April 30, 2004
Ms. Susan Blake
Internal Revenue Service
Office of Pre-Filing and Technical Guidance
1111 Constitution Ave., NW
Mint Bldg M3-353 LM:PFT
Washington, DC 20224
Re: I.R. 2004-14, Proposed Schedule M-3
Dear Ms. Blake:
The American Institute of Certified Public Accountants (AICPA) respectfully offers the enclosed comments, pursuant to the request in IR 2004-14, on the Proposed Schedule M-3 in general and, specifically, ways that taxpayer burden can be minimized. The AICPA is the largest professional association of certified public accountants in the United States, with more than 350,000 members in business, industry, public practice, government, and education.
The enclosed comments were developed by members of our Tax Accounting Technical Resource Panel and approved by the Tax Executive Committee. We would be pleased to discuss these comments with you or a member of your staff at any time. If you have any questions, please contact either Barry Tovig, Chair of the Tax Accounting Technical Resource Panel, at (202) 327-8821 or ; or George White, AICPA Technical Manager, at (202) 434-9268 or .
Sincerely,
Robert A. Zarzar
Chair, Tax Executive Committee
Enclosure
cc: Helen M. Hubbard, Tax Legislative Counsel
George Manousos, Tax Specialist
Robert M. Brown, Associate Chief Counsel (IT&A)
AICPA April 30, 2004
Proposed Schedule M-3 Comments Page 2
AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS
Comments on the Proposed Form 1120 Schedule M-3
April 30, 2004
Developed by the
Proposed Schedule M-3 Task Force
Robert Kilinskis, Chair
John Bennecke
Michelle Carlone
Paul Chameli
Rhonda Heddins
Mark Schmitz
Cristy Turgeon
George White, AICPA Technical Manager
AICPA April 30, 2004
Proposed Schedule M-3 Comments Page 2
AICPA April 30, 2004
Proposed Schedule M-3 Comments Page 2
AICPA April 30, 2004
Proposed Schedule M-3 Comments Page 2
AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS
Comments on the Proposed Form 1120 Schedule M-3
A. Summary of Comments
This submission responds to IR 2004-14, which requests comments on the Proposed Form 1120 Schedule M-3, including comments on significant difficulties that taxpayers may encounter if the use of Schedule M-3 is required for a tax year that begins before Schedule M-3 is finalized, as well as comments on methods to minimize burden to taxpayers.
The AICPA fully supports the Treasury and IRS goals to increase transparency in return filing, reduce the time required to examine tax returns and examine most recent tax returns filed. However, the AICPA does not believe that taxpayers and tax return preparers have sufficient time to establish the systems to support the process of gathering the required information and accurately complete the Schedule M-3 for the targeted effective date of tax years ending on or after December 31, 2004. Therefore, the AICPA recommends the following:
· The effective date for Schedule M-3 should be tax years ending on or after December 31, 2005 or (preferably) on or after December 31, 2006.
· For the initial year of compliance, the threshold for taxpayer’s required to use the Schedule M-3 should be increased to taxpayers with assets of $250 million or more. In this case, consider deferring the effective date for other taxpayers until tax years ending on or after December 31, 2006.
· For the first two years of required compliance, do not require the completion of Columns (A) and (D) of Parts III and IV. This will provide taxpayers additional time to complete the necessary system changes to accurately comply with the reporting requirements imposed by these columns.
These recommendations, more fully explained below, are followed by additional comments and recommendations and specific line comments on the proposed Schedule M-3 and instructions.
B. Proposed Schedule M-3
In an effort to increase the transparency of corporate tax return filings, the Treasury and IRS released in proposed draft form, Schedule M-3, “Net Income (Loss) Reconciliation for Corporations with Total Assets of $10 Million or More,” for use by certain corporate taxpayers filing Form 1120, U.S. Corporation Income Tax Return (herein, “Proposed Schedule M-3” , “Schedule M-3” or “proposed form”). This new form is proposed for corporations with assets of $10 million or more and is proposed to be required for tax years ending on or after December 31, 2004. Treasury and IRS also announced that other federal tax returns that require the completion of Schedule M-1, for example, Form 1065, U.S. Partnership Return of Income, and Form 1120S, U.S. Income Tax Return of an S Corporation, may incorporate Schedule M-3 in the future. Draft instructions for Schedule M-3 were released on March 11, 2004.
C. Recommendation: Delay the Effective Date of Schedule M-3
The AICPA respectfully requests a delay in the effective date of the utilization of the Schedule M-3 until the first taxable year ending on or after December 31, 2005, or (preferably) on or after December 31, 2006. This recommendation is based on the Proposed Schedule’s extensive change in fundamental tax preparation methodology, the inability for accounting software vendors to accommodate the changes by the proposed compliance date, the hardship involved in tracking the current year transactions, and the training burden the proposed deadline places on corporate tax departments.
1. Changes Required in Fundamental Tax Preparation Methodology
The Proposed Schedule M-3 requires taxpayers to abandon and replace their core methodology for calculating book-tax differences. The most common approach to prepare the Schedule M-1 is the balance sheet approach. Through years of repetition, taxpayers have become effective and efficient at reporting book-tax differences by this method. In a number of cases, the book-tax difference reported on the Schedule M-1 is simply the change in a year-end balance sheet amount. The Proposed Schedule M-3 requires a transaction by transaction approach to accumulating and identifying book-tax differences. In addition, book income and expense must be reported in categories defined by tax law. Most of these tax law categories do not exist for book purposes. Most corporate tax departments will be ill-prepared to make the transition to this type of methodology without significant investment in their compliance process.
In addition to the burden associated with the departure from a balance sheet approach, the proposed transactional approach to capturing book-tax differences eliminates the checks and balances inherent in the balance sheet approach. Under a transactional approach, the only way to determine that all book-tax differences are captured is to recode and examine every accounting transaction.
For example, assume Taxpayer uses a balance-sheet approach method to compute certain book-tax differences items under the current Form 1120 Schedule M-1 requirements. Further assume that Taxpayer has an inventory reserve for market write-downs for financial reporting purposes that are not deductible for federal income tax purposes until there is a charge to the reserve reflecting a disposition of the inventory. For many companies there may be a separate or combined reserve for excess and obsolete inventory.
The reserve activity may include a monthly standard addition to the reserve reflecting the book reserve expense, which would not be deductible for tax. The reserve may also include an adjustment at each quarter or year end to increase or decrease the reserve to the projected requirements with a corresponding adjustment to the income statement, which would not be deductible for tax. Finally, the reserve may be charged for dispositions or alternatively charges may be made to cost-of-goods-sold, which would be deductible for tax. Under a balance-sheet approach, the current book-tax difference is the change in the reserve from year to year. This change in reserve includes an add-back for the reserve expenses, a tax deduction for the charge-offs, and a reversal of any book adjustments. It is likely that most automated Form 1120 preparation systems compute the necessary Schedule M-1 adjustment from the balance sheet accounts. The book-tax difference is then easily verified by comparing reserve balances.
Under an approach necessary to prepare the Proposed Schedule M-3, expense per income statement required by Part IV, line 34, Column (A) would be the amount of reserve additions net of adjustments as reflected in the income statement. The Temporary Difference included in Column (B) would be the difference between either the charge-offs in the reserve or cost-of-goods sold as compared to the income statement expenses. In future years cumulative amounts of both income statement deductions and balance sheet charge-offs must be maintained to preserve the integrity of the information the Proposed Schedule M-3 requires.
If separate accounts exist for the book expenses and the reserve, then total amounts for the year may be used for the calculations. However, if amounts are combined in the financial statements, for example restructuring reserves, the ability to compute the amounts that the new Schedule M-3 requires becomes imprecise. For example, the monthly reserve additions for book purposes may not be allocated to specific costs expected to be incurred. If these costs represent different specific lines on Part III or Part IV on Schedule M-3, the expense per income statement (Column (A) on Parts III and IV of the Schedule M-3) will likely be an estimate. The reserve expense will likely occur in a month or quarter different than the tax amount, and the tax deduction may need to incorporate the rules for the recurring item exception (so-called 8-½ month rule), rules for determining deferred compensation (so-called 2-½ month rule) or other tax rules. The difficulty is that separate transactions on a monthly basis must be analyzed to compute the amounts Schedule M-3 requires. It is likely numerous sub-accounts must be created to automate the process.
2. Inability of Software and Accounting Processes to Accommodate the Proposed Compliance Date
It is the understanding of the AICPA that certain software vendors have stated they may be able to deliver a product in time to incorporate the Schedule M-3 for the 2004 tax return. However, the more significant burden is the change required to the internal information gathering systems and internal accounting processes of corporate tax departments, including the following:
· Identifying and mapping trial balance amounts on a transaction by transaction basis to appropriate lines in Column A of the Proposed Schedule M-3 and Page 1 of the Form 1120
· Identifying and mapping Schedule M-3 amounts to different line items on Page 1 of Form 1120
· Creating new trial balance sub-accounts necessary to meet the new, detailed tax reporting requirements
· Determining baseline data for the initial year of implementation
· Inability to use multiple sources of data
· Inability to convert non-U.S. currency into the system
3. Four or More Months of Transactions Posted for Current Year
At the time of the submission of this comment letter, calendar year taxpayers are four full months into the tax year of proposed implementation. Required compliance for tax years ending on or after December 31, 2004 would place a significant burden on accounting departments to revisit transactions from the beginning of the year. This would require a cumbersome process of recoding prior transactions and/or performing manual adjustments and reconciliations to identify book-tax differences. Further, software modifications are not likely to be complete for some time, increasing the number of manual accounting entries and re-work. This places a significant burden on taxpayers and creates substantial risk that accuracy is compromised.
4. Training
The proposed Schedule M-3 will place a burden on corporate tax departments, accounting departments, and other functions with responsibility for information reported on the tax return to train their employees on the requirements of the new form and the processes and documentation necessary to achieve efficient and effective compliance, including new software applications and coding requirements.
D. Recommendation: Increase the Asset Threshold to $250 Million or More for First Year Use Is Required
The AICPA respectfully requests that the threshold for compliance with the Proposed Schedule M-3 be increased to apply to corporate taxpayers with assets in excess of $250 million to be consistent with the tax shelter reporting threshold and to allow the IRS time to monitor information for the first year of implementation.
1. Consistency with Tax Shelter Reporting Threshold
The $250 million threshold corresponds to the threshold utilized for the requirement to disclose transactions with a significant book-tax difference under reg. section 1.6011-4, Requirement of Statement Disclosing Participation in Certain Transactions by Taxpayers. These taxpayers have already begun to gather information for the reporting of book-tax differences to comply with the tax shelter disclosure requirements and have gained information and experience that will assist them at gathering the required information for the Schedule M-3.
2. Allows IRS to Monitor and Adjust Before Full Compliance
Increasing the threshold to taxpayers with $250 million of assets would provide that approximately 10,000 taxpayers would utilize the Schedule M-3 in its initial year. This would allow the IRS and Treasury to review the Schedules M-3 filed by these taxpayers, better understand the impact of the Schedule M-3, and adjust the form or procedure as necessary before requiring more taxpayers to utilize the Schedule M-3. In order for the IRS and Treasury to complete their assessment of the Schedule M-3, the effective date for all other taxpayers should be deferred until tax years ending on or after December 31, 2006.
E. Recommendation: Do Not Require Parts III and IV, Columns (A) or (D) During First Two Compliance Years
The AICPA respectfully requests that the IRS and Treasury defer the requirement that Columns (A) and (D) of Parts III and IV be completed for the first two years of required compliance. By adopting this change, the IRS would still receive more consistency and comparability by standardized reporting of book to tax adjustments reported in Columns (B) and (C). This deferral would provide taxpayers additional time to implement the necessary system changes to comply with the requirements of Columns (A) and (D).
F. Impacts Outside Federal Income Tax
1. Cost of Tax Preparation and Effect on Smaller Taxpayers
The proposed Schedule M-3 will increase the cost of tax compliance. The accounting systems and processes necessary to provide the transaction by transaction detail will require full systems revisions from those currently utilized. The additional internal cost coupled with the additional cost of modifying compliance software, or purchasing new software will fall disproportionately on smaller business. This result occurs because the $10 million asset threshold will require systems changes for smaller taxpayers even though they may not have the same number of transactions required to be separately stated on Schedule M-3.
2. State Reporting
State reporting will likely add additional burden to implementation of the Proposed Schedule M-3 as certain states do not follow Federal book-tax adjustment processing. The new proposed schedule will present issues for state taxing authorities who will be forced to adapt their internal systems to process the new schedule. In the event that the states decide not to follow the Federal Schedule, taxpayers will be forced to track book-tax differences from both a balance sheet and a transactional perspective.