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12232: 1120/1120S/1065 - Schedule L and Schedule M-1


Fed Returns Generally

How is Schedule L related to Schedule M-1 in a business return (1120, 1120S, 1065)?

Schedule L - Book Basis

The Schedule L should be prepared on the accounting basis the business entity uses for its books and records. There are situations when the books are prepared on a different basis than the tax return. In the case of depreciation, an allowable method may be used for tax reporting purposes that is disallowed for book purposes. For example, §179, bonus or MACRS depreciation may be allowed for tax reporting purpose but straight-line depreciation is required for book reporting purposes. The accumulated depreciation on the Schedule L is to be reported on the “book” basis.

Schedule M-1 (or M-3 when required) – Book to Tax Basis

Generally, the entity wants to maximize the earnings shown on its financial statement so far as allowed by GAAP. However, the entity also wants to minimize its taxable income for the same period so far as allowed by federal income tax law. Schedule M-1 (or Schedule M-3 where required) serve as the mechanism of reporting the methodology used to convert “maximized” book earnings to “minimized” taxable income.

Example

These depreciation differences are, in essence, timing differences. If an asset’s cost is $10,000 and is expensed under §179 for tax purposes, but depreciated for five years using straight-line for book purposes, at the end of the five years, the book and tax depreciation for that asset will be the same.

To reconcile the book income to the tax income reported on the tax return, these differences are reported on the Schedule M-1 (or M-3 where required). For this example, here is how the M-1 adjustment would be presented over the five years of the asset:

  Tax Depreciation Book Depreciation Difference
Year 1 $10,000 $2,000 $8,000
Year 2 $0 $2,000 ($2,000)
Year 3 $0 $2,000 ($2,000)
Year 4 $0 $2,000 ($2,000)
Year 5 $0 $2,000 ($2,000)
Totals $10,000 $10,000 $0

The amounts reported on the Schedule L for accumulated depreciation for the first year would be $2,000. To reconcile to the Schedule M-1, you must enter an amount on line 8a (for an 1120) to show the book-to-tax adjustment. In future years, you must enter an amount on lines 5a (for an 1120) to show the book-to-tax adjustment. This would continue until the asset is fully depreciated.

This is what the program does automatically for you. This is helpful because Drake carries “book” depreciation from the 4562 detail screens to the Schedule L by the selection on the L screen Carry book accumulated depreciation & amortization to Schedule L. This is also helpful if you use an outside depreciation program: use screens 6, 7, and 8 for tax depreciation purposes, and enter the assets and accumulated depreciation amounts directly on the Schedule L.

This being said, there are times when preparers use 4562 detail screens, but also override the amount carrying to the Schedule L on the L screen. If the calculated “book depreciation” amount for the year on the Schedule L matches the depreciation amounts on the 4562, then there is no M-1 adjustment. But if there are differences calculated, the program makes the adjustment automatically.

Drake makes an automatic adjustment to reconcile “book” basis and “tax” basis to help in the preparation of accurate returns. Be aware that the software, in making an adjustment, does not know what the entity’s books or records contain. The adjustment is based on the data entry you provide. If the data entered is wrong, then our adjustment will be wrong.

For Further Information:

The code section that explains the requirement for the accounting method is §446(a), which is explained more fully under Reg. 1.446-1(a)(4).


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