Corporate tax filing has just gotten more complicated with the arrival of a new tax form: Schedule M-3 Net Income (Loss) Reconciliation for Corporations with Total Assets of $10 Million or More. The information recorded on the form will show discrepancies between book and taxable income. With the differences made more obvious—or transparent—the Internal Revenue Service (IRS) can more easily evaluate those that look legitimate and identify the ones that do not appear to be acceptable.
“In the 1990s, a lot of public accounting firms became aggressive about marketing tax planning schemes, many of which the IRS felt lacked economic substance,” said Cherie Hennig, professor in the School of Accounting and director of the Executive Master of Science in Taxation (EMST) program in the College of Business Administration. “The IRS had to audit taxpayers who had been sold boilerplate schemes and who had often suffered an abuse of trust because they were guided to abusive tax shelters.”
According to Hennig, “With the new M-3, the IRS has put taxpayers on notice that they’ll be scrutinized. They have to flag differences between book and taxable income and explain what causes them.”
Though many companies think they are well under the $10 million requirement, they might be surprised.
“Small- or medium-sized companies with real estate and equipment can easily get to $10M in gross assets,” Hennig said.
And once they’ve reached that size, the filing realities are complex.
“If a corporation has members of a consolidated group, each member has to file an M-3,” she said.” “And if a company includes subsidiaries, the situation is very convoluted because they have to file on both a consolidated and an individual basis.”
The challenge for tax preparers is that information on the financial statements to shareholders that differs from taxable income reported to the IRS must be disclosed.
“The information has to be scheduled out, and there has to be an explanation about which transactions gave rise to the differences,” Hennig said. “Some of the differences are perfectly legitimate, but the IRS wants to be able to see them and be able to measure the aggressiveness of the tax planning.”
The introduction of the M-3 form, therefore, will make the job of tax return preparers more difficult. But Hennig and her colleagues hope to ease the way. They are about to publish a book designed to help tax preparers understand the form.
“One of the most interesting consequences of our new tax environment is that now the tax professionals and the accountants, who rarely worked together in the past, have to work together on the book-tax reconciliation process,” she said. “In our book, we are trying to teach financial accounting rules to tax people so that they can get information into the desired format to complete the M-3, which is a very intricate, three-page form. They will then be able to assist accountants in preparing the tax accrual that goes on the balance sheet.”
The co-authors are taking care to make the book a handy “how-to.”
“Our text will be a practical, compliance-oriented explanation of the new form, with lots of examples and four case studies,” said Hennig, who has more than 100 publications in the tax field to her credit.
Despite her immersion in tax research, she admits that learning M-3 also posed challenges to her.
“My knowledge of financial accounting was definitely out of date,” she said. “With recent changes, we can’t just think of the tax profession as being separate from accounting. Today, you have to be able to exercise a lot of judgment, and in order to exercise that judgment wisely, tax professionals have to understand the financial accounting rules.”
The working title of the professional reference book is Book-Taxable Income Reconciliations: A Guide to Schedule M-3.