TEI comments on proposed Schedule M-3 of Form 1120: June 7, 2004.

On June 7, 2004, Tax Executives Institute filed the following comments to the Internal Revenue Service's Large and Midsize Business Division on the design and implementation of proposed Schedule M-3. The comments were prepared under the aegis of the Institute's Federal Tax Committee, whose chair is Neil D. Traubenberg of Storage Technology Corporation.

The following comments summarize Tax Executives Institute's discussions with LMSB and Treasury concerning the design of proposed Schedule M-3 and accompanying instructions, and other matters related to them.

Tax Executives Institute

Tax Executives Institute is the preeminent association of business tax executives in North America. Our more than 5,400 members represent 2,800 of the leading corporations in the United States, Canada, and Europe. TEI represents a cross-section of the business community, and is dedicated to developing and effectively implementing sound tax policy, to promoting the uniform and equitable enforcement of the tax laws, and to reducing the cost and burden of administration and compliance to the benefit of taxpayers and government alike. As a professional association, TEI is firmly committed to maintaining a tax system that works--one that is administrable and with which taxpayers can comply in a cost-efficient manner.

Members of TEI are responsible for managing the tax affairs of their companies and must contend daily with the provisions of the tax law relating to the operation of business enterprises. We believe that the diversity and professional training of our members enable us to bring an important, balanced, and practical perspective to the issues raised by proposed Schedule M-3 to Form 1120.

Background

Proposed draft form Schedule M3, 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, would expand the current Schedule M-1, and has a goal of increasing the transparency of corporate tax return filings. Schedule M-1 reconciles a corporation's financial accounting income or loss with taxable income or loss reported on Form 1120.

In releasing the draft of the proposed form on January 29, 2004, the Treasury Department announced that it will be finalized for use with federal income tax returns for tax years ending on or after December 31, 2004. In describing the proposal, it was stated:

* Schedule M-1 (and the related instructions) do not provide a uniform reporting requirement for "net income per books" on line 1 of Schedule M-1. As a result, taxpayers may provide information for (i) the worldwide group, (ii) the U.S. consolidated tax group, or (iii) something in between.

* Similarly, Schedule M-1 (and the related instructions) do not provide uniform disclosure requirements for reporting differences between financial accounting net income and taxable income. The lack of requirements prevent efficient comparisons among taxpayers and from year to year for the same taxpayers, thus making assessment of the risk of noncompliance associated with an issue or a taxpayer more difficult.

Goals of Schedule M-3

* 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.

* Provide consistent reporting among taxpayers and from year to year for each taxpayer....

* Periodically modify the form to highlight emerging issues, identify trends, and adapt to future changes encountered by large and mid-size corporations....

* Facilitate the use of Limited Issue Focused Examination (LIFE) audits through greater transparency. (1)

General Comments

TEI shares the goal that the Treasury and IRS adopt methods to reduce the time required to examine tax returns and be in a position to examine the most recent tax returns filed much sooner than in the past. However, TEI has significant concerns about certain aspects of the proposed Schedule M-3 that should be addressed before it is adopted. TEI recommends a delay of a year in the effective date of the filing requirement. Most importantly, TEI recommends a longer transition period before the requirements of column (A) of Parts III and IV are imposed upon taxpayers. (Column (D) is also problematic in similar ways for some taxpayers. See, e.g., the discussion below in regard to accrued liabilities included on Line 31 of Part IV.) During that time, the IRS and Treasury could review the data reported in columns (B) and (C) and make a more informed evaluation of whether column (A) (and, for that matter, column (D)) would be required. Given the cost of the changes necessary to complete the section, TEI submits the better course is to abandon column (A) of the Schedule.

TEI understands that the IRS intends the new Schedule M-3 to increase the currency and efficiency of audits by permitting a focused review within a relatively brief period (e.g., ninety days) of the filing of a return. The data presented in the new Schedule M-3 are intended to identify high risk issues so that it might be possible to make a decision whether to audit one or more issues in the return, or to forgo review of the return altogether, within that analytical process and timeframe. The process clearly can have mutual benefits. Just as the IRS hopes these enhancements may make it possible to conclude audits on a more timely basis by focusing on fewer issues and then reallocating audit resources to the returns of other taxpayers, taxpayers are similarly hopeful the changes will enable a more expeditious closure of their tax return examinations, thereby reducing aggregate taxpayer burdens. In particular, the new process will optimally eliminate the need to file Form 8886 for book-tax differences over $10 million as mostly redundant, and similarly anticipate that the additional time required to prepare the new Schedule M-3 will reduce the time required to produce information relative to Schedule M-1 during the subsequent audit. If these savings are not fully realized, the new filing requirement will in most cases represent a substantial net increase in taxpayer resource requirements necessary to meet filing requirements. Accordingly, TEI urges the IRS and Treasury to consider amelioratory changes to the Schedule as discussed in the balance of this letter.

Further, compiling the specific information required by the proposed Schedule M-3 (together with a proposed effective date tied to tax years ending on or after December 31, 2004) will impose a substantial burden on taxpayers that must make substantial adjustments to their accounting and information technology systems to comply. As we explained at our January 23, 2004 meeting (during which several members described their companies' accounting systems and roll-up procedures), the process for accumulating the required information and transferring it to the appropriate lines on the Schedule is not simple and instituting and mandating changes in that process should be very carefully weighed against the associated costs. Many taxpayers have already begun their processes for 2004 under current rules and requirements, and consequently the proposed effective date for Schedule M-3 has a clear retroactive effect.

To be sure, a substantial amount of the desired information can be accumulated in automated systems, but effecting necessary changes in those systems, particularly in general ledger systems and company-wide charts of accounts will, notwithstanding significant investments of dollars and time, be difficult and in some cases even impracticable or perhaps impossible. Further, minimizing the amount of manual processing of information by tax department personnel in the interface between company financial accounting systems and tax return preparation software (e.g., data accumulation, preparation of reclassification and consolidating journal entries, and preparation of Schedule M adjustments), is important to reduce the significant amounts of personnel and other costs associated with the data accumulations, especially in large enterprises.

As explained in our meetings, the process involves much more than simply mapping information transfers from a general ledger account, if it currently exists, to particular inputs in tax preparation software. Taxpayers would be required to modify and redesign their compliance processes from gathering and analyzing book income/loss information to computing and describing book tax-differences to fit within the line item categories of the proposed form. For the data to be correctly mapped to the Schedule, accounting and ledger systems will have to undergo a significant transformation so that the desired information is gathered into a discrete location that can then be mapped to the Schedule. Then, every time there is a new item added to the Schedule, similarly expensive and time-consuming systems reconfigurations would be required. For the tax software to generate the correct form, all book accounts and tax adjustments would need to be remapped into the software. Implementing major changes within a tax return software system adds incremental cost, requires a significant amount of resources and effort, and usually takes multiple return cycles to perfect. Again, the 2004 effective date greatly exacerbates the problems as many taxpayers are currently mapping data into extant data modules and software, and by the time these requirements are set, there will be very little time to make necessary transitions.

These problems are particularly acute with respect to the entries that must be made in Schedule M-3, Parts III and IV, column (A). Completing column (A) may in many cases be very difficult because, in addition to other factors, taxpayers currently categorize book income and deductions in the line item categories of Form 1120, page 1, which are very different from the line item categories included in the proposed form.

...