Financial income and taxable income vary because they are based on different sets of guidelines; financial income is based on U.S. accounting guidelines and taxable income is based on the U.S. tax code. A reconciliation between book and tax income involves adjusting for revenue and expense items affecting financial income before taxable income and vice versa. Plus, you'll need to adjust for other items that only affect financial income or taxable income.
Obtain an IRS form 1120, U.S. Corporation Tax Return, and use schedule M-1 to perform the reconciliation. The applicable boxes on the form are filled to arrive at an income amount that should match taxable income before the net operating loss deduction and special deductions.
Complete lines one to three of schedule M-1. On line one, enter the net income, or loss, per books. This amount is the net income reported on the income statement. On line two, enter the federal income taxes per books. This is the income tax expense reported on the income statement. On line three, enter the excess of capital losses over capital gains. Capital gains or losses result from the sale of investment property for a price over or under original cost; excess capital loss is the amount left over after capital losses are netted against capital gains.
Complete lines four and five of schedule M-1. On line four, enter income subject to tax and not recorded on books this year; list income amounts as line items. Examples of this type of income are installment sales income and rents received in advance. On line five, enter expenses recorded on books this year and not deducted on this return; list expenses separately. Examples of expenses include depreciation, charitable contributions and travel and entertainment.
Add lines one to five of schedule M-1. Lines one, two and three, completed in Step 2, plus lines four and five, completed in Step 3, equal the amount entered on line six of the schedule.
Complete line seven and eight of schedule M-1. On line seven, enter the income recorded on books this year and not included on the tax return and list separately. Examples of income entries on this line include tax exempt income and life insurance proceeds. On line eight, enter the deductions on this return not charged against book income this year; list items separately. Examples of deductions are depreciation, charitable contributions and bad debt write-offs.
Calculate the reconciled income balance. Add lines seven and eight from Step 5. The sum of these two amounts is listed on line nine of schedule M-1. Take line six, calculated in step 4, and subtract line nine to arrive at the reconciled income balance.
Complete schedule M-1 if the corporation’s total receipts plus assets are greater than $250,000. For corporations with $10 million or more in total assets, complete schedule M-3 instead.
- “Regulation: CPA Exam Review”; DeVry/Becker Educational Development Corp.; 2009
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