It is of extreme importance to determine taxable income from book income for tax
reporting purposes. Differing accounting methods such as accrual or cash as well as temporary
difference like charitable contributions tend to make book income and taxable income amounts
vary in outcomes. The Internal Revenue Service Codes and the generally accepted accounting
principles (GAAP) are different in the rules they use to report income that may or may not be
taxable. This is extremely important to consider as there are steep fines and penalties as well as
possible jail time for erroneous tax payments or reporting incorrect information. Reconciliation
of the two forms of reporting income should alleviate the possibility of errors.
If a C-corporation’s total assets equal less than ten million dollars then the company is
mandated to use the Schedule M-1 of Form 1120 to accomplish their reconciliation between
book income and taxable income. Recently, the IRS announced changes regarding the Schedule
M-1 allowing corporations whose total assets equal ten million dollars but less than fifty million
dollars and file certain forms may be able to file a Schedule M-1 in place of the Schedule M-3
that was previously required. This only replaces Parts II and Parts III and they must file Part I of
Schedule M-3 still. Schedule M-1 adds certain expenses to a corporation’s net income. An
example of these expenses include federal income tax expense, charitable donations over the
10% allowable amount, capital losses that are in excess over capital gains, and prepaid income
amounts. It also deducts certain amounts from net income such as tax-exempt interest and
various other deductions which are not recorded in book income. Schedule M-3 is a similar type
of report but is extremely more specific in nature and more time consuming to fill out than the
Schedule M-1 is.
The S-corporation is an entity that passes most income amounts and losses on to it’s
partners to be...