The Internal Revenue Service requires corporations to complete a U.S. corporation income tax return, more commonly known as Form 1120. The return has different variants such as 990-T for exempt organizations, 1120-F for foreign corporations and 1065 for limited liability companies. All businesses, large or small, that fall into the 1065 category as limited liability partnerships must also submit Schedule M-1 along with annual returns.
There is usually a difference between what a corporation reports on its financial statements as its yearly profit and the corporation’s actual taxable profit. These differences arise because of the way in which the IRS accounts for the corporation’s operations and the way in which the corporation accounts for its operations. The IRS, therefore, requires that corporations use Schedule M-1 to enlighten it about reconciliations for accounting and taxable profits. Schedule M-1 is a reconciliation form.
Schedule M-1 presents the reconciling calculation, and it allows the IRS to identify credits a corporation is claiming such as exempt income and deductible expenses. The schedule begins with net income or loss as per your books. Thereafter, each line describes the book and tax differences until it goes to line 10 to arrive at the taxable income. The schedule adds line 7, the income reported on the books and line 8, the deduction not charged against the books for the tax year and then subtracts that amount from the total of lines 1 through 5. Note that the taxable income that is arrived at on M-1 is the taxable income on line 28 of Form 1120. It is the taxable income before net operating loss deduction and special deductions.
Schedule M-1 income adjustments are those sources of income, such as exempt interest, that are not considered taxable. This income also include amounts that are not taxable in the current period. Hence, adjustments to income on Schedule M-1 also include some deferred incomes, such as life insurance proceeds or any other income that bears timing differences. Similarly, some income is taxable in the current period but is not included in your corporation’s financial statement for the current period. This may be previously deferred income not charged by the tax authorities or income that is, by convention and IRS rules, tax chargeable in accelerated mode. Examples of these include certain collected interests.
As with some nontaxable income, there are expenses that the IRS does not allow. These expenses are either exempt from being included at all or are deferred until some specified future occurrence. For example, partnerships cannot use penalties to reduce taxable income. They also cannot claim accrued payments to employees until they actually make the payments. As with income accelerated and charged immediately by the IRS, there are certain expenses that are accelerated and charged against taxable income in the current period. These expenses may be those deferred items disallowed in prior periods but allowed in the current period. An accrued expense, such as unpaid rent, that is not deductible in previous periods is one example.
- IRS Instructions for Form 1120
- IRS: Reconciliation of Income (Loss) and Analysis of Unappropriated Retained Earnings per Books
- Mass.gov: 2010 Schedule M-1 Instructions
- IRS: Reconciling Corporation Book and Tax Net Income, Tax Years 1995-2001
- IRS: U.S. Corporation Income Tax Return
- IRS: Schedule M-1 Audit Techniques