FAS Encore, Fast-Tax, or other) which is used to calculate amortization and depreciation.


The taxpayer is allowed to deduct the amount of goodwill amortization expense that is calculated by the method prescribed above in the tax treatment section. Since goodwill is not amortized for book purposes, the difference between the book amount (generally zero unless goodwill is impaired during the year) and the tax amount gives rise to a Schedule M adjustment.

Goodwill impairment per books $10,000

Goodwill amortization per tax 4,000



2.35 Depreciation/Amortization 3.11 Intangible Assets

Schedule M Guidance

29

MP510 Exchange Gain/Loss Tax Law

Unrealized foreign exchange gains, resulting from functional currency translation differences, are favorable M items, and should be deducted from book income. Similarly, unrealized foreign exchange losses are nondeductible and should be added back to income as an unfavorable M.


15.12 IRC 351 Transactions and Incorporations 16.01 Foreign Currency Transactions

Schedule M Guidance

30

MP520 Leased Inclusion Costs* GAAP (Financial Statement) Treatment

Automobile expenditures are generally expensed as incurred for GAAP purposes.

Tax Treatment

For tax purposes, IRC 280F(c) and Treas. Reg. 1.280F-7(a) require that a corporation must include a certain amount of income based on the fair value of the automobile for post-1986 leases of automobiles.

To determine the income inclusion under IRC 280F(a), consult the lease inclusion tables issued by the IRS annually in a revenue procedure (e.g., in Rev. Proc. 2009-24 for vehicles first leased in 2009). You will find tables that provide you with the IRC 280F(c)lease income inclusionby year, based on the fair market value of the automobile. Separate lease inclusion tables are provided for trucks (including sports-utility vehicles) and vans that are built on a truck chassis. Leased trucks and vans with loaded gross vehicle weight over 6,000 pounds are exempt from lease income inclusion.

The IRC 280F(c)lease income inclusionby year amount effectively reduces the lease payment deduction on the automobile for tax purposes.

Example:

A car with a fair market value of $21,300 leased for 3 years beginning April 15, 2009, would have an income inclusion amount of $11 (261/365 days $15 (from tables in Rev. Proc. 2009-24)) for 2009.

This amount would be included on page 1, line 10 of the Form 1120 (other income). It would also be included on page 2, line 25 of Schedule M-3 (Form 1120, Other Income (Loss) Items with Differences).


Source documents: Client information (fair market value of automobile) and the lease inclusion table (e.g., Rev. Proc. 2009-24 for 2009).


Look up the fair market value in lease inclusion table. Look across to the year in the lease. Include the amount in miscellaneous income on the return. You will need to determine the lease date and then include in income a pro-rata amount based on the number of days during the year the car was leased by the corporation.

Illustration: Table from Rev. Proc. 2009-24 (2009)

Fair Market Value Tax Income Inclusion Amount

1st 2nd 3rd 4th 5th and later

$21,000 $21,500 $15 $31 $47 $55 $64

Assumptions: Fair market value of the automobile = $21,300 Lease Date: April 15, 2009 Income inclusion under IRC Section 280F(c) = $11 ($15 261/365 Days) Schedule M unfavorable addback.


7.02 Lessor as Tax Owner

Schedule M Guidance

31

MP600 - Credit Expense Addback Tax Law

Pursuant to IRC 280C, a taxpayer cannot deduct expenses for which the taxpayer is also claiming a credit; the effect of this is an unfavorable Schedule M equal to the credit amount.


8.08 Federal-To-State Adjustments 9.14 Nonhighway Fuel Credit 9.15 Work Opportunity Credit 10.06 Alcohol Fuel Credit 10.22 General Business Credits 11.00 Research and Experimental Deductions and Credits 20.00 Federal Tax Credits 20.07 IRC 48C Advanced Energy Manufacturing Credit 20.08 Section 48D Credit: Qualifying Therapeutic Discovery Project Credit 20.11 IRC 45D New Markets Tax Credit 20.13 HIRE Act Credit 26.34 Fuel Tax Credit

Schedule M Guidance

32

MP610 Domestic Production Activity Deduction Potentially Applicable TCC Sections

8.08 Federal-To-State Adjustments 16.22 IRC 199 Calculations 19.00 Domestic Production Activities Deduction (IRC 199) 18.32 IRC 199 Considerations

Schedule M Guidance

33

MP700 Environmental Remediation Costs Tax Law

Under IRC 198(a), a taxpayer may elect to treat any qualified environmental remediation expenditure which is paid or incurred by the taxpayer as an expense which is not chargeable to capital account. Any expenditure which is so treated shall be allowed as a deduction for the taxable year in which it is paid. IRC 198 environmental remediation costs are separately stated on Form 1120, Schedule M-3, Part III, Line 29. Amounts shown on this line are generally deductible and a Schedule M adjustment should not be considered automatic.


2.46 Environmental Remediation 2.95 Specified Liability Loss (IRC 172(f)) 9.04 Specified Liability Loss (IRC 172(f))

Schedule M Guidance

34

MP800 or MT110 Acquisition/Reorganization Costs Tax Law

The regulations under IRC 195 provide that a taxpayer is deemed to make an election under IRC 195(b) to deduct start-up expenditures for the taxable year in which the active trade or business to which the expenditures relate begins. The regulations under IRC 248 or 709 provide that a corporation or partnership, respectively, is deemed to make an election under IRC 248(a) or 709(b) to deduct organizational expenditures for the taxable year in which the corporation or partnership begins business. Amortization of acquisition, reorganization, and start-up costs are separately stated items on Form 1120, Schedule M-3, Part III, Lines 23-25 and Line 27.


2.49 Organization Costs 2.50 Start-Up Costs 4.10 Acquisition Indebtedness 8.18 Mergers and Acquisitions 15.00 Distributions, Mergers and Acquisitions, Reorganizations and Other Capital Transactions 15.18 Other Transaction Considerations

Schedule M Guidance

35

MPB25A Bank Life Insurance Potentially Applicable TCC Sections

2.65 Life Insurance Loans 2.66 Life Insurance Premiums 6.17 Life Insurance

Schedule M Guidance

36

MPB25B Bank-Owned Life Insurance Income Potentially Applicable TCC Sections

6.17 Life Insurance

Schedule M Guidance

37

MPB30A Sec 291 Interest Expense Disallowance Potentially Applicable TCC Sections

10.16 Mining Exploration and Development Costs

Schedule M Guidance

38

MPB30B Sec 265 Interest Expense Disallowance Potentially Applicable TCC Sections

5.24 Tax-Exempt Interest

Schedule M Guidance

39

MPX100 Deemed Inclusions Potentially Applicable TCC Sections

16.03 Subpart F Income (IRC 951 - 964)

Schedule M Guidance

40

MPX200 Distribution of PTI 16.01 Foreign Currency Transactions

Schedule M Guidance

41

MPX210 PTI Exchange Gain/Loss Potentially Applicable TCC Sections

16.01 Foreign Currency Transactions

Schedule M Guidance

42

MPX300 - Branch Remittance Gain/Loss Potentially Applicable TCC Sections

16.01 Foreign Currency Transactions 16.15 Branch Profits Tax 16.16 Branch Level Interest Tax

Schedule M Guidance

43

MPX400 Section 78 Gross-Up Potentially Applicable TCC Sections

8.08 Federal-To-State Adjustments 8.12 Foreign Source Dividends and IRC 78 Gross-Up

Schedule M Guidance

44

MPX500 Reverse Section 901 Taxes Potentially Applicable TCC Sections

16.07 Foreign Tax Credits

Schedule M Guidance

45

MPX600 FSC Commission Potentially Applicable TCC Sections

8.10 Foreign Sales Corporation ("FSC")

Schedule M Guidance

46

MPX700 Section 965 DASTM Gain/Loss Potentially Applicable TCC Sections

16.01 Foreign Currency Transactions 16.24 Foreign Account Tax Compliance Act (FATCA)

Schedule M Guidance

47

MPX800 Gross Foreign Dividend Not Previously Taxed Potentially Applicable TCC Sections

16.01 Foreign Currency Transactions

Schedule M Guidance

48

MPX900 Excess Distribution 2 Potentially Applicable TCC Sections

16.05 Passive Foreign Investment Company ("PFIC")

Schedule M Guidance

49

MTA10A Accrued Bonus* GAAP (Financial Statement) Treatment

ASC 710, Compensation - General, requires a liability to be accrued for employees compensation for future absences if all of the following conditions are met:

1. The employers obligation is attributable to employees services already rendered, 2. The obligation relates to rights that vest or accumulate, 3. Payment is probable, and 4. The amount can be reasonable estimated.

Bonuses are accrued by a charge to income if both of the following are met:

1. The amount can be reasonably estimated, and 2. It is probable that the liability has been incurred at the financial reporting date.

Tax Treatment

A vacation, sick leave pay, or bonus (to employees with no significant ownership) deduction is generally limited to the amount earned or awarded during the year to the extent that:

1. The amount is paid to employees during the year, or 2. The amount is vested as of the last day of the tax year (fixed and determinable) and is paid to

employees within 2 months after the end of the year. (IRC 404(a)(5); Temp. Reg. 1.404(b)-1T, Q & A-1 and Q & A-2(b))

IRC 461 requires that the following conditions be met for an accrual to be deductible for tax purposes:

The liability must be fixed and determinable at end of the tax year (versus probable and estimable for GAAP as discussed above)

Economic performance must have occurred (i.e., the services have been provided). In general, under IRC 404(a)(11) and Treas. Reg. 1.461-4(d)(2)(iii)(A), deferred compensation is generally deducted for tax purposes in the same tax year that the payment is recognized in income of the recipient. Treas. Reg. 1.404(b)-1T allows that economic performance will be considered to have occurred if the taxpayer made payment within 2 months of the end of the tax year (original due date of the return without regard to extensions) in which the services were provided.

Amounts not paid within 2 months of year end are considered deferred compensation and are not deductible until the tax year paid.


The trial balance will provide the amount of expense accrued at year-end, but client contact is required to determine the amount paid within 2 months. Also, prior year workpapers will be required in order to find the amount paid within 2 months and deducted on the prior-year tax return.


The adjustment amount is calculated in the following manner:

Accrued vacation, beginning of year $20,000

Amount paid within 2-1/2 months in prior year -5,000

Accrued vacation, adjusted beginning of year (not deducted in prior year return)

$15,000

Accrued vacation, end of year 30,000

Schedule M Guidance

50

Amount paid within 2-1/2 months in current year -10,000

Accrued vacation, adjusted end of year $ 20,000



Change from beginning to end of tax year

Adjustment to book income Why?

Net Increase in Accrued Vacation per Books (GAAP) (Net of payment within 2- 1/2 months)

Addback To increase book accrual, the journal entry on the GAAP set of books was a debit to expense and a credit to accrual liability. This is not allowed for tax purposes for the reasons mentioned above. The expense must be added back.

Net Decrease in Accrued Vacation per Books (GAAP) (Net of payment within 2-1/2 months)

Reduction To decrease book accrual, the entry was a debit to accrued liability and a credit to cash. This now becomes deductible for the tax set of books for the reasons mentioned above.


2.31 Economic Performance [including Accrual Method Liability Quick Reference Sheet] 2.32 Vacation Pay, Bonus Pay, and Deferred Compensation [including Accrual Method Liability Resource]

6.02 Deferred Compensation 6.03 FICA Treatment of Nonqualified Deferred Compensation, Vacation Pay and Bonuses 6.04 Application of 409A

Schedule M Guidance

51

MTA10B Accrued Payroll Tax Law

Please see MTA10A Accrued Bonus*


2.31 Economic Performance [including Accrual Method Liability Quick Reference Sheet] 2.32 Vacation Pay, Bonus Pay, and Deferred Compensation [including Accrual Method Liability

Resource] 6.02 Deferred Compensation 6.04 Application of 409A

Schedule M Guidance

52

MTA10C Accrued Deferred Compensation Tax Law




Resource] 6.02 Deferred Compensation 6.03 FICA Treatment of Nonqualified Deferred Compensation, Vacation Pay and Bonuses

Schedule M Guidance

53

MTA10D Accrued Rabbi Trust Tax Law

A Rabbi Trust is generally designed to provide some assurance that future benefit obligations will be satisfied. The IRS will find a valid rabbi trust exists if all three conditions are met: the trust's assets must be available to all the general creditors of the employer if the employer files for bankruptcy , there are no insolvency triggers that hasten payments to employees when the employer's net worth falls below a certain point, thereby bypassing creditors before insolvency is declared , there is a procedure to provide notice to the trustee of the bankruptcy of the employer or financial hardship of the employer. Because a rabbi trust is subject to the claims of the employer's general creditors, the employer is considered the owner of the trust and the executive is not subject to tax on the deferred amounts until payments are actually received. When payments are actually received and the executive is taxed, the employer may take a corresponding deduction.


2.31 Economic Performance [including Accrual Method Liability Quick Reference Sheet] 6.02 Deferred Compensation 6.04 Application of 409A

Schedule M Guidance

54

MTA10E Accrued Benefits Tax Law



2.31 Economic Performance [including Accrual Method Liability Quick Reference Sheet] 2.53 Incurred but not Reported Employee Medical Expense (Including IBNR in Workers'

Compensation) 6.02 Deferred Compensation 6.03 FICA Treatment of Nonqualified Deferred Compensation, Vacation Pay and Bonuses 6.04 Application of 409A 6.12 Plan Terminations and Significant Reductions in Future Benefit Accruals

Schedule M Guidance

55

MTA10F Accrued Vacation* Tax Law




Resource] 6.02 Deferred Compensation 6.03 FICA Treatment of Nonqualified Deferred Compensation, Vacation Pay and Bonuses 6.04 Application of 409A

Schedule M Guidance

56

MTA10G Accrued ASC 715 (formerly FASB 106) Tax Law

Generally, accruals for post-retirement benefits under ASC 715, Compensation Retirement Benefits, (formerly FASB 106) are not deductible for tax purposes until paid. The costs accrued are any benefits which are expected to be paid by the employer not otherwise covered by another pension or qualified plan. These benefits commonly include postretirement health care and life insurance provided outside a plan.

For book purposes, these costs are accrued currently in the financial accounts, but are not deductible for tax purposes until paid. The costs are generally treated the same as deferred compensation.


2.31 Economic Performance [including Accrual Method Liability Quick Reference Sheet] 6.09 Funding 6.23 Post-Retirement Benefits

Schedule M Guidance

57

MTA10H Accrued Severance Tax Law


The liability must be fixed and determinable at end of the tax year (versus probable and estimable for GAAP as discussed above).

Economic performance must have occurred (i.e., the services have been provided).

Treas. Reg. 1.404(b)-1T imposes the additional requirement that payment must be made within 2-1/2 months of the end of the tax year (original due date of the return without regard to extensions) that the services were provided. Amounts not paid within 2-1/2 months are not deductible until the tax year paid (it also generally must be includable as income by the recipient).

IRC 404(a)(11) states that no amount is treated as paid for this purpose until it is actually received by the employee.


2.31 Economic Performance [including Accrual Method Liability Quick Reference Sheet]

Schedule M Guidance

58

MTA10I Accrued Commissions Tax Law


The liability must be fixed and determinable at end of the tax year (versus probable and estimable for GAAP as discussed above).

Economic performance must have occurred (i.e., the services have been provided).

Treas. Reg. 1.404(b)-1T imposes the additional requirement that payment must be made within 2-1/2 months of the end of the tax year (original due date of the return without regard to extensions) that the services were provided. Amounts not paid within 2-1/2 months are not deductible until the tax year paid (it also generally must be includable as income by the recipient).

IRC 404(a)(11) states that no amount is treated as paid for this purpose until it is actually received by the employee.


2.31 Economic Performance [including Accrual Method Liability Quick Reference Sheet]

Schedule M Guidance

59

MTA10J or MT120 - Accrued Professional Fees* GAAP (Financial Statement) Treatment

In order to fairly represent the expenses applicable to a reporting period (i.e., the matching principle), GAAP requires an accrual for professional fees that have been incurred as of year-end but have not been paid.

Expenses are generally recognized when an entity's economic benefits are consumed (i.e., actual or expected cash outflow) in revenue-earning activities or otherwise.

Tax Treatment

For tax purposes, expenses are allowed as deductions only after the all events test is satisfied and economic performance has occurred. This requires that the expenses be both fixed and determinable and that the services are performed. Since the accrual for book purposes does not require that the deduction amount be fixed and determinable, differences arise between book and tax. IRC 461 requires that an accrual meet the following criteria to be deductible: The liability must be fixed and determinable at the end of the tax year (versus probable and estimable for GAAP, as discussed above) and economic performance must have occurred (i.e., the services have been provided) prior to year end under Treas. Reg. 1.461-4(d)(2)(i).

The all events test for accrued professional fees is generally satisfied the earlier of the date that: (1) the required performance occurs, (2) payment is due, or (3) payment is made. The economic performance requirement for accrued professional fees is generally satisfied as the services are provided to the taxpayer.

Note: The mere execution of an insurance or service contract (e.g., professional service contracts including those for audit and tax services) by an accrual method taxpayer does not satisfy the all events test for incurring the liability. For example, absent a prepayment, the amount of accrued professional fees deductible in the 2010 tax year would be limited to the amount of services actually performed in that tax year (2010). See Rev. Rul. 2007-3 and TCC Section 2.44 Executory Contracts.

The recurring item exception should be considered when the all events test is satisfied in the earlier year as a result of payment due or made, and the services are provided within 8 months of year-end.

Under Treas. Reg. 1.461- 5, taxpayer using an accrual method may adopt the recurring item exception for recurring items incurred by the taxpayer. Under the recurring item exception, a liability is treated as incurred for a taxable year if:

1. as of the end of that taxable year, all events have occurred to establish the fact of the liability and the amount of the liability can be determined with reasonable accuracy;

2. economic performance with respect to the liability occurs before the earlier of a. date on which taxpayer timely files the return or b. within 8 1/2 months of tax year end;

3. liability is recurring in nature and 4. either the amount of the liability is not material or the deduction of the liability in that taxable year

results in better matching of the deduction with the income to which it relates than would result from accruing the liability for the taxable year in which economic performance occurs.

The 3 month rule should be considered. For economic performance purposes, the taxpayer can treat the services as provided/rendered at the time of payment if the services are expected to be provided within 3 months of payment (Treas. Reg. 1.461-4(d)(6)(ii)).

See Tax Alert 07002 for a detailed discussion of accrued professional fees.


The accrual of professional fees should be relatively easy to find on both the trial balance and the financial statements. To determine the deductible tax expense, consulting the client for additional details and facts will be necessary. In most cases, however, the entire accrual will be disallowed and added back to book income.

Schedule M Guidance

60


If the increase in the accrual is larger than the allowable tax deduction, the difference should be added back to book income as an unfavorable adjustment. In the following example accrued professional fees (estimated) for services to be provided in the following year were accrued by XYZ Corp.

Beginning Balance 12/31/0X $20,000


Ending Balance 12/31/0X 30,000


2.31 Economic Performance [including Accrual Method Liability Quick Reference Sheet] 2.33 Accrued Professional Fees 2.44 Executory Contracts

Schedule M Guidance

61

MTA10K Accrued Directors Fees Tax Law

For tax purposes, expenses are usually allowed as deductions only after they meet both the all events test and economic performance has been met. This requires that the expenses be both fixed and determinable and that the services are performed. Since the accrual for book purposes does not require that the deduction amount be fixed and determinable, differences arise between book and tax.

IRC 461 requires that an accrual meet the following criteria to be deductible: The liability must be fixed and determinable at the end of the tax year and economic performance must have occurred (i.e., the services have been provided) prior to year end under Treas. Reg. 1.461-4(d)(2)(i). Under Treas. Reg. 1.461-5, taxpayer using an accrual method may adopt the recurring item exception for recurring items incurred by the taxpayer. Under the recurring item exception, a liability is treated as incurred for a taxable year if:

1. as of the end of that taxable year, all events have occurred to establish the fact of the liability and the amount of the liability can be determined with reasonable accuracy;

2. economic performance with respect to the liability occurs before the earlier of a. date on which taxpayer timely files the return or b. within 8 1/2 months of tax year end;

3. liability is recurring in nature and 4. either the amount of the liability is not material or the deduction of the liability in that taxable year

results in better matching of the deduction with the income to which it relates than would result from accruing the liability for the taxable year in which economic performance occurs.


2.31 Economic Performance [including Accrual Method Liability Quick Reference Sheet] 6.02 Deferred Compensation 6.04 Application of 409A 6.18 Compensation Paid to Top Executives

Schedule M Guidance

62

MTA10L Accrued Related Party Compensation Tax Law

Generally, accrued related party compensation accruals are not deductible for tax purposes until the recipient recognizes the income.


2.31 Economic Performance [including Accrual Method Liability Quick Reference Sheet] 2.78 Related Party Expenses 6.02 Deferred Compensation 6.04 Application of 409A

Schedule M Guidance

63

MTA10M Accrued Retirement GAAP (Financial Statement) Treatment

In order to fairly represent the expenses applicable to a reporting period (i.e., the matching principle), GAAP requires an accrual for retirement costs (e.g., retirement plans, pension plans, 401(k) plans) that have been incurred as of year-end but have not been paid. Expenses are generally recognized when an entity's economic benefits are consumed (i.e., actual or expected cash outflow) in revenue-earning activities or otherwise.

Tax Treatment

For tax purposes, accrued retirement/pension/401(k) expenses (deferred compensation) are allowed as deductions only after the all events test is satisfied, economic performance has occurred (i.e., the services have been provided), and the requirements under IRC 404(a)(5) are met.

The timing of the tax deduction will vary depending on the type of plan. A stock bonus, pension, or profit-sharing plan that meets the requirements of IRC 401(a) is a qualified plan. For qualified plans, generally the deduction is allowed as contributions to the plan are made. For nonqualified plans, generally the deduction is allowed as payments are made to the employee.

Under IRC 404(a), expenses are generally deductible in the year they are paid. However, IRC 404(a)(6) provides a special rule for payments made by a pension trust, employees annuity, or stock bonus or profit-sharing trust. If payment is made by one of these types of plan, the taxpayer is deemed to have made payment during the taxable year for which the return is being prepa

Schedule M Guidance

Documents

ld450 schedule

schedule ms

tax reconciliation

mp100a federal income

city income taxes

mp100c foreign income

applicable standards

tax practice manual