Comments on Schedule M-3 with the Objective of Reducing Burden and Duplication

Transcription

1 August 1, 2011 Ms. Heather Maloy Commissioner Internal Revenue Service Large Business and International Division Mint Building 801 Ninth Street, NW M4-313 Washington, DC RE: Comments on Schedule M-3 with the Objective of Reducing Burden and Duplication Dear Ms. Maloy: The American Institute of Certified Public Accountants (AICPA) appreciates the opportunity to provide comments relative to Schedule M-3, Net Income (Loss) Reconciliation. This letter incorporates preliminary comments and suggestions from our April 25, 2011 letter 1 on this subject, and provides additional comments, recommendations, and responses to specific questions posed by the Internal Revenue Service (IRS). We use Schedule M-3 in this letter to refer generally and collectively to the filing requirements described below in Purpose and Development of Schedule M-3, unless otherwise specifically noted as to a particular form or schedule. As the national professional association of certified public accountants comprised of approximately 370,000 members, the AICPA is well positioned to comment on Schedule M-3. Our members prepare income tax returns that include Schedule M-3 for thousands of corporate and partnership taxpayers, advise taxpayers regarding Schedule M-3 reporting, and review returns of those taxpayers that prepare their own returns that include Schedule M-3. Based on our members significant experience with the Schedule M-3, we offer the following comments of a technical nature, as well as our views regarding the level of burden on taxpayers and practitioners, and our suggestions for change. 1 _ _Sch_M3_Comments.pdf

2 Internal Revenue Service August 1, 2011 Page 2 of 9 Recommendations Based on input from its members, the AICPA believes that Schedule M-3 is not achieving its stated goals (see Schedule M-3 Stated Goals below), and in fact, there is unnecessary duplication of purpose between Schedule M-3 and Schedule UTP, Uncertain Tax Position Statement. As discussed in detail below and in the Appendices, we believe that IRS should consider significant revisions to, and elimination of, certain elements of Schedule M-3, so as to reduce undue taxpayer burden. I. IRS consideration of the following Schedule M-3 revisions, eliminations, and alternatives A summary of the recommendations to the Schedule M-3 are included below. Further details and specifics associated with these recommendations are included in Appendix B, and the other appendices. Revisions to Parts I, II and III of Schedule M-3: Eliminate required completion of columns (a) and (d) of Parts II and III of Schedule M-3 for all years, and not just the first year that a taxpayer is required to file Schedule M-3; If this recommendation is not accepted, then consider ways for eliminating the extensive duplication between Page 1 of Form 1120 and column (d) of Parts II and III of Schedule M-3, including potentially revising Page 1 of Form 1120 for all filers or at a minimum not requiring completion of Page 1 of Form 1120 by Schedule M-3 filers. Similar changes should be considered for all form types, including Forms 1120-F, 1120-L, 1120-PC, 1120-S, and Eliminate and revise certain lines on Parts II and III of Schedule M-3, such as eliminate the line in Part II for Items relating to reportable transactions (see Appendices B and D for discussion and additional examples). Revise supporting detail required for certain lines in Parts I, II and III of Schedule M-3, such as eliminate in Part I most of the supporting detail for lines 5-7 (see Appendices B and D for discussion and additional examples). Alternatives to revising Parts II and III of Schedule M-3 (for detailed discussions, see Appendix B, section D. General Suggestions): Eliminate and replace Parts II and III of Schedule M-3 with an expanded Schedule M-1 that would be used by all business taxpayers (see sample format in Appendix C). Part I of Schedule M-3 would still be required for certain business filers, or, Consider combining Page 1 of Form 1120 (and similar forms) with the columnar format of Parts II and III of Schedule M-3, or,

3 Internal Revenue Service August 1, 2011 Page 3 of 9 Consider revamping the entire income tax return, at least for certain taxpayers with audited financial statements. Eliminate Form 8916-A, Supplemental Attachment to Schedule M-3. Eliminate the reportable entity partner (REP) requirement related to the Form 1065 Schedule M-3. Consider increasing the Schedule M-3 asset threshold above $10 million, in particular as to filers of Forms 1065 and 1120-S. This is consistent with the AICPA s recommendation regarding keeping the Schedule UTP asset threshold for these taxpayers above $10 million. 2 Expand the use of Schedule B (Form 1120) and Schedule C (Form 1065) for risk assessment in lieu of adding new lines and requesting additional supporting detail on Schedule M-3 (e.g., eliminate the R&D expenditures line from Schedule M-3, Part III, and replace it with a question on Schedules B/C). Allow a consolidated group of corporations that all file Form 1120, except one corporation that files a Form 1120-PC, to file as only a Form 1120 consolidated group, and not as a mixed group, that otherwise requires sub-consolidations and Form 8916, Reconciliation of Schedule M-3 Taxable Income with Tax Return Taxable Income for Mixed Groups. Revise Form 8916 to be a columnar form that shows side-by-side eliminations and limitations for each sub-group. Consider phasing in revisions to Schedule M-3 over more than one year, including allowing those taxpayers that might want to fully report on Schedule M-3 to do so for a period of time (e.g., continued completion of columns (a) and (d), if this requirement is eliminated for taxpayers), because of the time it takes software developers, taxpayers, and practitioners to change their technology, processes, and record keeping. II. IRS and Treasury provide information on the use and effectiveness of Schedule M-3 data We request IRS and Treasury to provide feedback to the public regarding how Schedule M-3 data is actually being used. In addition, it would be helpful to taxpayers and practitioners to understand if IRS believes Schedule M-3 has been effective in risk assessment and examinations, and how such effectiveness is being measured. 2 See AICPA comment letters dated December 2, 2010, A% %20UTP%20letter.pdf, as well as June 1, 2010, AICPA%20Comments% %20on%20Ann% pdf, for further details regarding AICPA recommendations associated with the filing threshold for Schedule UTP.

4 Internal Revenue Service August 1, 2011 Page 4 of 9 III. Meeting between IRS and external stakeholders to discuss Schedule M-3 Based on the favorable results of prior collaboration between IRS and external stakeholders during the development of Schedule M-3, we request that the IRS Schedule M-3 Working Group hold meetings with external stakeholders to discuss its findings from both internal and external data gathered, such as the detailed information we provide in this letter, and any IRS proposed revisions to Schedule M-3. IV. IRS review of the effectiveness of all transparency reporting tools We request that IRS consider expanding this Schedule M-3 initiative to include review of all transparency tools, including Forms 8275, 8275-R, and 8886, Schedule UTP, and the expanded ownership reporting on Forms 1065 and Discussion Purpose and Development of Schedule M-3 The Schedule M-3 was developed by IRS and the Department of the Treasury (Treasury) to replace Schedule M-1 for certain business filers, with a view towards increasing transparency and standardization in the reporting of book to tax (book-tax) differences. It was first required to be filed by certain corporations filing Form 1120 for tax years ended December 31, Subsequently, that initial Schedule M-3 served as a model for developing unique Schedules M-3 for certain corporations filing Forms 1120-S, 1120-PC, and 1120-L, certain partnerships filing Form 1065, and certain foreign corporations filing Form 1120-F. Reporting requirements were further expanded by requiring additional detail for certain Schedule M-3 filers on Forms 8916 and 8916-A, and for all Schedule M-3 filers on Form 1120 (Schedule B) and Form 1065 (Schedule C). Role of External Stakeholders IRS and Treasury used a collaborative approach in developing and expanding Schedule M-3, enlisting stakeholders, such as AICPA, for their review of the Schedule M-3 concepts and the various draft schedules and related instructions, comments on the estimated burden that would be imposed on taxpayers and their advisers, and suggestions for change. Announcement , released in September 2010 with other Schedule UTP guidance, announced the creation by IRS of a working group to study and revise Schedule M-3, and stated that the group would work with external stakeholders to develop appropriate revisions to Schedule M-3. The AICPA is pleased to be asked once again for our input as IRS considers revisions to Schedule M-3. Request for Meeting of IRS and External Stakeholders The AICPA believes that IRS, Treasury and external stakeholders found the collaboration for the initial design and expansion of Schedule M-3 to be enlightening and productive, and believes that

5 Internal Revenue Service August 1, 2011 Page 5 of 9 similar collaboration would be useful in its revisions of Schedule M-3. Consistent with such previous collaboration efforts, we recommended in our April 25, 2011 letter that IRS meet with stakeholders quickly to discuss in more detail Schedule M-3 and taxpayer burden and duplication. Our request was acknowledged, but not accepted, perhaps because IRS is still in a fact gathering stage. Once additional input has been received from stakeholders, we hope that IRS will reconsider our request for a meeting with external stakeholders and that additional collaboration will take place before finalizing any revisions to Schedule M-3. Request for Current IRS Use of Schedule M-3 Data The AICPA also requested in our previous letter information regarding how IRS and Treasury are currently using the data from Schedule M-3. For example, it would be helpful to know if the Large Business and International Division (LB&I) has been able to use (and if so, generally how it is being used) Schedule M-3 data to help select returns and issues for examination, one of the primary purposes of Schedule M-3. We still believe this information would be useful to stakeholders as we discuss the benefits and burdens related to Schedule M-3 and the impact of the new Schedule UTP disclosure requirements. If taxpayers more clearly understand the IRS utilization of the Schedule M-3 data, they may place greater emphasis on the presentation of items on Schedule M-3, or be able to offer alternatives to IRS that would help IRS to achieve its goals, as well as provide more consistency and reduce taxpayer burden. Because of reduced resources, increased time pressures, not understanding why the book data is needed, and the perception that IRS does not use such data, a taxpayer may not place as much focus on making presentation reclassifications and adjustments on the Schedule M- 3, especially when the reporting requirement for an item is not clear or not generally easy to understand, or is subject to different interpretations. Rather, they may focus their meager resources on properly calculating and reporting the final tax liability, making timely elections, completing and timely filing international forms, timely e-filing the return, and timely paying the tax. As such, these facts may bring into question the reliability of the Schedule M-3 data on which LB&I may be making risk decisions and highlight the need for more transparency with respect to the IRS use of Schedule M-3 data. Schedule M-3 Stated Goals Listed below are the stated goals of the Schedule M-3 as set forth in the Schedule M-3 General Explanation. These were included with the January 28, 2004 press release (IR ) that announced the proposed Schedule M-3 (note that the General Explanation was later replaced on with links to the most current Schedule M-3 form and instructions). Increase transparency while minimizing overall taxpayer burden. Reduce the time required to examine tax returns and be in a position to examine the most recent tax returns filed.

6 Internal Revenue Service August 1, 2011 Page 6 of 9 Provide consistent reporting among taxpayers and from year to year for each taxpayer. Provide 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. Periodically modify the form to highlight emerging issues, identify trends, and adapt to future changes encountered by large and midsize corporations. Facilitate tax return selection and issue identification through electronic filing. Facilitate the use of Limited Issue Focused Examination (LIFE) audits through greater transparency. Duplication of Purpose between Schedule M-3 and Schedule UTP Both Schedules M-3 and UTP, which seek to improve transparency and increase exam efficiency, have increased taxpayer reporting burden. Taxpayers also are confronted with an array of additional requirements, including electronic filing, that at least in part support exam efficiency, and these requirements have added significant time and costs to return preparation. In light of the burden borne by taxpayers, it is important that these tools not be duplicated and that they be used effectively by IRS. We suggest that the Schedule M-3 evaluation initiative be expanded, such that IRS, and in particular LB&I, consider analyzing all such risk assessment tools, their purposes, and discuss with taxpayers how they are being used, and what efficiency goals, if any, are being met or not met. For instance, in announcing the Schedule UTP proposal, Commissioner Shulman made the following comments on January 26, 2010: Today, we spend up to 25 percent of our time in a large corporate audit searching for issues rather than having a straightforward discussion with the taxpayer about the issues. It would add efficiency to the process if we had access to more complete information earlier in the process regarding the nature and materiality of a taxpayer s uncertain tax positions. The goals of our proposal are simple: to cut down the time it takes to find issues and complete an audit ensure that both the IRS and taxpayer spend time discussing the law as it applies to their facts, rather than looking for information and to help us prioritize selection of issues and taxpayers for examination.

7 Internal Revenue Service August 1, 2011 Page 7 of 9 These comments are strikingly similar to comments from IRS and Treasury officials included in IR , when the Schedule M-3 proposal was announced six years earlier on January 28, 2004: The proposed Schedule M-3 will make differences between financial accounting net income and taxable income more transparent. This will help agents determine from the return whether the return should be audited and identify the differences that matter most in the audit of the return. We see benefits to taxpayers and the IRS from the new Schedule: a reduction in unnecessary audits and a swifter focus on those differences that are more likely to arise when taxpayers take aggressive positions or engage in aggressive transactions. In addition, the increased transparency will have a deterrent effect. The new Schedule will let the IRS sharpen and improve monitoring of corporate compliance. Our objective is to identify and resolve potential audit issues promptly. This information will help us do so. These changes will enable us to focus our compliance resources on returns and issues that need to be examined and avoid those that do not. Increasing the transparency of corporate tax returns is critical to our objectives to provide certainty to taxpayers sooner and to improve overall compliance. The need for IRS to introduce the Schedule UTP reporting requirements after six years of Schedule M-3 reporting suggests that Schedule M-3 has not succeeded in meeting the goals originally set for it transparency, consistency and efficiency. Parts II and III of Schedule M-3 focus on book-tax difference risk, and we acknowledge that Schedule UTP goes beyond that to include other items, such as tax credit risks. But Schedule UTP also seems to be an acknowledgement of the limitations of Schedule M-3 in effectively describing the book-tax difference. Anecdotal evidence suggests that this limitation has also been expressed to taxpayers by many IRS examiners, who have commented they received more information from Schedule M- 1 than they receive through Schedule M-3 reporting. We believe that the shortest path to meeting the challenges that these various transparency initiatives seek to address would be for government, in collaboration with private sector stakeholders, to undertake a fresh and comprehensive review of the whole array of transparency and exam efficiency tools currently in use. This review might include such tools as Schedules M- 3 and UTP, Forms 8275, 8275-R, and 8886, and the expanded ownership reporting on Forms 1120 and 1065.

8 Internal Revenue Service August 1, 2011 Page 8 of 9 Asset Threshold for Schedule M-3 and Schedule UTP As it stands today, the Schedule M-3 filing threshold for all potential types of filers is total assets at the end of the tax year equal to or exceeding $10 million (note that partnerships have additional criteria if the asset threshold is not met). This places an undue burden on many privately-owned businesses that are not of a significant size and have even more limited resources than other, larger businesses. The AICPA has previously expressed its concerns regarding the fully-phased-in filing threshold of Schedule UTP of $10 million or more in total assets. We reiterate these concerns again as the ultimate threshold remains a very important issue for our members. As such, we continue to recommend that the Service maintain on a permanent basis the filing threshold for Schedule UTP at the level of $100 million in total assets for corporations. Having a permanent Schedule UTP filing threshold that is substantially higher than $10 million recognizes that small, privately-held entities are especially concerned about the burdens attendant to the obligation to file Schedule UTP, including increased costs of both financial statement audits and tax return preparation. Assuming that the Schedule M-3 is maintained in its current or similar form, having a Schedule M-3 total asset filing threshold that is significantly higher than the $10 million as it stands today, and that is comparable to our recommendations for the Schedule UTP filing threshold, ($100 million in total assets) would recognize the similar significant burden placed upon smaller businesses and their resources constraints. Responses to Specific IRS Questions IRS requested suggestions and feedback to specific Schedule M-3 questions grouped into six categories (see Appendix A). Our observations on or responses to those questions are included in Appendix B. The questions seem to assume that Schedule M-3 will be continued in its current 3- part format. However, we encourage IRS to consider other alternatives, including those that we discuss in Appendix B, section D. General suggestions. The Schedule M-3 concept and form were developed during the same time that IRS was developing its Modernized e-file (MeF) system. The stacked return format for a consolidated return (i.e., separate return, and separate Schedule M-3 for each includible corporation) was due partly to limitations of MeF and XML (Extensible Markup Language), including inability to receive columnar-formatted data, and concerns over PDF file size. As technology has changed since then, and as IRS reviews its overall systems and processes for improvement, we suggest that consideration should be given to redesign how taxpayers are required to provide book-tax difference information with their tax returns, as well as re-considering the usefulness and importance of such book-tax information in overall risk assessment. Further, in light of the severe impact on businesses of our current global economic conditions, we appeal to IRS to consider the increased cost to taxpayers from required Schedule M-3 reporting, without demonstrated benefit to IRS, Treasury, and taxpayers. Tax departments of companies or

9 Internal Revenue Service August 1, 2011 Page 9 of 9 others who are charged with completing tax returns properly, timely, and efficiently, usually are not able to participate in the design of their companies basic financial and accounting systems. These systems are designed to deliver information with which to manage the business and to provide the information necessary for the financial statements. Information requirements for tax purposes, other than the basics to calculate the correct tax liability, take a back seat in development of taxpayers accounting systems. Thus, when tax return items more closely follow the financial statement reporting, a tax return can be prepared more timely and efficiently. If Schedule M-3 information is nice to have, but costs money to produce, and duplicates information necessary to calculate the correct tax liability that is already provided in other parts of the tax return, it falls into the bottom of the cost-benefit bucket of the company s many spending needs. In response to the IRS s specific questions on this subject, Appendix B summarizes the detailed comments received from many AICPA members, including corporate and partnership Schedule M-3 filers, all of which support the foregoing discussion and recommendations. Closing The AICPA looks forward to continuing our discussions with IRS regarding Schedule M-3 and hopes that a meeting with external stakeholders can be arranged soon. Please feel free to contact Linda S. Gurene, Chair of the AICPA Schedule M-3 Task Force, at linda.gurene02@ey.com, or (210) ; Benson S. Goldstein, AICPA Senior Technical Manager, at bgoldstein@aicpa.org, or (202) ; or Michelle R. Koroghlanian, AICPA Technical Manager at mkoroghlanian@aicpa.org, or (202) Sincerely, Patricia A. Thompson, CPA Chair, Tax Executive Committee Attachments: Appendix A: Schedule M-3 Questions Posed by IRS Appendix B: Detailed Responses to Specific IRS Questions Appendix C: Sample Revised Schedule M-1 Book-Tax Reconciliation Appendix D: Examples of Revisions and Eliminations to Specific Schedule M-3 Lines and Attachments cc: Ms. Deborah Palacheck, Senior Advisor, Internal Revenue Service, Large Business and International Division

10 Appendix A Schedule M-3 Questions Posed by IRS (See Appendices B, C and D for AICPA responses) A. Time and Costs to Comply with the Schedule M-3 Filing Requirement 1. In completing the Schedule M-3 when you were first required to file it, what costs, if any, did you incur in setting up for the initial year? 2. After the initial year, do you continue to incur additional costs? If yes, please describe. 3. What costs, if any, do you incur when the IRS makes changes to the Schedule M-3 (e.g., the addition of certain lines)? B. Specific Data Provided on Schedule M-3 1. How closely do the lines on the Schedule M-3 align to the way you keep your books? What steps must you take to align the way you keep your books to the lines on the Schedule M-3? 2. Are there more natural categories that the Schedule M-3 could include to track more closely to your books? If yes, please provide some examples. 3. Are some lines more difficult to prepare than others? If yes, which lines are the most difficult and what makes them difficult? 4. Do some lines reflect duplicative reporting of items? If yes, what information is duplicated and how can the process be improved? 5. Do you net items to complete certain lines of the Schedule M-3? If so, please provide some examples of the types of netted items and the lines on the Schedule M-3 where these are reported. 6. What types of items are reflected in the attachments for the other with difference lines in Parts II and III? Would you prefer that some of these items be requested on separate lines? 7. Based on your experiences with the IRS, how have the IRS used the attachments you provide in response to the other with difference lines of Parts II and III? 8. Which, if any, lines of the M-3 do not allow for accurate responses and why? 9. What lines, if any, would you recommend eliminating and why? 10. What suggestions, if any, do you have for improving the reporting of information currently required on attachment 8916-A (currently for the cost of goods sold line, the interest income line, and the interest expense line)? C. Audit Experience 1. How has your audit experience changed, both positively and/or negatively, since the introduction of the Schedule M-3? Appendix A Page i of ii

11 D. General Suggestions 1. What attachments, if any, can be eliminated by incorporating the data elsewhere on the Schedule M-3? 2. What suggestions do you have for improving the design of attachment(s) that would make reporting easier? 3. What suggestions do you have for improving the design of the Schedule M-3 that would make it easier to complete, improve accuracy of information, and reduce duplication of information? E. Instructions 1. Describe any problems or challenges you face in following or understanding the instructions for completion of the Schedule M How can the Schedule M-3 instructions be improved? F. Consolidation and Sub-Consolidation Processes 1. For preparers subject to consolidation but not to sub-consolidation (no L and PC subsidiaries), how can the consolidation process and instructions be improved? How can MeF be improved for such consolidation filers? 2. For preparers subject to sub-consolidation (L and PC subsidiaries), how can the subconsolidation process and instructions be improved? How can MeF be improved for such consolidation filers? Appendix A Page ii of ii

12 Appendix B Detailed Responses to Specific IRS Questions Regarding the specific IRS questions in Appendix A, below is a summary of responses received from many AICPA members, both from a practitioner as well as from a corporate and partnership taxpayer point of view. A. Time and Costs to Comply with the Schedule M-3 Filing Requirement When Schedule M-3 was introduced, IRS representatives publicly acknowledged that taxpayers would face upfront and ongoing burden of cost and time (see, for example, IR , which requested comments on ways to minimize taxpayer burden). Taxpayers were told that this burden would be offset through reduced examination time. However, as discussed in section C below, the collective experiences of AICPA members and practitioners do not show such reduction, and, in fact, taxpayers continue to incur significant ongoing burden resulting from Schedule M-3, with little or no perceived benefit. IRS Time Estimates The ongoing cost to taxpayers has been acknowledged in the time estimates included by IRS in the Form 1120 instructions. For example, a single corporation that is required to file a 2010 Schedule M-3 and Schedule B is expected to incur on average almost 100 more hours than a corporation allowed to file Schedule M-1. For a consolidated return group that is required to file Schedule M-3, the 100 hours is estimated to increase by an additional 85 hours per corporation for recordkeeping and form preparation. Adding to that, each corporation that reports cost of goods sold is estimated to incur on average more than 20 additional hours when it is required to file Schedule M-3 (and the supporting Form 8916-A, Part I) than if it were allowed to file Schedule M-1. Increased Return Preparation Fees Tax practitioners advised their clients when Schedule M-3 was introduced to expect a fee increase associated with implementation of Schedule M-3. In many cases, this was as much as a 10-35% increase over prior year fees. Many taxpayers have not seen significant decrease in fees in subsequent years because of ongoing additional work required to properly report Schedule M- 3, as discussed below, and the addition of new Schedule M-3 lines, attachments, and schedules. Parallel Tax System Much of the required additional time results from the fact that Schedule M-3 is a parallel system of computing taxable income. Also, those taxpayers that must file Schedule M-3 for U.S. Appendix B Page i of xi

13 Federal income tax purposes must still provide book-tax differences in a Schedule M-1 format, since some states still use that format. As such, software vendors did not redesign tax preparation systems to incorporate the new Schedule M-3 reporting requirements, but bolted on this new system, requiring duplicate mapping of accounts, analysis of detail, and many manual adjustments to report things differently on Schedule M-3 than they are reported on other parts of the tax return (for example, Page 1 of Form 1120). Column (a) of Parts II and III In particular, many taxpayers incur a significant amount of extra return preparation time related to properly reporting column (a), Income (Loss) or Expense per Income Statement, of Parts II and III, and for no perceived benefit. The majority of taxpayers general ledger income/expense accounts do not map directly to the 60+ categories for this column, resulting in the need for manual reclassifications and adjustments, for example, when a single general ledger account must be disaggregated to show two or more amounts on different lines of Schedule M-3. In addition, many accounts that may initially be automatically mapped by the tax preparation software to the appropriate line may then have to be manually adjusted to comply with the Schedule M-3 instructions; for example, to reclassify and aggregate amounts related to a reportable transaction, or for accounts in which there are no book-tax differences that must be reclassified and aggregated in Part II, line 28, all of which can only be determined after the return is substantially complete. Since a separate Schedule M-3 is required for each corporation, this analysis and resulting adjustments must be made for each corporation in a consolidated return, as well as reviewed and analyzed at the consolidated level. Consolidated Return Groups Large consolidated return groups often have multiple general ledger systems and sometimes use multiple tax return preparers or a combination of in-house and external resources. Such corporations use software, like Hyperion, to consolidate for financial statement purposes, which then can be mapped for Form 1120, page 1 and posting data of book-tax differences, in a Schedule M-1 format. However, there is not a similar consolidation for column (a) of Schedule M-3, and tax departments and external preparers must incur a significant amount of additional time to generate the information. Completing a separate Schedule M-3 for each entity has resulted in a significant increase in the size of the returns prepared and the review required. While the prior year work and knowledge can be leveraged from year to year, each year brings new issues, new book-tax differences and the need to address all of these on the forms. Effectively, one change to the Schedule M-3 to update a subtle nuance after the original mapping has been done, can result in significant time in order to rerun the return. Review Process The review process for the Schedule M-3 also has created additional burdens for taxpayers. Historically, taxpayers prepare a workpaper reporting book income followed by all the book-tax Appendix B Page ii of xi

14 differences to conclude with the taxable income. With the Schedule M-3, many book-tax differences that were historically reported on different lines in the detail attachments to the Schedule M-1 are now mapped to one line on the Schedule M-3. Therefore, the review of the Schedule M-3 is much more complex. One member commented that they recently had staff spend an entire day trying to tie the items on Schedule M-3 to the client s detailed book to taxable income schedule... and this was just at the consolidated level and not for each separate entity. In general, we still see taxpayers putting in a good faith effort to complete the information required on the Schedule M-3, but from a cost-benefit perspective, taxpayers may not put forth the effort to report items on Schedule M-3 as precisely as they would like to if they had more time and budget associated with the preparation of the tax return, particularly when they consider that exposure for non-compliance is likely low.. One member commented that after a while, it becomes very difficult to tie the taxpayer s books and records into the specific lines required by Schedule M-3. It would seem that an IRS auditor would also have the same difficulty and additional time consumption in an examination. Column (d) of Parts II and III Finally, many taxpayers spend extra time during the tax return preparation and review process because of column (d), Income (Loss) or Deduction per Tax Return, of Parts II and III, which duplicates information found in other parts of the return. For example, taxable income computed via column (d) of Schedule M-3 (Form 1120) must agree with taxable income before net operating loss (NOL) and special deductions reported on Form 1120, page 1, line 28. Ensuring that taxable income totals agree requires some additional time. Many taxpayers must then spend significant amounts of additional time to reconcile individual line items, such as interest income, which appropriately, but perhaps not understandably, may be different between Schedule M-3 and Form 1120, page 1. For example, a Schedule M-3 filer reports interest income from a partnership on Form 1120, page 1, line 5, Interest, but is instructed not to include this same amount in Interest Income on Schedule M-3, Part I, line 13. Instead, this amount must be combined with other partnership items and included in either line 9 or 10 of Schedule M-3, Part II, depending on whether it is from a U.S. or foreign partnership. Such differences must be reconciled, explained, and documented, requiring additional time, which yields little, if any, added value. B. Specific Data Provided on Schedule M-3 Columns (a) and (d) As explained in the discussion that follows, the AICPA believes that columns (a) and (d) of Parts II and III of Schedule M-3 create most of the administrative burden associated with Schedule M- 3, are not aligned with how keep book or how compute book-tax differences, and result in duplicative reporting. As such, the AICPA strongly suggests that the requirement to complete columns (a) and (d) of Schedule M-3 be eliminated. Worded another way, our recommendation here is to expand the optional completion of columns (a) and (d) of Parts II and III of Schedule Appendix B Page iii of xi

15 M-3 from just the first year that the taxpayer is required to file Schedule M-3, and make it optional each year. Since the inception of Schedule M-3, a taxpayer is generally not required to complete columns (a) and (d) of Parts II and III of Schedule M-3 for the first year that the taxpayer is required to file Schedule M-3. Presumably, the data provided in columns (b) and (c) of Parts II and III of Schedule M-3 are perceived as being of more value to the government than these other columns. Forcing a reclassification of the financial books of a company based on a Treasury-specified chart of accounts in order to complete columns (a) and (d) of Parts II and III of Schedule M-3 is extremely burdensome and can be perceived as unreasonable or without purpose. Book general ledger accounts do not map directly to the majority of the lines for Column (a) of the Schedule M-3. Taxpayers initially map their general ledger accounts to the line item on the Schedule M-3 that they believe best reflects the majority of the account activity. This results in the need to prepare manual adjustments to properly report items in accounts that are not mapped to the specific Schedule M-3 line for which they relate. Examples include: Gross foreign dividends not previously taxed/previously taxed; U.S. dividends not eliminated in tax consolidation; reportable transactions; section 481(a) adjustment; sale versus lease/purchase versus lease; other equity based compensation; parachute payments; compensation with section 162(m) limitation; deferred compensation; current year acquisition costs; section 198 environmental remediation costs; COLI premiums; section 118 exclusion; and many of the amounts reported in other income/expense items with differences. This mapping and reconciliation activity adds unnecessary complexity and burden to the Schedule M-3 preparation because taxpayers and practitioners do not believe there are a significant number of line items on the Schedule M-3 for which the book income/expense amount is relevant from a risk perspective. However, if there are specific line items for which IRS believes the related book amount should be reported (e.g., meals and entertainment), this could be requested as a separate amount on a supplemental schedule, such as Form 1120 Schedule B. Moreover, there is confusion regarding whether the line item description is describing the booktax difference, the book income or expense, or the income or expense. The book description of an item doesn t necessarily translate exactly into the tax description (as identified in the line items for the Schedule M-3) of the item. Some examples follow: Example 1: Warranty reserve. If a taxpayer has a book-tax difference reported in Other Expense/Deduction Items with Differences to report the book-tax difference related to their warranty reserve, this is a book-tax difference that is generally calculated by the change from one year-end to another in the balance sheet warranty reserve account. Taxpayers generally do not have a book expense called warranty expense reserve; they may have an expense account called Appendix B Page iv of xi

16 warranty expense. That book expense account relates to current activity that was never part of the warranty expense reserve, activity that released some of the warranty expense reserve, and activity that increased the warranty expense reserve. If the line item is to report only the activity related to warranty expense that impacted the warranty expense reserve, extensive work would be required by taxpayers to report that specific activity in column (a). Example 2: Prepaid insurance. A taxpayer generally does not have an expense account called prepaid insurance. Therefore, the taxpayer will map an account called insurance expense, which includes all insurance expenses (prepaid and otherwise) to the prepaid insurance supporting line for the Other Expense/Deduction Items with Differences. Mapping the entire activity for all insurance expense does not coincide directly with the description taxpayers provide for the book-tax difference. Example 3: Hedges. For book purposes, income or loss from hedge transactions may be included in interest expense. The tax preparer may not know hedging activity exists, or even if they are aware, they may not be able to gather the information to report the amount in column (a). Example 4: Acquisition and Reorganization Fees. It is complex and time consuming to gather all the different elements onto the correct lines of the Schedule M-3 for column (a) reporting. This is only increased with the recent changes in the financial accounting rules such that all these amounts are expensed for book purposes. Therefore, there is additional tracking and mapping required for tax reporting purposes only. From a taxpayer s perspective, it does not appear that putting forth the effort to segregate the activity of the book expense accounts between the current activity and the activity that impacted only the reserve account or the prepaid account solely to report amounts on Schedule M-3 would provide any additional benefit to IRS in their risk assessment process. Therefore, we respectfully request that the requirement to complete columns (a) and (d) of the Schedule M-3 be eliminated. Specific Line Items Part I Line 8, Adjustment to eliminations of transactions between includible entities and nonincludible entities, and other reconciling adjustments reported on Line 10, for Part I continue to cause concerns for taxpayers. Some taxpayers use the equity method for reporting and making adjustments in Part I (line 8 or line 10). Use of different methods results in an inability to accurately compare a taxpayer to another taxpayer for items like partnership income and income from related corporations that are not included in the consolidated income tax return but relate to entities that file separate returns. Furthermore, if a taxpayer has significant intercompany dividends that flow up the chain, it can be very confusing as to how to report the elimination entries and intercompany dividend adjustments. A taxpayer recently spent significant time reviewing the instructions attempting to understand this issue and found the instructions to be Appendix B Page v of xi

17 quite confusing. Clarifying guidance would be beneficial to taxpayers to ensure proper completion of these line items. Completion of Part I is also very confusing for privately held businesses that report more than one entity in their financial statements that are not consolidated for tax return purposes. It is very rare to have financial statements that do not include another entity due to the variable interest entity requirements for commonly controlled entities. Some taxpayers do not understand the benefit of starting with worldwide income and worldwide balance sheet information on Part I, then subtracting non-includible information as opposed to just starting with includible information. Furthermore, our experience is that some IRS auditors are not utilizing the information from Part I during the audit process. Consideration should be given to raising the Schedule M-3 asset threshold, as well as whether requirements to file Schedule M-3 should be eliminated for certain form types. Specific Line Items Parts II and III Many line items that were of interest to Treasury and/or IRS at the time Schedule M-3 was designed, we believe, are no longer necessary today. For example, there are fewer taxpayer reportable transactions, or the IRS has developed other ways to obtain the information, such as Schedule UTP. Also, when the IRS removes an item or lowers the attention level of an item on its Tiered Issue list or reduces the risk level of other issues, it should consider whether any line item relating to the matter should be removed from the Schedule M-3. Different line items, or additional questions, may now be more helpful for IRS risk analysis, and so we recommend periodically revising the line items, to capture only data that is necessary and will be used in the audit process. Furthermore, with respect to detail descriptions of book-tax differences, the design of the form and the limitation of tax preparation software results in less information being provided now than prior to the introduction of Schedule M-3. The description for the Schedule M-3 line is the only description available for all the book-tax differences for that line item. For example, a taxpayer may have various types of unearned/deferred revenue items that prior to the Schedule M-3 would have been listed as separate book-tax differences. However, with the Schedule M-3, this detail is no longer visible to the IRS for their risk assessment. Furthermore, the book activity for column (a) for unearned/deferred revenues is, generally, included in sales and is difficult, if not impossible, to segregate from sales to report in column (a). We also find that some of the supporting data requested by the Schedule M-3 instructions for various lines might be more effectively requested by an examiner through an IDR. For example, a new line, Research and development costs, was added to the 2010 Schedule M-3. The requested supporting data appears to be the data used by IRS to audit the research credit. Obtaining data through the Schedule M-3 for risk assessment regarding the research credit might more appropriately be handled through a targeted question, on Schedule B (Form 1120). This new line is another example of increased burden imposed by the Schedule M-3 in terms of the additional amount of time that a taxpayer will incur to obtain the amounts to report in column Appendix B Page vi of xi

18 (a), as most taxpayers do not separately report book research expenditures in their general ledger. We question the addition of new reporting requirements for the Schedule M-3, such as the new line added for research and development (R&D) expenditures, at a time when many practitioners and taxpayers question the continued usefulness of the Schedule M-3 in light of the Service s request for reporting of uncertain tax positions (UTPs). We recognize the IRS has recently provided a frequently asked question (FAQ) on its website that attempts to provide a simplified procedure for reporting R&D expenditures on Schedule M-3, however, we nevertheless believe this new R&D line expands the original purpose of the Schedule M-3, rather than increasing transparency and reducing duplication and burden. Thus, despite the FAQ, we recommend elimination of the R&D cost expenditures line on Schedule M-3. An example of another group of items that are difficult to map to the Schedule M-3 specific line items are the various components of what, for book purposes, is categorized as wages (e.g., vacation accrual, bonus accrual, compensation with section 162(m) limitation, stock based compensation, other deferred compensation items). While we believe that the requirement to complete columns (a) and (d) should be eliminated, if columns (a) and (d) continue to be required, it may be helpful to group the various compensation line items with wages (similar to the Part II line 23 group of items) and have the wages line have column (a) and (d) completed, and then have the detail compensation items book-tax differences line items below complete columns (b) and (c). Furthermore, there is confusion regarding where certain items should actually be reported. For example, if an executive hits a section 162(m) limitation and part of that limitation is due to stock based compensation, is the adjustment that covers both section 162(m) limitation and stock based compensation reported as a section 162(m) limitation or in stock based compensation? Form 8916-A Taxpayers that report cost of goods sold on Schedule M-3, Part II, line 17 must spend significant time providing supporting data in Part I of Form 8916-A, Supplemental Attachment to Schedule M-3. There is substantial variation regarding how taxpayers interpret the instructions and, as a result, the level of detail provided for book and adjustment amounts significantly varies. For example, for book purposes, many taxpayers report the labor and overhead cost of goods sold costs (e.g., wages, depreciation) as general costs and then complete a calculation to allocate those costs to ending inventory and cost of goods sold using several allocation methods. Therefore, the detail of the costs allocated to cost of goods sold are difficult if not impossible to determine (without analyzing the allocation calculations prepared for book purposes) and, as previously stated, would require significant manual entries to report items on the Form 8916-A appropriately. Some taxpayers may be putting forth the effort to complete this analysis for Form 8916-A, while others with limited resources may not be able to perform the analysis for the return. Variations in practice such as this one results in reduced ability to compare taxpayers for risk assessment purposes. Furthermore, it appears that the information from Form 8916-A is not being utilized by IRS examiners. Unless this information is being utilized by IRS, we highly recommend that Part I of the Form 8916-A be eliminated. Appendix B Page vii of xi

19 Furthermore, for taxpayers with a significant amount of intercompany debt, the interest reporting required on Form 8916-A can take significant time to gather. These amounts are not easily obtained from the taxpayers books. A taxpayer recently spent an entire afternoon trying to get this out of their books and records and into the system on the appropriate lines. We request that Part II of the Form 8916-A be eliminated, particularly if this information is not being utilized by the IRS. Duplication of Information Reported Elsewhere in the Tax Return Many items requested in the Schedule M-3 are items that are already provided or could be provided in other areas of the tax return. For example, Part I of Form 8916-A duplicates much of the information requested on Schedule A, Cost of Goods Sold. Information reported on Schedule M-3 duplicates some of the information reported on Forms 5471, 8858, and 8865 (e.g., name, EIN, dividends; book net income; assets and liabilities). Another prime example is the reporting of reportable transactions on the Schedule M-3 and also on Form If a taxpayer abandons two pieces of property during the year and one results in a loss of $4 million and the other a loss of $14 million with the second resulting in a reportable transaction, why should they be reported in two separate places on the Schedule M-3, especially in light of the required information on the Form 8886? This requirement results in more manual entries to place book-tax differences in the specific line items required on the Schedule M-3. Taxpayers are burdened enough with the expanded reporting requirements; therefore, we request that any duplicated information requested on the Schedule M-3 be eliminated. Partnerships Reporting on Schedule M-3 The Schedule M-3 was designed with a primary focus on multi-national consolidated groups. Many partnerships have limited books and records and thus have to create additional workpapers to provide the Schedule M-3 specific information. We believe this additional burden due to the Schedule M-3 reporting is not resulting in information utilized by IRS examiners and creates an extreme burden on small partnerships, particularly when such partnerships may only have one or two book-tax differences. Furthermore, the reportable entity partnership requirement adds additional complexity and is too complex for the IRS to examine or even enforce. Additionally, many hedge funds are partnerships. These taxpayers have the significant burden to now produce the Schedule M-3 information that, we believe, is not being utilized by the IRS. If the information from the Schedule M-3 for partnerships is not being utilized by the IRS, we respectfully request that the Schedule M-3 reporting requirements for these entities be eliminated. Appendix B Page viii of xi