Schedule M-3 - Net Income (Loss) Reconciliation for Certain Partnerships

Memo of Major Changes for the 2008 Instructions for Schedule M-3 (F 1065), Net
Income (Loss) Reconciliation for Certain Partnerships

We have updated the years (as applicable) in the Examples that appear throughout the
Instructions.
Due to the addition of line 4b in Part I, we have updated (as appropriate) line references
to line 4 to differentiate between line 4a and line 4b
Due to a redesign of Form 1065, the section on Analysis of Net Income (Loss) has moved
from page 4 to page 5 of Form 1065 (it still appears in page 4 of Form 1065-B).
Throughout the document, we have revised the text pertaining to Analysis of Net Income
to make it clear that it appears on page 5 of Form 1065 and page 4 of Form 1065-B.
Page 1. We have revised the “What’s New” section. We have deleted last year’s items, as
they are no longer new. In their place, we have inserted text about line instructions we
have added that pertain to the new lines (Part I, line 4b; and Part I, line 12) on Schedule
M-3 (Form) 1065.
Page 2. On the “Adjusted Total Assets Worksheet”, on line 8, we revised the text to read
“Adjusted Total Assets. Enter the greater of line 6 or line 7”. We did this to conform to
the general language used when comparing figures from two lines on a worksheet.
Page 4. Under “Schedule M-2” we deleted the sentence stating that the amount from line
3 of Schedule M-2 has to be the same amount that appears on Part I, line 11 of Schedule
M-3. This conforms to a similar text change made in the Instructions for Form 1065.
Page 5. In the last paragraph in the second column, and carrying over to the third column,
we added instructions related to new line 4b.
Page 8. In the first column, we added instructions for new line 12.

Userid: DJBUCH00

PAGER/SGML
Page 1 of 17

Fileid:

DTD INSTR04

Leadpct: 0%

Pt. size: 9

...rs\bn4bb\documents\epicfiles\2008 Epic Files\I1065SM32008work.sgm

Instructions for Schedule M-3 (Form 1065)

❏

Draft

❏

Ok to Print

(Init. & date)

18:06 - 13-AUG-2008

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

2008

Department of the Treasury
Internal Revenue Service

Instructions for Schedule
M-3 (Form 1065)
Net Income (Loss) Reconciliation for Certain Partnerships
Section references are to the Internal
Revenue Code unless otherwise noted.
Form 1065-B. Schedule M-3 (Form
1065) is filed with both Forms 1065 and
1065-B. Line references to these returns
are the same unless otherwise noted.

General Instructions
Purpose of Schedule
Schedule M-3 Part I asks certain
questions about the partnership’s
financial statements and reconciles
financial statement net income (loss) for
the consolidated financial statement
group to income (loss) per the income
statement for the partnership.
Schedule M-3 Parts II and III reconcile
financial statement net income (loss) for
the partnership (per Schedule M-3, Part I,
line 11) to Analysis of Net Income (Loss),
line 1, which is found on page 5 on Form
1065, and page 4 on Form 1065-B.

What’s New
Instructions have been added for the
following new lines on Part I of Schedule
M-3.
• Line 4b is used to report the accounting
standard used in computing the
worldwide consolidated net income (loss)
stated in Part I, line 4a. See page 5.
• Line 12 is used to report the total
assets and liabilities of the entities
included or removed on lines 4, 5, 6, and
7 of Part I. See page 8.

Where To File
If the partnership is required to file (or
voluntarily files) Schedule M-3 (Form
1065), the partnership must file Form
1065 or Form 1065-B and all attachments
and schedules, including Schedule M-3
(Form 1065), with the Department of the
Treasury, Internal Revenue Service
Center, Ogden, UT 84201-0011.

Who Must File
Note. A U.S. partnership filing Form
1065 or Form 1065-B that is not required
to file Schedule M-3 may voluntarily file
Schedule M-3 in place of Schedule M-1.
Any entity that files Form 1065, U.S.
Return of Partnership Income, or Form
1065-B, U.S. Return of Income for

Electing Large Partnerships, must
complete and file Schedule M-3 instead of
Schedule M-1, Reconciliation of Income
(Loss) per Books With Income (Loss) per
Return, if any of the following is true:
1. The amount of total assets at the
end of the tax year reported on Schedule
L, line 14, column (d), is equal to $10
million or more.
2. The amount of adjusted total assets
for the year is equal to $10 million or
more. See Total Assets and Adjusted
Total Assets, on this page.
3. The amount of total receipts is
equal to $35 million or more. Total
receipts is defined in the instructions for
Codes for Principal Business Activity and
Principal Product or Service in the
Instructions for Form 1065, page 41, or
Form 1065-B, page 33.
4. An entity that is a reportable entity
partner with respect to the partnership (as
defined under these instructions) owns or
is deemed to own, directly or indirectly, an
interest of 50 percent or more in the
partnership’s capital, profit, or loss, on
any day during the tax year of the
partnership.
Note. A common trust fund or foreign
partnership must file Schedule M-3 if it
meets any of the tests discussed above.

Total Assets and Adjusted Total
Assets
The partnership should figure its adjusted
total assets using the worksheet on
page 2.
For purposes of determining for
Schedule M-3 whether the partnership’s
adjusted total assets (under these
instructions) equal $10 million or more,
the partnership’s total assets at the end of
the tax year must be determined on an
overall accrual method of accounting
unless both of the following apply: (a) the
tax return of the partnership is prepared
using an overall cash method of
accounting, and (b) the partnership does
not prepare financial statements using,
and is not included in financial statements
prepared on, an accrual basis.
See the instructions for Schedule M-3,
Part I, line 1, regarding non-tax-basis
income statements and related
non-tax-basis balance sheets to be used
in the preparation of Schedule M-3 and
the related non-tax-basis balance sheets
to be used in the preparation of Schedule
L.
Cat. No. 38800Y

In the case of a partnership year
ending because of a section 708
termination (sale or exchange within a
12-month period of 50 percent or more of
the partnership interest in income and
capital), the total assets of the partnership
at the end of the year for determining the
requirement to file Schedule M-3 are
determined immediately before the
section 708 termination and any actual or
deemed contribution or distribution of the
partnership assets under the provisions of
section 708.
Example 1.
1. U.S. partnership A, a limited liability
company (LLC), owns 60 percent of the
income and capital of U.S. partnership B,
also an LLC. For its 2008 tax year ending
December 31, 2008, A prepares
non-tax-basis GAAP (generally accepted
accounting principles) consolidated
financial statements with B that report
total assets at the end of the year of $12
million. For 2008, A files Form 1065 and
reports on its non-tax-basis
unconsolidated GAAP Schedule L total
assets at the end of the year of $7 million.
The $7 million total includes $3 million for
its investment in B under the equity
method of accounting. The amount of
total liabilities at the end of 2008 reported
to A’s partners on Schedules K-1 is $5
million. A made distributions of $1 million
during 2008 reflected on Schedule M-2,
line 6. The amount of A’s adjusted total
assets is $8 million for the 2008 tax year.
A has total receipts for the 2008 tax year
of $15 million. A has no reportable entity
partners (as defined under Reportable
Entity Partner Reporting Responsibilities,
on this page). A is not required to file
Schedule M-3 for the 2008 tax year based
on its total assets or adjusted total assets.
A is not required to file Schedule M-3 for
the 2008 tax year based on its total
receipts. A is not required to file Schedule
M-3 for the 2008 tax year based on
reportable entity partners. A is not
required to file Schedule M-3 under any of
the four tests and therefore is not required
to file Schedule M-3 for the 2008 tax year.
A may voluntarily file Schedule M-3 for
the 2008 tax year. If A does not file
Schedule M-3, it must file Schedule M-1.
2. Same facts as in Example 1.1
except that U.S. partnership A has total
receipts for 2008 of $40 million. Because
A has total receipts of $35 million or more
for its tax year ending December 31,

Page 2 of 17

Instructions for Schedule M-3 (Form 1065)

18:06 - 13-AUG-2008

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

2008, A must complete Schedule M-3 for
2008.
3. R, a U.S. partnership, files Form
1065 for the tax year ending December
31, 2008. R has total assets at the end of
2008 reported on Schedule L, line 14,
column (d), of $7.5 million. The aggregate
amount of total liabilities at the end of
2008 reported to R’s partners on
Schedules K-1 is $5 million. R made
distributions of $3 million during 2008
reflected on Schedule M-2, line 6. R did
not report a loss for 2007 on Schedule
M-2, line 3. R did not report adjustments
to capital on Schedule M-2, lines 4 or 7. R
has adjusted total assets for 2008 in the
tentative amount of $10.5 million, the sum
of $7.5 million plus $3 million (the amount
of distributions that must be added back
to determine adjusted total assets for
2008), an amount that is not less than the
total liabilities at the end of 2008 reported
to R’s partners on Schedules K-1.
Because R has adjusted total assets of
$10 million or more for its tax year ending
December 31, 2008, R must file Schedule
M-3 for 2008.
4. Same facts as in Example 1.3
except that the amount of total liabilities at
the end of 2008 reported to R’s partners
on Schedules K-1 is $11 million. R made
distributions of $1.5 million during 2008
as reflected on Schedule M-2, line 6. R
has adjusted total assets for 2008 equal
to $11 million, the greater of the tentative
amount of $9 million, the sum of $7.5
million plus $1.5 million (the amount of
distributions that must be added back to
determine adjusted total assets for 2008),
or $11 million (the amount of the total
liabilities at the end of 2008 reported to
R’s partners on Schedules K-1). Because
R has adjusted total assets of $10 million
or more for its tax year ending December
31, 2008, R must file Schedule M-3 for
2008.
5. S, a U.S. partnership, files Form
1065 for the tax year ending December
31, 2008. S has total assets at the end of
2008 reported on Schedule L, line 14,
column (d), of $7.5 million. The amount of
total liabilities at the end of 2008 reported
to S’s partners on Schedules K-1 is $5

million. S made no distributions during
2008 reflected on Schedule M-2, line 6. S
reported a loss of ($3 million) for 2008 on
Schedule M-2, line 3. S did not report
adjustments to capital on Schedule M-2,
lines 4 or 7. S has adjusted total assets
for 2008 in the tentative amount of $10.5
million, the sum of $7.5 million plus $3
million (the amount of the loss stated as a
positive amount that must be added back
to determine adjusted total assets for
2008).This tentative amount is compared
to the total liabilities at the end of 2008 as
reported to S’s partners on Schedules
K-1, and the greater of the two amounts is
considered the adjusted total assets.
Because S has adjusted total assets of
$10 million or more for its tax year ending
December 31, 2008, S must file Schedule
M-3 for 2008.
6. T, a U.S. partnership, files Form
1065 for the tax year ending December
31, 2008. T has total assets at the end of
2008 reported on Schedule L, line 14,
column (d), of $7.5 million. The amount of
total liabilities at the end of 2008 reported
to T’s partners on Schedules K-1 is $5
million. T made no distributions during
2008 reflected on Schedule M-2, line 6. T
did not report a loss for 2008 on Schedule
M-2, line 3. T did not report adjustments
to capital on Schedule M-2, line 7, but did
report a negative adjustment of ($3
million) on Schedule M-2, line 4. T has
adjusted total assets for 2008 in the
tentative amount of $10.5 million, the sum
of $7.5 million plus $3 million (the amount
of the negative adjustment stated as a
positive amount that must be added back
to determine adjusted total assets for
2008), an amount that is not less than the
total liabilities at the end of 2008 reported
to T’s partners on Schedules K-1.
Because T has adjusted total assets of
$10 million or more for its tax year ending
December 31, 2008, T must file Schedule
M-3 for 2008.

partnership filing Form 1065 or Form
1065-B is an entity that:
• Owns or is deemed to own, directly or
indirectly, under these instructions a 50
percent or greater interest in the income,
loss, or capital of the partnership on any
day of the tax year, and
• Was required to complete Schedule
M-3 on its most recently filed U.S. federal
income tax return or return of income filed
prior to that day.
For the purposes of these instructions,
the following rules apply.
1. The parent corporation of a
consolidated tax group is deemed to own
all corporate and partnership interests
owned or deemed to be owned under
these instructions by any member of the
tax consolidated group.
2. The owner of a disregarded entity
is deemed to own all corporate and
partnership interests owned or deemed to
be owned under these instructions by the
disregarded entity.
3. The owner of 50 percent or more of
a corporation by vote on any day of the
corporation tax year is deemed to own all
corporate and partnership interests
owned or deemed to be owned under
these instructions by the corporation
during the corporation tax year.
4. The owner of 50 percent or more
of partnership income, loss, or capital on
any day of the partnership tax year is
deemed to own all corporate and
partnership interests owned or deemed to
be owned under these instructions by the
partnership during the partnership tax
year.
5. The beneficial owner of 50 percent
or more of the beneficial interest of a trust
or nominee arrangement on any day of
the trust or nominee arrangement tax
year is deemed to own all corporate and
partnership interests owned or deemed to
be owned under these instructions by the
trust or nominee arrangement.

Reportable Entity Partner
Reporting Responsibilities

A reportable entity partner with respect
to a partnership (as defined on page 2)
must report the following to the
partnership within 30 days of first
becoming a reportable entity partner and,
after first reporting to the partnership
under these instructions, thereafter within
30 days of the date of any change in the
interest it owns or is deemed to own,
directly or indirectly, under these
instructions, in the partnership.

For the purposes of these instructions, a
reportable entity partner with respect to a

Adjusted Total Assets Worksheet
1. Enter total assets at the end of the tax year on Schedule L,
line 14, column (d) . . . . . . . . . . . . . . . . . . . . . . . . . .
2. Enter capital distributions on Schedule M-2, lines 6a and 6b
(shown as a positive amount) . . . . . . . . . . . . . . . . . .
3. Enter any loss reported on Schedule M-2, line 3 (shown as
a positive amount) . . . . . . . . . . . . . . . . . . . . . . . . . .
4. Enter the amount of any positive adjustment on Schedule
M-2, line 7 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .
5. Enter the amount of any negative adjustment on Schedule
M-2, line 4 (shown as a positive amount) . . . . . . . . . . .
6. Add lines 1 through 5 . . . . . . . . . . . . . . . . . . . . . . . . .
7. Enter combined total liabilities (recourse and nonrecourse)
on all Schedules K-1 (Form 1065), Part II, Item K, or
Schedules K-1 (Form 1065-B) . . . . . . . . . . . . . . . . . .
8. Adjusted Total Assets. Enter the greater of line 6 or line 7

1.
2.
3.
4.
5.
6.

7.
8.

Note: For line 2 above, if the partnership reflects partner capital account changes resulting from the sale of a
partnership interest on Schedule M-2 as matching contributions and distributions (on lines 2a and 2b and on
lines 6a and 6b, respectively), reduce the amounts shown on lines 6a and 6b by such matching amounts.

-2-

1. Name.
2. Mailing address.
3. Employer identification number
(EIN), if applicable.
4. Entity or organization type.
5. State or country in which it is
organized.
6. Date on which it first became a
reportable entity partner.
7. Date with respect to which it is
reporting a change in its ownership
interest in the partnership, if applicable.
8. The interest in the partnership it
owns or is deemed to own in the
partnership, directly or indirectly (as

Page 3 of 17

Instructions for Schedule M-3 (Form 1065)

18:06 - 13-AUG-2008

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

defined under these instructions) as of the
date with respect to which it is reporting.
9. Any change in that interest as of
the date with respect to which it is
reporting.
The reportable entity partner must
retain copies of required reports it makes
to partnerships under these instructions.
Each partnership must retain copies of
the required reports it receives under
these instructions from reportable entity
partners.
For more information, see Item D.
Reportable Entity Partner on page 4.
Example 2.
1. P, a U.S. corporation, is the parent
of a financial consolidation group with 50
domestic subsidiaries DS1 through DS50
and 50 foreign subsidiaries FS1 through
FS50, all 100 percent owned on
September 16, 2008. On September 15,
2008, P filed a consolidated tax return on
Form 1120 and was required to complete
Schedule M-3 for the tax year ending
December 31, 2007. On September 16,
2008, DS1, DS2, DS3, FS1, and FS2
each acquire a 10 percent partnership
interest in partnership K, which files Form
1065 for the tax year ending December
31, 2008. P is deemed to own, directly or
indirectly, under these instructions all
corporate and partnership interests of
DS1, DS2, and DS3, as the parent of the
tax consolidation group, and therefore is
deemed to own 30 percent of K on
September 16, 2008. P is deemed to
own, directly or indirectly, under these
instructions all corporate and partnership
interests of FS1 and FS2 as the owner of
50 percent or more of each corporation by
vote and therefore is deemed to own 20
percent of K on September 16, 2008. P is
therefore deemed to own 50 percent of K
on September 16, 2008. P owns or is
deemed to own, directly or indirectly,
under these instructions 50 percent or
more of K on September 16, 2008, and
was required to complete Schedule M-3
on its most recently filed U.S. income tax
return filed prior to that date. Therefore, P
is a reportable entity partner of K as of
September 16, 2008. On October 5,
2008, P reports to K, as it is required to
do, that P is a reportable entity partner as
of September 16, 2008, deemed to own
under these instructions a 50 percent
interest in K. K is therefore required to
complete Schedule M-3 when it files its
Form 1065 for its tax year ending
December 31, 2008.
2. Throughout 2008, A, a limited
liability company (LLC) filing Form 1065
for calendar year 2008, owns, as its only
asset, 50 percent of each of B, C, D, and
E, each also an LLC filing Form 1065 for
calendar year 2008. A is owned by
individuals and S corporations not
required to complete Schedule M-3 for
2007, 2008, or 2009. B, C, D, and E are
owned by A and by individuals and S
corporations not required to complete
Schedule M-3 for 2007, 2008, or 2009.
For the partnership tax years ending

December 31, 2008, each of B, C, D, and
E has no year-end liabilities, $3 million in
total assets and $6 million in adjusted
total assets (the difference equal to the
distributions by each in 2008), and 2008
total receipts of $20 million. As of
December 31, 2008, no owner, direct or
indirect, of B, C, D, or E was required to
complete Schedule M-3 on its most
recently filed U.S. income tax return or
return of income. Neither B, C, D, or E is
required to complete Schedule M-3 for
2008. For the partnership tax year ending
December 31, 2008, A has no year-end
liabilities, $6 million in total assets and
$12 million in adjusted total assets (the
difference equal to the distributions in
2008), and 2008 total receipts of $6
million. As of December 31, 2008, no
owner, direct or indirect, of A was
required to complete Schedule M-3 on its
most recently filed U.S. income tax return.
A must complete Schedule M-3 when it
completes its Form 1065 for 2008
because A has adjusted total assets of
$10 million or more.
3. Same ownership facts as in
Example 2.2 continued to calendar year
2009. On March 3, 2009, A files its Form
1065 with Schedule M-3 for the
partnership tax year ended December 31,
2008. As of March 4, 2009, A becomes a
reportable entity partner with respect to
any partnership in which it owns or is
deemed to own, directly or indirectly,
under these instructions a 50 percent or
greater interest in the income, loss, or
capital of the partnership. A owns 50
percent of each of B, C, D, and E and is
therefore a reportable entity partner with
respect to each as of March 4, 2009, the
day after it filed its 2008 Form 1065 with a
required Schedule M-3. On March 20,
2009, A reports to B, C, D, and E, as it is
required to do within 30 days of March 4,
that it is a reportable entity partner owning
a 50 percent interest. Each of B, C, D,
and E is required to complete Schedule
M-3 for 2009 because each has a
reportable entity partner. A will determine
if it must complete Schedule M-3 for 2009
based on its separate facts for 2009.
4. Same ownership facts as in
Example 2.2 for calendar year 2008
except that A is owned 50 percent by
corporation Z that was first required to
complete Schedule M-3 for its corporate
tax year ended December 31, 2007, and
that filed its Form 1120 with Schedule
M-3 for 2007 on September 15, 2008. As
of September 16, 2008, Z was a
reportable entity partner with respect to A
and, through A, with respect to B, C, D,
and E. On October 5, 2008, Z reports to
A, B, C, D, and E, as it is required to do
within 30 days of September 16, that Z is
a reportable entity partner directly owning
(with respect to A) or deemed to own
indirectly (with respect to B, C, D, and E)
a 50 percent interest. Therefore, because
Z was a reportable entity partner for 2008,
each of A, B, C, D, and E is required to
complete Schedule M-3 for 2008,
regardless of whether they would

-3-

otherwise be required to complete
Schedule M-3 for that year.

Other Form 1065 Schedules
Affected by Schedule M-3
Requirements
Schedule L
If a non-tax-basis income statement and
related non-tax-basis balance sheet is
prepared for any purpose for a period
ending with or within the tax year,
Schedule L must be prepared showing
non-tax-basis amounts. See the
discussion in the instructions for Schedule
M-3, Part I, line 1, of non-tax-basis
income statements and related
non-tax-basis balance sheets prepared
for any purpose and the impact on the
selection of the income statement used
for Schedule M-3 and the related
non-tax-basis balance sheet amounts that
must be used for Schedule L.
Total assets at the end of the tax year
shown on Schedule L, line 14, column (d),
must equal the total assets of the
partnership as of the last day of the tax
year, and must be the same total assets
reported by the partnership in the
non-tax-basis financial statements, if any,
used for Schedule M-3. If the partnership
prepares non-tax-basis financial
statements, Schedule L must report the
non-tax-basis financial statement total
assets. If the partnership does not
prepare non-tax-basis financial
statements, Schedule L must be based
on the partnership’s books and records.
The Schedule L balance sheet can show
tax-basis balance sheet amounts if the
partnership is allowed to use books and
records for Schedule M-3 and the
partnership’s books and records reflect
only tax-basis amounts.
Generally, total assets at the beginning
of the year (Schedule L, line 14, column
(b)) must equal total assets at the close of
the prior year (Schedule L, line 14,
column (d)). For each Schedule L balance
sheet item reported for which there is a
difference between the current opening
balance sheet amount and the prior
closing balance sheet amount, attach a
statement that reports the balance sheet
item, the prior closing amount, the current
opening amount, and a short explanation
of the change. Such reasons for these
differences include technical terminations
and mergers.
For purposes of measuring total assets
at the end of the year, the partnership’s
assets may not be netted or reduced by
partnership liabilities. In addition, total
assets may not be reported as a negative
amount. If Schedule L is prepared on a
non-tax-basis method, an investment in
another partnership may be shown as
appropriate under the partnership’s
non-tax-basis method of accounting,
including, if required by the partnership’s
reporting methodology, the equity method
of accounting for investments. If Schedule
L is prepared on a tax-basis method, an

Page 4 of 17

Instructions for Schedule M-3 (Form 1065)

18:06 - 13-AUG-2008

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

investment by the partnership in another
partnership must be shown as an asset
and measured by the partnership’s
adjusted basis in its partnership interest.
Any liabilities contributing to such
adjusted basis must be shown on
Schedule L as partnership liabilities.
Example 3. A, a limited liability
company (LLC), files Form 1065 for
calendar year 2008. B, a general
partnership, also files Form 1065 for
calendar year 2008. A is a general
partner in B. A’s capital account in B at
the close of 2008 is negative $4 million.
This reflects A’s 2008 contribution to B’s
capital of $2 million reduced by A’s share
of 2008 losses passing through to it from
B, $6 million. A’s adjusted basis in B at
December 31, 2008, is $16 million, its $4
million negative tax capital account in B
plus its $20 million share of B’s liabilities
under section 752. A prepares only
tax-basis income statements and balance
sheets. On its Schedule L, A reports as
an asset the adjusted basis of its
investment in B, $16 million. A also
reports its $20 million share of B’s
liabilities in the liabilities section of
schedule L. A does not report its $4
million negative capital account in B on
Schedule L.
Example 4. Same facts as in
Example 3, except that B is an LLC and A
is a member of B. None of B’s liabilities
are recourse with respect to A. A is not
obligated to restore any deficit capital
account in B. A prepares non-tax-basis
income statements and balance sheets
under an accounting method that requires
the use of the equity method of
accounting to account for its investment in
B. On its non-tax-basis books and
records, A initially reports $2 million as its
investment in B, the amount of A’s capital
contribution. A then reduces its $2 million
investment in B by its share of B’s
allocable losses. Because A’s allocable
share of B’s losses is $6 million, A’s
investment in B under the equity method
is reduced to $0. Because A is not liable
to repay any of B’s liabilities and is not
obligated to restore any deficit with
respect to its capital account in B, A does
not report any of B’s liabilities on A’s
Schedule L balance sheet.

Schedule M-2
The beginning and ending capital
accounts reported on Schedule M-2, lines
1 and 9, must agree with Schedule L, line
21. The partnership may use tax-basis
amounts or apply the rules in Regulations
section 1.704-1(b)(2)(iv) to determine the
partners’ capital accounts in item L of the
partners’ Schedules K-1. If the beginning
and ending capital accounts shown on
Schedule L, line 21, differ from the total of
the amounts reported in item L of all the
partners’ Schedules K-1, attach a
schedule that explains the differences in
total amounts.

Entity Considerations for
Schedule M-3
For purposes of Schedule M-3,
references to the classification of an entity
(for example, as a corporation, a
partnership, or a trust) are references to
the treatment of the entity for U.S. income
tax purposes. An entity that generally is
disregarded as separate from its owner
for U.S. income tax purposes
(disregarded entity) must not be
separately reported on Schedule M-3
except, if required, on Part I, line 7a or 7b.
On Schedule M-3, Parts II and III, any
item of income, gain, loss, deduction, or
credit of a disregarded entity must be
reported as an item of its owner. In
particular, the income or loss of a
disregarded entity must not be reported
on Part II, lines 7, 8, or 9 as from a
separate partnership or other
pass-through. The financial statement
income or loss of a disregarded entity is
included on Part I, line 7a or 7b, only if its
financial statement income or loss is
included on Part I, line 11, but not on Part
I, line 4a.

ownership for the tax year of the
partnership. The maximum percentage of
actual or deemed ownership for a
reportable entity partner for a tax year of
the partnership is the maximum
percentage interest owned or deemed
owned under these instructions by the
reportable entity partner in the
partnership’s capital, profit, or loss on any
day during the tax year of the partnership.
The reportable entity partner must
retain copies of required reports it makes
to partnerships under these instructions.
Each partnership must retain copies of
the required reports it received under
these instructions from reportable entity
partners. See Reportable Entity Partner
Reporting Responsibilities on page 2.

Part I. Financial
Information and Net
Income (Loss)
Reconciliation

Completion of Schedule M-3

When To Complete Part I

A partnership required to file Schedule
M-3 must complete the schedule in its
entirety. At the time the Form 1065 or
Form 1065-B is filed, all applicable
questions must be answered on Part I, all
columns must be completed on Parts II
and III, and all numerical data required by
Schedule M-3 must be provided. Any
schedule required to support a line item
on Schedule M-3 must be attached at the
time Schedule M-3 is filed and must
provide the information required for that
line item.

Part I must be completed for any tax year
for which the partnership files Schedule
M-3.

Any partnership required to file
Schedule M-3 must check all boxes that
apply on the top of page 1 above Part I of
Schedule M-3 with respect to the reasons
for which the Schedule M-3 is required to
be filed. A partnership not required to file
Schedule M-3, but that is doing so
voluntarily, should check box E on page 1
of Schedule M-3.

Specific Instructions
Item D. Reportable Entity
Partner
On Schedule M-3, page 1, if the
partnership has any reportable entity
partners for the year, check Item D. A
partnership must report the name, EIN if
applicable, and maximum percentage of
actual or deemed ownership of each
reportable entity partner if there are one
or two reportable entity partners for the
tax year of the partnership, and, if there
are more than two reportable entity
partners for the tax year of the
partnership, the two reportable entity
partners with the largest maximum
percentage of actual or deemed

-4-

Line 1. Questions Regarding
the Type of Income Statement
Prepared
For lines 1 through 11, use only the
financial statements of the U.S.
partnership filing Form 1065 or Form
1065-B. If the U.S. partnership filing Form
1065 or Form 1065-B is controlled by
another entity, the U.S. partnership must
use for its Schedule M-3, Part I, its own
financial statements and not the financial
statements of the controlling entity.

Non-Tax-Basis Financial
Statements and Tax-Basis
Financial Statements
A tax-basis income statement is allowed
for Schedule M-3 and a tax-basis balance
sheet for Schedule L only if no
non-tax-basis income statement and no
non-tax-basis balance sheet were
prepared for any purpose and the books
and records of the partnership reflect only
tax-basis amounts. The partnership is
deemed to have non-tax-basis income
statements and the related non-tax-basis
balance sheets for the current tax year for
purposes of Schedule M-3 and Schedule
L if such non-tax-basis financial
statements were prepared for and
presented to management, creditors,
members or partners, government
regulators, or any other third parties for a
period ending with or within the tax year.
If a Form 10-K is filed with the SEC for
the period ending with or within the tax
year, the partnership must check “Yes” for
line 1a and use that income statement for
Schedule M-3. If Form 10-K is not filed
and a non-tax-basis income statement is
prepared that is a certified non-tax-basis

Page 5 of 17

Instructions for Schedule M-3 (Form 1065)

18:06 - 13-AUG-2008

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

income statement for the period ending
with or within the tax year, the partnership
must check “Yes” for line 1b and use that
income statement for Schedule M-3. If
Form 10-K is not filed and no certified
non-tax-basis income statement is
prepared but an unaudited non-tax-basis
income statement is prepared for the
period ending with or within the tax year,
the partnership must check “Yes” for line
1c and use that income statement for
Schedule M-3.
Order of priority in accounting
standards. If no Form 10-K is filed and
two or more non-tax-basis income
statements are both certified
non-tax-basis income statements for the
period, the income statement prepared
according to the following order of priority
in accounting standards shall be used.
1. U.S. Generally Accepted
Accounting Principles (GAAP).
2. International Financial Reporting
Standards (IFRS).
3. Any other International Accounting
Standards (IAS).
4. Any regulatory accrual accounting.
5. Any other accrual accounting
standard.
6. Section 704(b) book accounting.
7. Any other fair market value
reporting standard.
8. Any cash basis standard.
If no non-tax-basis income statement
is certified and two or more non-tax-basis
income statements are prepared, the
income statement prepared according to
the first listed of the accounting standards
above shall be used.
If no non-tax-basis financial
statements are prepared for the U.S.
partnership filing Schedule M-3, the U.S.
partnership must check “No” on questions
1a, 1b, and 1c, skip lines 2 through 3b,
and enter the net income (loss) per the
books and records of the U.S. partnership
on line 4a.

Consolidated Financial Statements
If a partnership filing a Schedule M-3
(a) is included in the non-tax-basis
consolidated financial statements of a
group (consolidated financial statement
group) with an entity parent filing a U.S
tax return and Schedule M-3, (b) has its
income (loss) included and removed by
the entity parent on that entity parent’s
Schedule M-3, Part I, and (c) does not
have a separate non-tax-basis financial
statement (certified or otherwise) of its
own, the partnership must answer
questions 1a, 1b, and 1c as appropriate
for its own tax return and must report on
its own Schedule M-3, as appropriate, the
amount for the partnership’s net income
(loss) that is equal to the amount included
and removed in the entity parent’s
Schedule M-3, Part I. However, if in the
circumstances described immediately
above, the partnership does have
separate non-tax-basis financial
statements (certified or otherwise) of its
own, independent of the amount of the
partnership’s net income included in the

consolidated financial statements with the
entity parent, the partnership must
answer questions 1a, 1b, and 1c, as
appropriate, for its own tax return, based
on its own separate non-tax-basis income
statement, and must report on line 4a the
net income (loss) amounts shown on its
separate income statement.

Lines 2 and 3. Questions
Regarding Income Statement
Period and Restatements
Enter the beginning and ending dates on
line 2 for the partnership’s annual income
statement period ending with or within the
current tax year.
The questions on lines 3a and 3b,
regarding income statement
restatements, refer to the worldwide
consolidated income statement issued by
the partnership filing Form 1065 or Form
1065-B and used to prepare Schedule
M-3. Answer “Yes” on lines 3a and/or 3b
if the partnership’s annual income
statement has been restated for any
reason. Attach a short explanation of the
reasons for the restatement in net income
for each annual income statement period
that is restated, including the original
amount and restated amount of each
annual statement period’s net income.
The attached schedule is not required to
report restatements on an entity-by-entity
basis.

Line 4. Worldwide Consolidated
Net Income (Loss) per Income
Statement
Report on line 4a the worldwide
consolidated net income (loss) per the
income statement (or books and records,
if applicable) of the partnership.
In completing Schedule M-3, the
partnership must use financial statement
amounts from the financial statement type
checked “Yes” on line 1, or from its books
and records if line 1c is checked “No.” If
line 1a is checked “Yes,” report on line 4a
the net income amount reported in the
income statement presented to the SEC
on the partnership’s Form 10-K.
If a partnership prepares non-tax-basis
financial statements, the amount on line
4a must equal the financial statement net
income (loss) for the income statement
period ending with or within the tax year
as indicated on line 2.
If the partnership prepares
non-tax-basis financial statements and
the income statement period differs from
the partnership’s tax year, the income
statement period indicated on line 2
applies for purposes of lines 4a through 8.
If the partnership does not prepare
non-tax-basis financial statements and
has checked “No” on line 1c, enter the net
income (loss) per the books and records
of the partnership on line 4a.
Check the appropriate box on line 4b
to indicate which of the following
accounting standards was used for line
4a.

-5-

1. U.S. Generally Accepted
Accounting Principles (GAAP).
2. International Financial Reporting
Standards (IFRS).
3. Section 704(b).
4. Any other International Accounting
Standards (IAS).
5. Other (specify).
Report on lines 5a through 10, as
instructed below, all adjustment amounts
required to adjust worldwide net income
(loss) reported on line 4a (whether from
financial statements or books and
records) to net income (loss) of the
partnership that must be reported on line
11.

Line 5. Net Income (Loss) of
Nonincludible Foreign Entities
Remove the financial statement net
income (line 5a) or loss (line 5b) of each
foreign entity that is included on line 4a
and is not the partnership (nonincludible
foreign entity). In addition, on line 8,
adjust for consolidation eliminations and
correct for minority interest and
intercompany dividends between any
nonincludible foreign entity and the
partnership filing Form 1065 or Form
1065-B. Do not remove in Part I the
financial statement net income (loss) of
any nonincludible foreign entity accounted
for on line 4a using the equity method.
Attach a supporting schedule that
provides the name, EIN (if applicable),
and net income (loss) included on line 4a
that is removed on this line 5 for each
separate nonincludible foreign entity. The
amounts of income (loss) detailed on the
supporting schedule should be reported
for each separate nonincludible foreign
entity without regard to the effect of
consolidation or elimination entries. If
there are consolidation or elimination
entries relating to nonincludible foreign
entities whose income (loss) is reported
on the attached schedule that are not
reportable on line 8, the net amounts of
all such consolidation and elimination
entries must be reported on a separate
line on the attached schedule, so that the
separate financial accounting income
(loss) of each nonincludible foreign entity
remains separately stated.
For example, if the net income (after
consolidation and elimination entries) of a
nonincludible foreign sub-consolidated
group is being reported on line 5a, the
attached supporting schedule should
report the income (loss) of each separate
nonincludible foreign legal entity from
each such entity’s own financial
accounting net income statement or
books and records, and any consolidation
or elimination entries (for intercompany
dividends, minority interests, etc.) not
reportable on line 8 should be reported on
the attached supporting schedule as a net
amount on a line separate and apart from
lines that report each nonincludible
foreign entity’s separate net income
(loss).

Page 6 of 17

Instructions for Schedule M-3 (Form 1065)

18:06 - 13-AUG-2008

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

Line 6. Net Income (Loss) of
Nonincludible U.S. Entities
Remove the financial statement net
income (line 6a) or loss (line 6b) of each
U.S. entity that is included on line 4a and
is not an includible entity in the
partnership return (nonincludible U.S.
entity). In addition, on line 8, adjust for
consolidation eliminations and correct for
minority interest and intercompany
dividends between any nonincludible U.S.
entity and any includible entity. Do not
remove in Part I the financial statement
net income (loss) of any nonincludible
U.S. entity accounted for on line 4a using
the equity method.
Attach a supporting schedule that
provides the name, EIN (if applicable),
and net income (loss) included on line 4a
that is removed on line 6 for each
separate nonincludible U.S. entity. The
amounts of income (loss) detailed on the
supporting schedule should be reported
for each separate nonincludible U.S.
entity without regard to the effect of
consolidation or elimination entries. If
there are consolidation or elimination
entries relating to nonincludible U.S.
entities whose income (loss) is reported
on the attached schedule that are not
reportable on line 8, the net amounts of
all such consolidation and elimination
entries must be reported on a separate
line on the attached schedule, so that the
separate financial accounting income
(loss) of each nonincludible U.S. entity
remains separately stated.
For example, if the net income (after
consolidation and elimination entries) of a
nonincludible U.S. sub-consolidated
group is being reported on line 6a, the
attached supporting schedule should
report the income (loss) of each separate
nonincludible U.S. legal entity from each
such entity’s own financial accounting net
income statement or books and records,
and any consolidation or elimination
entries (for intercompany dividends,
minority interests, etc.) not reportable on
line 8 should be reported on the attached
supporting schedule as a net amount on a
line separate and apart from lines that
report each nonincludible U.S. entity’s
separate net income (loss).

Line 7a. Net Income (Loss) of
Other Foreign Disregarded
Entities and
7b. Net Income (Loss) of Other
U.S. Disregarded Entities
Include on line 7a or 7b the financial net
income or (loss) of each disregarded
entity in the U.S. tax return that is not
included in the consolidated financial
group, and therefore not included in the
income reported on line 4a, but that is
included on line 11. Include on line 7a the
financial income or (loss) of any foreign
disregarded entity that is not included in
the income reported on line 4a but that is
included on line 11 (other foreign
disregarded entities). Include on line 7b
the financial income or (loss) of any U.S.

disregarded entity that is not included in
the income reported on line 4a but that is
included on line 11 (other U.S.
disregarded entities). In addition, on line
8, adjust for consolidation eliminations
and correct for minority interest and
intercompany dividends for any other
disregarded entity.
Attach a supporting schedule that
provides the name, EIN, and net income
(loss) per the financial statement or books
and records included on line 7a or 7b for
each separate foreign or U.S. disregarded
entity. The amounts of income (loss)
detailed on the supporting schedule
should be reported for each separate
other disregarded entity without regard to
the effect of consolidation or elimination
entries solely between or among the
entities listed. If there are consolidation or
elimination entries relating to such
separate other disregarded entities whose
income (loss) is reported on the attached
schedule that are not reportable on line 8,
the net amounts of all such consolidation
and elimination entries must be reported
on a separate line on the attached
schedule, so that the separate financial
accounting income (loss) of each
separate other disregarded entity remains
separately stated.
For example, if the net income (after
consolidation and elimination entries) of a
sub-consolidated group of other foreign
disregarded entities is being reported on
line 7a, the attached supporting schedule
should report the income (loss) of each
separate other foreign disregarded entity
from each disregarded entity’s own
financial accounting net income statement
or books and records, and any
consolidation or elimination entries (for
intercompany dividends, minority
interests, etc.) not reportable on line 8
should be reported on the attached
supporting schedule as a net amount on a
line separate and apart from lines that
report each other foreign disregarded
entity’s separate net income (loss).

Line 8. Adjustment to
Eliminations of Transactions
Between Includible Entities and
Nonincludible Entities
Adjustments on line 8 to reverse certain
financial accounting consolidation or
elimination entries are necessary to
ensure that transactions between
includible entities and nonincludible U.S.
or foreign entities are not eliminated, in
order to report the correct total amount on
line 11. Also, additional consolidation
entries and elimination entries may be
necessary on line 8 related to
transactions between includible entities
that are in the consolidated financial
statement group and other includible
entities that are not in the consolidated
financial statement group but that are
reported on line 7a or 7b in order to report
the correct total amount on line 11.
Include on line 8 the total of the
following: (i) amounts of any adjustments
to consolidation entries and elimination

-6-

entries that are contained in the amount
reported on line 4a, required as a result of
removing amounts on line 5 or 6; and (ii)
amounts of any additional consolidation
entries and elimination entries that are
required as a result of including amounts
on line 7a or 7b. This is necessary in
order that the consolidation entries and
intercompany elimination entries included
in the amount reported on line 11 are only
those applicable to the financial net
income (loss) of includible entities for the
financial statement period. For example,
adjustments must be reported on line 8 to
remove minority interest and to reverse
the elimination of intercompany dividends
included on line 4a that relate to the net
income of entities removed on line 5 or 6
because the income to which the
consolidation or elimination entries relate
has been removed. Also, for example,
consolidation or elimination entries must
be reported on line 8 to eliminate any
intercompany dividends between entities
whose income is included on line 7a or 7b
and other entities included in the U.S.
income tax return.
If an entity owner of an interest in
another entity: (1) accounts for the
interest in the other entity in the owner’s
separate general ledger on the equity
method, and (2) fully consolidates the
other entity in the owner’s consolidated
financial statements, but that entity is not
includible in the owner’s Form 1065 or
Form 1065-B, then, as part of reversing
all consolidation and elimination entries
for the nonincludible entity, the owner
must reverse on line 8 the elimination of
the equity income inclusion from the other
entity. If the owner does not account for
the other entity on the equity method on
its own general ledger, it will not have
eliminated the equity income for
consolidated financial statement
purposes, and therefore will have no
elimination of equity income to reverse.
The attached supporting schedule for
line 8 must identify the type (for example,
minority interest, intercompany dividends,
etc.) and amount of consolidation or
elimination entries reported, as well as
the names of the entities to which they
pertain. It is not necessary, but it is
permitted, to report on line 8
intercompany eliminations that net to
zero, such as intercompany interest
income and expense.

Line 9. Adjustment to Reconcile
Income Statement Period to Tax
Year
Include on line 9 any adjustments
necessary to the income (loss) of the
partnership to reconcile differences
between the partnership’s income
statement period reported on line 2 and
the partnership’s tax year. Attach a
schedule describing the adjustment.

Line 10. Other Adjustments To
Reconcile to Amount on Line 11
Include on line 10 any other adjustments
to reconcile net income (loss) on line 4a

Page 7 of 17

Instructions for Schedule M-3 (Form 1065)

18:06 - 13-AUG-2008

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

through line 9, with net income (loss) of
the partnership reported on line 11.
For any adjustment reported on line
10, attach a supporting schedule with an
explanation of each net adjustment
included on line 10.

Line 11. Net Income (Loss) per
Income Statement of the
Partnership.
Report on line 11 the net income (loss)
per the income statement (or books and
records, if applicable) of the partnership.
Amounts reported in column (a) of Parts II
and III (see page 8) must be reported on
the same accounting method as is used
to report the amount of net income (loss)
per income statement of the partnership
on line 11.
Do not, in any event, report on line 11
the net income of entities other than the
partnership filing Form 1065 or Form
1065-B for the tax year. For example, it is
not permissible to remove the income of
nonincludible entities on lines 5 and/or 6,
above, then to add back such income on
lines 7 through 10, such that the amount
reported on line 11 includes the net
income of entities not includible in the
U.S. income tax return. A principal
purpose of Schedule M-3 is to report on
line 11 only the financial accounting net
income of only the partnership (including
any other includible entities) filing Form
1065 or Form 1065-B.
Whether or not the partnership
prepares financial statements, line 11
must include all items that impact the net
income (loss) of the partnership even if
they are not recorded in the profit and
loss accounts in the partnership’s general
ledger, including, for example, all
post-closing adjusting entries (including
workpaper adjustments) and dividend
income or other income received from
nonincludible entities.
Example 5.
1. U.S. partnership P owns 60% of
corporation DS1 which is fully
consolidated in P’s financial statements.
P does not account for DS1 in P’s
separate general ledger on the equity
method. DS1 has net income of $100
(before minority interests) and pays
dividends of $50, of which P receives
$30. The dividend is eliminated in the
consolidated financial statements. In its
financial statements, P consolidates DS1
and includes $60 of net income ($100
less the minority interest of $40) on line
4a.
P must remove the $100 net income of
DS1 on line 6a. P must reverse on line 8
the elimination of the $40 minority interest
net income of DS1. In addition, P
reverses its elimination of the $30
intercompany dividend in its financial
statements on line 8. The net result is that
P includes the $30 dividend from DS1 on
line 11 and on Part II, line 6, column (a).
P’s taxable dividend income from DS1
must be reported on Part II, line 6, column
(d).

2. U.S. partnership C owns 60% of
the capital and profits interests in U.S.
LLC N. C does not account for N in C’s
separate general ledger on the equity
method. N has net income of $100
(before minority interests) and makes no
distributions during the tax year. C treats
N as a corporation for financial statement
purposes and as a partnership for U.S.
income tax purposes. In its financial
statements, C consolidates N and
includes $60 of net income ($100 less the
minority interest of $40) on line 4a.
C must remove the $100 net income of
N on line 6a. C must reverse on line 8 the
elimination of the $40 minority interest net
income of N. The result is that C includes
no income for N either on line 11 or on
Part II, line 7, column (a). C’s taxable
income from N must be reported by C on
Part II, line 7, column (d).
3. U.S. partnership P owns 60% of
corporation DS1, which is fully
consolidated in P’s financial statements.
P accounts for DS1 in P’s separate
general ledger on the equity method. DS1
has net income of $100 (before minority
interests) and pays dividends of $50, of
which P receives $30. The dividend
reduces P’s investment in DS1 for equity
method reporting on P’s separate general
ledger where P includes its 60% equity
share of DS1 income, which is $60. In its
financial statements, P eliminates the
DS1 equity method income of $60 and
consolidates DS1, including $60 of net
income ($100 less the minority interest of
$40) on line 4a.
P must remove the $100 net income of
DS1 on line 6a. P must reverse on line 8
the elimination of the $40 minority interest
net income of DS1 and the elimination of
the $60 of DS1 equity income. The net
result is that P includes the $60 of equity
method income from DS1 on line 11 and
on Part II, line 5, column (a). P’s taxable
dividend income from its investment in
DS1 must be reported on Part II, line 6,
column (d).
4. U.S. partnership C owns 60% of
the capital and profits interests in U.S.
LLC N. C accounts for N in C’s separate
general ledger on the equity method. N
has net income of $100 (before minority
interests) and makes no distributions
during the tax year. C treats N as a
corporation for financial statement
purposes and as a partnership for U.S.
income tax purposes. For equity method
reporting on C’s separate general ledger,
C includes its 60% equity share of N
income, which is $60. In its financial
statements, C eliminates the $60 of N
equity method income and consolidates
N, including $60 of net income ($100 less
the minority interest of $40) on line 4a.
C must remove the $100 net income of
N on line 6a. C must reverse on line 8 the
elimination of the $40 minority interest net
income of N and the elimination of the
$60 of N equity method income. The
result is that C includes the $60 of equity
method income for N on line 11 and on
Part II, line 7, column (a). C’s taxable

-7-

income from N must be reported by C on
Part II, line 7, column (d).
5. U.S. partnership C owns 60% of
the capital and profits interests in U.S.
LLC N. C accounts for N in C’s separate
general ledger on the equity method. N
has net income of $100 (before minority
interests) and pays a $50 cash
distribution, of which C receives $30. The
distribution reduces C’s investment in N
for equity method reporting on C’s
separate general ledger. C treats N as a
corporation for financial statement
purposes and as a partnership for U.S.
income tax purposes. For equity method
reporting on C’s separate general ledger,
C includes its 60% equity share of N
income, which is $60. In its financial
statements, C eliminates the $60 of N
equity method income and consolidates N
and includes $60 of net income ($100
less the minority interest of $40) on line
4a.
C must remove the $100 net income of
N on line 6a. C must reverse on line 8 the
elimination of the $40 minority interest net
income of N and the elimination of the
$60 of N equity method income. The
result is that C includes the $60 of equity
method income for N on line 11 and on
Part II, line 7, column (a). C’s taxable
income from N must be reported by C on
Part II, line 7, column (d).
6. U.S. partnership P owns 100% of
the stock of U.S. LLC Q, a disregarded
entity. Q is included in P’s federal income
tax return, even though Q is not included
in P’s consolidated financial statements
on either a consolidated basis or on the
equity method. Q has current year net
income of $100 after taking into account
its $40 interest payment to P. P has net
income of $1,040 after recognition of the
interest income from Q. Because Q is a
disregarded entity, 100% of the net
income of both P and Q must be reported
on P’s Form 1065 or Form 1065-B and
the intercompany interest income and
expense must be removed by
consolidation elimination entries.
P must report its financial statement
net income of $1,040 on line 4a and
reports Q’s net income of $100 on line 7b
as a U.S. disregarded entity not included
on line 4a, but included on line 11. Then,
in order to reflect the full consolidation of
the financial accounting net income of P
and Q at line 11, the following
consolidation and elimination entry is
reported on line 8: offsetting entries to
remove the $40 of interest income
received from Q included by P on line 4a,
and to remove the $40 of interest
expense of Q included in line 7b for a net
change of zero. The result is that line 11
reports $1,140: $1,040 from line 4a, and
$100 from line 7. Stated another way, line
11 includes the entire $1,000 net income
of P, measured before recognition of the
intercompany interest income from Q and
the consolidation of Q operations, plus
the entire $140 net income of Q,
measured before interest expense to P. P
is not required to include on the attached

Page 8 of 17

Instructions for Schedule M-3 (Form 1065)

18:06 - 13-AUG-2008

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

supporting schedule for line 8 the
offsetting adjustment to the intercompany
elimination of interest income and interest
expense (though it is permitted to do so).

Line 12. Total Assets and
Liabilities of Entities Included
or Removed on Part I, Lines 4,
5, 6, and 7
Line 12 must be completed by all
partnerships that file Schedule M-3.
Report on lines 12a, 12b, 12c, and 12d
the total amounts (not just the
partnership’s share) of assets and
liabilities of entities added or removed on
Part I, lines 4, 5, 6, and 7. On line 12a,
enter the assets and liabilities of all of the
entities included in completing Part I, line
4. On line 12b, enter the assets and
liabilities removed on Part I, line 5. On
line 12c, enter the assets and liabilities
removed on Part I, line 6. On line 12d,
enter the assets and liabilities included on
Part I, line 7.

Parts II and III
General Reporting Information
For each line item in Parts II and III,
report in column (a) the amount of net
income (loss) included on Part I, line 11,
and report in column (d) the amount
included in taxable income on Analysis of
Net Income (Loss), line 1, which is found
on page 5 of Form 1065 and page 4 of
Form 1065-B..
Note. A schedule or explanation may be
attached to any line even if none is
required.

When To Complete Columns (a)
and (d)
A partnership is not required to complete
columns (a) and (d) of Parts II and III for
the first tax year the partnership is
required to file Schedule M-3. The
partnership must complete columns (a)
through (d) of Parts II and III for all tax
years subsequent to the first tax year the
partnership is required to file Schedule
M-3.
If, for any tax year (or tax years) prior
to the first tax year a partnership is
required to file Schedule M-3, a
partnership voluntarily files Schedule M-3
instead of Schedule M-1, then in those
voluntary filing years the partnership is
not required to complete columns (a) and
(d) of Parts II and III. In addition, in the
first tax year the partnership is required to
file Schedule M-3 the partnership is not
required to complete columns (a) and (d)
of Parts II and III.
If a partnership chooses not to
complete columns (a) and (d) of Parts II
and III in the first tax year the partnership
is required to file Schedule M-3 (or in any
year in which the partnership voluntarily
files Schedule M-3), then Part II, line 26,
is reconciled by the partnership in the
following manner:

1. Report the amount from Part I, line
11, on Part II, line 26, column (a);
2. Leave blank Part II, lines 1 through
25, columns (a) and (d);
3. Leave blank Part III, columns (a)
and (d); and
4. Report on Part II, line 26, column
(d), the sum of Part II, line 26, columns
(a), (b), and (c).
Note. Part II, line 26, column (d), must
equal the amount on Analysis of Net
Income (Loss), line 1, which is found on
page 5 of Form 1065, and page 4 of Form
1065-B. Thus, column (d) on Part II and
Part III must include not only items
contributing to the ordinary income (loss)
from trade or business activities on Form
1065, page 1, line 22 (line 25 of Part I for
Form 1065-B), but also certain of the
separately stated items on Schedule K.

When To Complete Columns (b)
and (c)
Columns (b) and (c) of Parts II and III
must be completed for any tax year for
which the partnership files Schedule M-3.
For any item of income, gain, loss,
expense, or deduction for which there is a
difference between columns (a) and (d),
the portion of the difference that is
temporary must be entered in column (b)
and the portion of the difference that is
permanent must be entered in column (c).
If financial statements are prepared by
the partnership in accordance with
generally accepted accounting principles
(GAAP), differences that are treated as
temporary for GAAP must be reported in
column (b) and differences that are
permanent (that is, not temporary for
GAAP) must be reported in column (c).
Generally, pursuant to GAAP, a
temporary difference affects (creates,
increases, or decreases) a deferred tax
asset or liability.
If the partnership does not prepare
financial statements, or the financial
statements are not prepared in
accordance with GAAP, report in column
(b) any difference that the partnership
believes will reverse in a future tax year
(that is, have an opposite effect on
taxable income in a future tax year (or
years) due to the difference in timing of
recognition for financial accounting and
U.S. income tax purposes) or is the
reversal of such a difference that arose in
a prior tax year. Report in column (c) any
difference that the partnership believes
will not reverse in a future tax year (and is
not the reversal of such a difference that
arose in a prior tax year).
If the partnership is unable to
determine whether a difference between
column (a) and column (d) for an item will
reverse in a future tax year or is the
reversal of a difference that arose in a
prior tax year, report the difference for
that item in column (c).
Example 6. For the 2006, 2007, and
2008 tax years, partnership A has
adjusted total assets (under these
instructions) of $8 million, $11 million, and

-8-

$12 million, respectively. Based on the
amount of its adjusted total assets, A is
required to file Schedule M-3 for its 2007
and 2008 tax years, but not for its 2006
tax year. Further, for its 2006, 2007, and
2008 tax years, A is not required to file
Schedule M-3 based on any of the other
required tests.
For its 2006 tax year, A voluntarily files
Schedule M-3 instead of Schedule M-1
and does not complete columns (a) and
(d) of Parts II and III.
For A’s 2007 tax year, the first tax year
that A is required to file Schedule M-3, A
is only required to complete Part I and
columns (b) and (c) of Parts II and III.
For A’s 2008 tax year, A is required to
complete Schedule M-3 in its entirety.

Reporting Requirements for
Parts II and III
Note. The following requirements for
columns (a) and (d) do not apply to
partnerships for the first tax year
Schedule M-3 is required. See When To
Complete Columns (a) and (d), earlier.

General Reporting Requirements
If an amount is attributable to a reportable
transaction described in Regulations
section 1.6011-4(b), the amount must be
reported in columns (a), (b), (c), and (d),
as applicable, of Part II, line 10, Items
relating to reportable transactions,
regardless of whether the amount would
otherwise be reported on Part II or Part III
of Schedule M-3. Thus, if a taxpayer files
Form 8886, Reportable Transaction
Disclosure Statement, the amounts
attributable to that reportable transaction
must be reported on Part II, line 10.
A partnership is required to report in
column (a) of Parts II and III the amount
of any item specifically listed on Schedule
M-3 that is in any manner included in the
partnership’s current year financial
statement net income (loss) or in an
income or expense account maintained in
the partnership’s books and records, even
if there is no difference between that
amount and the amount included in net
income (loss) for tax purposes unless (a)
otherwise provided in these instructions
or (b) the amount is attributable to a
reportable transaction described in
Regulations section 1.6011-4(b) and is
therefore reported on Part II, line 10. For
example, with the exception of interest
income reflected on a Schedule K-1
received by the partnership as a result of
the partnership’s investment in a
partnership or other pass-through entity,
all interest income included on Part I, line
11, whether from unconsolidated affiliated
entities, third parties, banks, or other
entities, whether from foreign or domestic
sources, whether taxable or exempt from
tax, and whether classified as some other
type of income for U.S. income tax
purposes (such as dividends), must be
included on Part II, line 11, column (a).
Likewise, all fines and penalties included
on Part I, line 11, paid to a government or
other authority for the violation of any law

Page 9 of 17

Instructions for Schedule M-3 (Form 1065)

18:06 - 13-AUG-2008

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

for which fines or penalties are assessed
must be included on Part III, line 7,
column (a), regardless of the government
authority that imposed the fines or
penalties, regardless of whether the fines
or penalties are civil or criminal,
regardless of the classification,
nomenclature, or terminology attached to
the fines or penalties by the imposing
authority in its actions or documents.
If a partnership would be required to
report in column (a) of Parts II and III the
amount of any item specifically listed on
Schedule M-3 in accordance with the
preceding paragraph, except that the
partnership has capitalized the item of
income or expense and reports the
amount in its financial statement balance
sheet or in asset and liability accounts
maintained in the partnership’s books and
records, the partnership must report the
proper tax treatment of the item in
columns (b), (c), and (d), as applicable.
Furthermore, in applying the two
preceding paragraphs, a partnership is
required to report in column (a) of Parts II
and III the amount of any item specifically
listed on Schedule M-3 that is included in
the partnership’s financial statements or
exists in the partnership’s books and
records, regardless of the nomenclature
associated with that item in the financial
statements or books and records.
Accurate completion of Schedule M-3
requires reporting amounts according to
the substantive nature of the specific line
items included in Schedule M-3 and
consistent reporting of all transactions of
like substantive nature that occurred
during the tax year. For example, all
expense amounts that are included in the
financial statements or exist in the books
and records that represent some form of
“Bad debt expense” must be reported on
Part III, line 26, in column (a), regardless
of whether the amounts are recorded or
stated under different nomenclature in the
financial statements or the books and
records such as: “Provision for doubtful
accounts;” “Expense for uncollectible
notes receivable;” or “Impairment of trade
accounts receivable.” Likewise, as stated
in the preceding paragraph, all fines and
penalties must be included on Part III, line
7, column (a), regardless of the
terminology or nomenclature attached to
them by the partnership in its books and
records or financial statements.
With limited exceptions, Part II
includes lines for specific items of income,
gain, or loss (income items). (See lines 1
through 21.) If an income item is
described on lines 1 through 21, report
the amount of the item on the applicable
line, regardless of whether there is a
difference for the item. If there is a
difference for the income item, or only a
portion of the income item has a
difference and a portion of the item does
not have a difference, and the item is not
described on lines 1 through 21, report
and describe the entire amount of the
item on line 22.

With limited exceptions, Part III
includes lines for specific items of
expense or deduction (expense items).
(See lines 1 through 28.) If an expense
item is described on lines 1 through 28,
report the amount of the item on the
applicable line, regardless of whether
there is a difference for the item. If there
is a difference for the expense item, or
only a portion of the expense item has a
difference and a portion of the item does
not have a difference and the item is not
described on lines 1 through 28, report
and describe the entire amount of the
item on line 29.
If there is no difference between the
financial accounting amount and the
amount reported for tax purposes of an
entire item of income, loss, expense, or
deduction and the item is not described or
included on Part II, lines 1 through 22, or
Part III, lines 1 through 29, report the
entire amount of the item in column (a)
and (d) of Part II, line 25.
Separately stated and adequately
disclosed. Each difference reported in
Parts II and III must be separately stated
and adequately disclosed. In general, a
difference is adequately disclosed if the
difference is labeled in a manner that
clearly identifies the item or transaction
from which the difference arises. For
further guidance about adequate
disclosure, see Regulations section
1.6662-4(f) and Rev. Proc. 2006-48,
2006-47 I.R.B. 934. If a specific item of
income, gain, loss, expense, or deduction
is described on Part II, lines 7 through 21,
or Part III, lines 1 through 28, and the line
does not indicate to “attach schedule” or
“attach details,” and the specific
instructions for the line do not call for an
attachment of a schedule or statement,
then the item is considered separately
stated and adequately disclosed if the
item is reported on the applicable line and
the amount(s) of the item(s) are reported
in the applicable columns of the
applicable line. See the instructions for
Part II, lines 1 through 6, for specific
additional information required to be
provided for these particular lines.
Note. A schedule or explanation may be
attached to any line even if none is
required.
Except as otherwise provided,
differences for the same item must be
combined or netted together and reported
as one amount on the applicable line of
Schedule M-3. However, differences for
separate items must not be combined or
netted together. Each item (and
corresponding amount attributable to that
item) must be separately stated and
adequately disclosed on the applicable
line of Schedule M-3 or any schedule
required to be attached, even if the
amounts are below a certain dollar
amount.
Example 7. Partnership B prepares
GAAP financial statements. In prior years,
B acquired intellectual property (IP) and
goodwill through several corporate

-9-

acquisitions. The IP is amortizable for
both U.S. income tax and financial
statement purposes. In the current year,
B’s annual amortization expense for IP is
$9,000 for U.S. income tax purposes and
$6,000 for financial statement purposes.
The goodwill is not amortizable for U.S.
income tax purposes and is subject to
impairment for financial statement
purposes. In the current year, B records
an impairment charge on the goodwill of
$5,000. B must report the amortization
attributable to the IP on Part III, line 21,
and report $6,000 in column (a), a
temporary difference of $3,000 in column
(b), and $9,000 in column (d). B must
report the goodwill impairment on Part III,
line 19, and report $5,000 in column (a), a
permanent difference of ($5,000) in
column (c), and $0 in column (d).
Example 8. Partnership C is a
calendar year partnership that placed in
service ten depreciable fixed assets in
2002. C was required to file Schedule M-3
for its 2007 tax year and is required to file
Schedule M-3 for its 2008 tax year. C’s
total depreciation expense for its 2008 tax
year for five of the assets is $50,000 for
income statement purposes and $70,000
for U.S. income tax purposes. C’s total
annual depreciation expense for its 2008
tax year for the other five assets is
$40,000 for income statement purposes
and $30,000 for U.S. income tax
purposes. C treats the differences
between financial statement and U.S.
income tax depreciation expense as
giving rise to temporary differences that
will reverse in future years. C must
combine all of its depreciation
adjustments. Accordingly, C must report
on Part III, line 25, for its 2008 tax year
income statement depreciation expense
of $90,000 in column (a), a temporary
difference of $10,000 in column (b), and
U.S. income tax depreciation expense of
$100,000 in column (d).
Example 9. Partnership D is a
calendar year partnership that was
required to file Schedule M-3 for its 2007
tax year and is required to file Schedule
M-3 for its 2008 tax year. On December
31, 2008, D establishes three reserve
accounts in the amount of $100,000 for
each account. One reserve account is an
allowance for accounts receivable that
are estimated to be uncollectible. The
second reserve is an estimate of coupons
outstanding that may have to be paid.
The third reserve is an estimate of future
warranty expenses. In its financial
statements, D treats the three reserve
accounts as giving rise to temporary
differences that will reverse in future
years. The three reserves are expenses
in D’s 2008 financial statements but are
not deductions for U.S. income tax
purposes in 2008. D must not combine
the Schedule M-3 differences for the
three reserve accounts. D must report the
amounts attributable to the allowance for
uncollectible accounts receivable on Part
III, line 26, Bad debt expense, and must
separately state and adequately disclose

Page 10 of 17

Instructions for Schedule M-3 (Form 1065)

18:06 - 13-AUG-2008

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

the amounts attributable to each of the
other two reserves, coupons outstanding
and warranty costs, on a required,
attached schedule that supports the
amounts on Part III, line 29.
Example 10. Partnership E is a
calendar year partnership that was
required to file Schedule M-3 for its 2007
tax year and is required to file Schedule
M-3 for its 2008 tax year. On January 2,
2008, E establishes an allowance for
uncollectible accounts receivable (bad
debt reserve) of $100,000. During 2008,
E increased the reserve by $250,000 for
additional accounts receivable that may
become uncollectible. Additionally, during
2008 E decreases the reserve by $75,000
for accounts receivable that were
discharged in bankruptcy during 2008.
The balance in the reserve account on
December 31, 2008, is $275,000. The
$100,000 amount to establish the reserve
account and the $250,000 to increase the
reserve account are expenses on E’s
2008 financial statements but are not
deductible for U.S. income tax purposes
in 2008. However, the $75,000 decrease
to the reserve is deductible for U.S.
income tax purposes in 2008. In its
financial statements, E treats the reserve
account as giving rise to a temporary
difference that will reverse in future tax
years. E must report on Part III, line 26,
Bad debt expense, for its 2008 tax year
income statement bad debt expense of
$350,000 in column (a), a temporary
difference of ($275,000) in column (b),
and U.S. income tax bad debt expense of
$75,000 in column (d).
Example 11. Partnership F is a
calendar year partnership that was
required to file Schedule M-3 for its 2007
tax year and is required to file Schedule
M-3 for its 2008 tax year. During 2008, F
incurs $200 of meals and entertainment
expenses that F deducts in computing net
income per the income statement. $50 of
the $200 is subject to the 50% limitation
under section 274(n). In its financial
statements, F treats the limitation on
deductions for meals and entertainment
as a permanent difference. Because
meals and entertainment expenses are
specifically described on Part III, line 6,
Meals and entertainment, F must report
all of its meals and entertainment
expenses on this line, regardless of
whether there is a difference. Accordingly,
F must report $200 in column (a), $25 in
column (c), and $175 in column (d). F
must not report the $150 of meals and
entertainment expenses that are
deducted in F’s financial statement net
income and are fully deductible for U.S.
income tax purposes on Part II, line 25,
Other items with no differences, and the
$50 subject to the limitation under section
274(n) on Part III, line 6.

Part II. Reconciliation of
Net Income (Loss) per
Income Statement of
Partnership With Income
(Loss) per Return
Lines 1 Through 9. Additional
Information for Each Entity
For any item reported on lines 1 or 3
through 5, attach a supporting schedule
that provides the name of the entity for
which the item is reported, the entity’s
EIN (if applicable), the type of entity
(corporation, partnership, etc.), and the
item amounts for columns (a) through (d).
See the instructions for lines 2 and 6
through 9 for the specific information
required for those particular lines.

Line 1. Income (Loss) From
Equity Method Foreign
Corporations
Report on line 1, column (a), the financial
income (loss) included on Part I, line 11,
for any foreign corporation accounted for
on the equity method and remove such
amount in column (b) or (c), as
applicable. Report the amount of
dividends received and other taxable
amounts received or includible from
foreign corporations on lines 2 through 4,
as applicable.

Line 2. Gross Foreign
Dividends Not Previously Taxed
Except as otherwise provided in this
paragraph, report on line 2, column (d),
the amount (before any withholding tax)
of any foreign dividends included on
Analysis of Net Income (Loss), line 1,
which is found on page 5 of Form 1065,
and page 4 of Form 1065-B, and report
on line 2, column (a), the amount of
dividends from any foreign corporation
included on Part I, line 11. Do not report
on line 2 any amounts that must be
reported on line 3 or dividends that were
previously taxed and must be reported on
line 4. (See the instructions below for
lines 3 and 4.) Report withholding taxes
on Part III, line 29, Other expense/
deduction items with differences, or line
25, Other items with no differences, as
applicable.
For any dividends reported on line 2
that are received on a class of voting
stock of which the partnership directly or
indirectly owned 10% or more of the
outstanding shares of that class at any
time during the tax year, report on an
attached supporting schedule for line 2:
(1) the name of the dividend payer, (2)
the payer’s EIN (if applicable), (3) the
class of voting stock on which the
dividend was paid, (4) the percentage of
the class directly or indirectly owned, and
(5) the amounts for columns (a) through
(d).

-10-

Line 3. Subpart F, QEF, and
Similar Income Inclusions
Report on line 3, column (d), the amount
included in taxable income under section
951 (relating to Subpart F), gains or other
income inclusions resulting from elections
under sections 1291(d)(2) and 1298(b)(1),
and any amount included in taxable
income pursuant to section 1293 (relating
to qualified electing funds). The amount of
Subpart F income corresponds to the total
of the amounts reported by the
partnership on line 6, Schedule I, of all
Forms 5471, Information Return of U.S.
Persons With Respect to Certain Foreign
Corporations. The amount of qualified
electing fund income corresponds to the
total of the amounts reported by the
partnership on line 3(a), Part II, of all
Forms 8621, Return by a Shareholder of
a Passive Foreign Investment Company
(PFIC) or Qualified Electing Fund.
Also include on line 3 passive foreign
investment company mark-to-market
gains and losses under section 1296. Do
not report such gains and losses on line
14.

Line 4. Gross Foreign
Distributions Previously Taxed
Report on line 4, column (a), any
distributions received from foreign
corporations that were included on Part I,
line 11, and that were previously taxed for
U.S. income tax purposes. For example,
include in column (a) amounts that are
excluded from taxable income under
sections 959 and 1293(c). Remove such
amounts in column (b) or (c), as
applicable. Report the full amount of the
distribution before any withholding tax.
Report withholding taxes on Part III, line
29, Other expense/deduction items with
differences, or line 25, Other items with
no differences, as applicable. Since
previously taxed foreign distributions are
not currently taxable, line 4, column (d), is
shaded. (Also, see instructions above for
line 2.)

Line 5. Income (Loss) From
Equity Method U.S.
Corporations
Report on line 5, column (a), the financial
income (loss) included on Part I, line 11,
for any U.S. corporation accounted for on
the equity method and remove such
amount in column (b) or (c), as
applicable. Report on line 6 the amount of
dividends received from any U.S.
corporations.

Line 6. U.S. Dividends
Report on line 6, column (a), the amount
of dividends included on Part I, line 11,
that were received from any U.S.
corporation. Report on line 6, column (d),
the amount of any U.S. dividends
included in taxable income on Analysis of
Net Income (Loss), line 1, which is found
on page 5 of Form 1065, and page 4 of
Form 1065-B..
For any dividends reported on line 6
that are received on classes of voting

Page 11 of 17

Instructions for Schedule M-3 (Form 1065)

18:06 - 13-AUG-2008

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

stock in which the partnership directly or
indirectly owned 10% or more of the
outstanding shares of that class at any
time during the tax year, report on an
attached supporting schedule for line 6:
(1) the name of the dividend payer, (2)
the payer’s EIN (if applicable), (3) the
class of voting stock on which the
dividend was paid, (4) the percentage of
the class directly or indirectly owned, and
(5) the amounts for columns (a) through
(d).

Line 7. Income (Loss) From U.S.
Partnerships and
Line 8. Income (Loss) From
Foreign Partnerships
For any interest owned by the partnership
that is treated as an investment in a
partnership for U.S. income tax purposes
(other than an interest in a disregarded
entity), report amounts on line 7 or 8, as
described below:
1. In column (a), the sum of the
partnership’s distributive share of income
or loss from a U.S. or foreign partnership
that is included on Part I, line 11;
2. In column (b) or (c), as applicable,
the sum of all differences, if any,
attributable to the partnership’s
distributive share of income or loss from a
U.S. or foreign partnership; and
3. In column (d), the sum of all
amounts of income, gain, loss, or
deduction attributable to the partnership’s
distributive share of income or loss from a
U.S. or foreign partnership (that is, the
sum of all amounts reportable on the
partnership’s Schedule(s) K-1 received
from the partnership (if applicable)),
without regard to any limitations
computed at the partner level (for
example, limitations on utilization of
charitable contributions, capital losses,
and interest expense).
For each partnership reported on line 7
or 8, attach a supporting schedule that
provides the name, EIN (if applicable),
end of year profit-sharing percentage (if
applicable), end of year loss-sharing
percentage (if applicable), and the
amount reported in column (a), (b), (c), or
(d) of lines 7 or 8, as applicable.
Example 12. U.S. partnership H is a
calendar year partnership that was
required to file Schedule M-3 for its 2007
tax year and is required to file Schedule
M-3 for its 2008 tax year. H has an
investment in a U.S. partnership USP. H
prepares financial statements in
accordance with GAAP. For its 2008 tax
year, H’s financial statement net income
includes $10,000 of income attributable to
its share of USP’s net income. H’s
Schedule K-1 from USP reports $5,000 of
ordinary income, $7,000 of long-term
capital gains, $4,000 of charitable
contributions, and $200 of section 179
expense. H must report on line 7 $10,000
in column (a), a permanent difference of
($2,200) in column (c), and $7,800 in
column (d).

Line 9. Income (Loss) From
Other Pass-Through Entities
For any interest in a pass-through entity
(other than an interest in a partnership
reportable on line 7 or 8, as applicable)
owned by the U.S. partnership (other than
an interest in a disregarded entity), report
the following on line 9:
1. In column (a), the sum of the
partnership’s distributive share of income
or loss from the pass-through entity that is
included on Part I, line 11;
2. In column (b) or (c), as applicable,
the sum of all differences, if any,
attributable to the pass-through entity;
and
3. In column (d), the sum of all taxable
amounts of income, gain, loss, or
deduction reportable on the partnership’s
Schedule(s) K-1 received from the
pass-through entity (if applicable).
For each pass-through entity reported
on line 9, attach a supporting schedule
that provides that entity’s name, EIN (if
applicable), the partnership’s end of year
profit-sharing percentage (if applicable),
the partnership’s end of year loss-sharing
percentage (if applicable), and the
amounts reported by the partnership in
column (a), (b), (c), or (d), of line 9, as
applicable.

Line 10. Items Relating to
Reportable Transactions
Any amounts attributable to any
reportable transactions (as described in
Regulations section 1.6011-4) must be
included on line 10 regardless of whether
the difference, or differences, would
otherwise be reported elsewhere in Part II
or Part III. Thus, if a taxpayer files Form
8886 for any reportable transaction
described in Regulations section
1.6011-4, the amounts attributable to that
reportable transaction must be reported
on line 10. In addition, all income and
expense amounts attributable to a
reportable transaction must be reported
on line 10, columns (a) and (d), even if
there is no difference between the
financial statement amounts and the tax
return amounts.
Each difference attributable to a
reportable transaction must be separately
stated and adequately disclosed. A
partnership will be considered to have
separately stated and adequately
disclosed a reportable transaction on line
10 if the partnership sequentially numbers
each Form 8886 and lists by statement
number (shown on line A of Form 8886)
on the supporting schedule for line 10
each sequentially numbered reportable
transaction and the amounts required for
line 10, columns (a) through (d).
Instead of satisfying the requirements
of the preceding paragraph, a partnership
will be considered to have separately
stated and adequately disclosed a
reportable transaction if the partnership
attaches a supporting schedule that
provides the following for each reportable
transaction:

-11-

1. A description of the reportable
transaction disclosed on Form 8886 for
which amounts are reported on line 10;
2. The name and reportable
transaction number, if applicable, as
reported on lines 1a and 1c, respectively,
of Form 8886; and
3. The type of reportable transaction
(that is, listed transaction, confidential
transaction, transaction with contractual
protection, etc.) as reported on line 2 of
Form 8886.
If a transaction is a listed transaction
described in Regulations section
1.6011-4(b)(2), the description also must
include the published guidance number
shown on line 3 of Form 8886. In addition,
if the reportable transaction involves an
investment in the transaction through
another entity such as a partnership, the
description must include the name and
EIN (if applicable) of that entity as
reported on line 5 of Form 8886.
Example 13. Partnership J is a
calendar year partnership that was
required to file Schedule M-3 for its 2007
tax year and is required to file Schedule
M-3 for its 2008 tax year. J incurred
seven different abandonment losses
during its 2008 tax year. One loss of $12
million results from a reportable
transaction described in Regulations
section 1.6011-4(b)(5), another loss of $5
million results from a reportable
transaction described in Regulations
section 1.6011-4(b)(4), and the remaining
five abandonment losses are not
reportable transactions. J discloses the
reportable transactions giving rise to the
$12 million and $5 million losses on
separate Forms 8886 and sequentially
numbers them X1 and X2, respectively. J
must separately state and adequately
disclose the $12 million and $5 million
losses on line 10. The $12 million loss
and the $5 million loss will be adequately
disclosed if J attaches a supporting
schedule for line 10 that lists each of the
sequentially numbered forms, Form
8886-X1 and Form 8886-X2, and with
respect to each reportable transaction
reports the appropriate amounts required
for line 10, columns (a) through (d).
Alternatively, J’s disclosures will be
adequate if the description provided for
each loss on the supporting schedule
includes the names and reportable
transaction numbers, if any, disclosed on
the applicable Form 8886, identifies the
type of reportable transaction for the loss,
and reports the appropriate amounts
required for line 10, columns (a) through
(d). J must report the losses attributable
to the other five abandonment losses on
line 21e, regardless of whether a
difference exists for any or all of those
abandonment losses.
Example 14. Partnership K is a
calendar year partnership that was
required to file Schedule M-3 for its 2007
tax year and is required to file Schedule
M-3 for its 2008 tax year. K enters into a
transaction with contractual protection
that is a reportable transaction described

Page 12 of 17

Instructions for Schedule M-3 (Form 1065)

18:06 - 13-AUG-2008

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

in Regulations section 1.6011-4(b)(4).
This reportable transaction is the only
reportable transaction for K’s 2008 tax
year and results in a $7 million capital
loss for both financial accounting
purposes and U.S. income tax purposes.
Although the transaction does not result
in a difference, K is required to report on
line 10 the following amounts: ($7 million)
in column (a), zero in columns (b) and (c),
and ($7 million) in column (d). The
transaction will be adequately disclosed if
K attaches a supporting schedule for line
10 that (a) sequentially numbers the Form
8886 and refers to the
sequentially-numbered Form 8886-X1
and (b) reports the applicable amounts
required for line 10, columns (a) through
(d). Alternatively, the transaction will be
adequately disclosed if the supporting
statement for line 10 includes a
description of the transaction, the name
and reportable transaction number, if any,
and the type of reportable transaction
disclosed on Form 8886.

Line 11. Interest income
Attach Form 8916-A. Complete Part II
and enter the amounts shown on line 6,
columns (a) through (d), on Schedule
M-3, line 11, columns (a) through (d), as
applicable.
Report on line 11, column (a), the total
amount of interest income included on
Part I, line 11, and report on line 11,
column (d), the total amount of interest
income included on Analysis of Net
Income (Loss), line 1, which is found on
page 5 of Form 1065, and page 4 of Form
1065-B, that is not required to be reported
elsewhere on Schedule M-3. In columns
(b) or (c), as applicable, adjust for any
amounts treated for U.S. income tax
purposes as interest income that are
treated as some other form of income for
financial accounting purposes, or vice
versa. For example, adjustments to
interest income resulting from
adjustments made in accordance with
instructions for line 16, Sale versus lease,
should be made in columns (b) and (c) of
line 11.
Do not report on line 11 amounts
reported in accordance with instructions
for lines 7, 8, 9, 10, and 20.

Line 12. Total Accrual to Cash
Adjustment
This line is completed by a partnership
that prepares financial statements (or
books and records, if permitted) using an
overall accrual method of accounting and
uses an overall cash method of
accounting for U.S. income tax purposes
(or vice versa). With the exception of
amounts required to be reported on line
10, the partnership must report on line 12
a single amount net of all adjustments
attributable solely to the use of the
different overall methods of accounting
(for example, adjustments related to
accounts receivable, accounts payable,
compensation, accrued liabilities, etc.),
regardless of whether a separate line on

Schedule M-3 corresponds to an item
within the accrual to cash reconciliation.
Differences not attributable to the use of
the different overall methods of
accounting must be reported on the
appropriate lines of Schedule M-3 (for
example, a depreciation difference must
be reported on Part III, line 25).
Example 15. Partnership L is a
calendar year partnership that was
required to file Schedule M-3 for its 2007
tax year and is required to file Schedule
M-3 for its 2008 tax year. L prepares
financial statements in accordance with
GAAP using an overall accrual method of
accounting. L uses an overall cash
method of accounting for U.S. income tax
purposes. L’s financial statements for the
year ending December 31, 2008, report
accounts receivable of $35,000, an
allowance for bad debts of $10,000, and
accounts payable of $17,000 related to
current year acquisition and
reorganization legal and accounting fees.
In addition, for L’s year ending December
31, 2008, L reported financial statement
depreciation expense of $15,000 and
depreciation for U.S. income tax purposes
of $25,000. For L’s 2008 tax year using
an overall cash method of accounting, L
does not recognize the $35,000 of
revenue attributable to the accounts
receivable, cannot deduct the $10,000
allowance for bad debt, and cannot
deduct the $17,000 of accounts payable.
In its financial statements, L treats both
the difference in overall accounting
methods used for financial statement and
U.S. income tax purposes and the
difference in depreciation expense as
temporary differences. L must combine all
adjustments attributable to the differences
related to the overall accounting methods
on line 12. As a result, L must report on
line 12, $8,000 in column (a) ($35,000 $10,000 - $17,000), ($8,000) in column
(b), and zero in column (d). L must not
report the accrual to cash adjustment
attributable to the legal and accounting
fees on Part III, line 18, Current year
acquisition/reorganization legal and
accounting fees. Because the difference
in depreciation expense does not relate to
the use of the cash or accrual method of
accounting, L must report the
depreciation difference on Part III, line 25,
Depreciation, and report $15,000 in
column (a), $10,000 in column (b), and
$25,000 in column (d).

Line 13. Hedging Transactions
Report on line 13, column (a), the net
gain or loss from hedging transactions on
Part I, line 11. Report in column (d) the
amount of taxable income from hedging
transactions as defined in section
1221(b)(2). Use columns (b) and (c) to
report all differences caused by treating
hedging transactions differently for
financial accounting purposes and for
U.S. income tax purposes. For example, if
a portion of a hedge is considered
ineffective under GAAP but still is a valid
hedge under section 1221(b)(2), the
difference must be reported on line 13.

-12-

The hedge of a capital asset, which is not
a valid hedge for U.S. income tax
purposes but may be considered a hedge
for GAAP purposes, must also be
reported here.
Report hedging gains and losses
computed under the mark-to-market
method of accounting on line 13 and not
on line 14.
Report any gain or loss from inventory
hedging transactions on line 13 and not
on line 15.

Line 14. Mark-to-Market Income
(Loss)
Report on line 14 any amount
representing the mark-to-market income
or loss for any securities held by a dealer
in securities, a dealer in commodities
having made a valid election under
section 475(e), or a trader in securities or
commodities having made a valid election
under section 475(f). “Securities” for
these purposes are securities described
in section 475(c)(2) and section 475(e)(2).
“Securities” do not include any items
specifically excluded from sections
475(c)(2) and 475(e)(2), such as certain
contracts to which section 1256(a)
applies.
Report hedging gains and losses
computed under the mark-to-market
method of accounting on line 13, Hedging
transactions, and not on line 14.

Line 15. Cost of Goods Sold
Report on line 15 any amounts deducted
as part of cost of goods sold during the
tax year, regardless of whether the
amounts would otherwise be reported
elsewhere in Part II or Part III. However,
do not report the items mentioned in the
next paragraph on line 15. Examples of
amounts that must be included on line 15
are amounts attributable to inventory
valuation, such as amounts attributable to
cost-flow assumptions, additional costs
required to be capitalized (including
depreciation) such as section 263A costs,
inventory shrinkage accruals, inventory
obsolescence reserves, and lower of cost
or market (LCM) write-downs.
Note. The entries in columns (a) and (d)
are negative amounts.
Do not report the following on line 15
or on Form 8916-A:
• Amounts reportable on line 10;
• Any gain or loss from inventory hedging
transactions reportable on line 13;
• Amounts reportable on line 16;
• Amounts reportable on line 19;
• Mark-to-market income or (loss)
associated with the inventories of dealers
in securities under section 475 reportable
on line 14;
• Section 481(a) adjustments related to
cost of goods sold or inventory valuation
reportable on line 17;
• Fines and penalties reportable on Part
III, line 7;
• Judgments, damages, awards, and
similar costs, reportable on Part III, line 8;
and

Page 13 of 17

Instructions for Schedule M-3 (Form 1065)

18:06 - 13-AUG-2008

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

• Amounts included on Part III, line 28,
Purchase versus lease.

Important. Complete and attach Form
8916-A, Part I, for each item listed on line
15 in columns (a) through (d).
Example 16. Partnership C is a
calendar year partnership that placed in
service ten depreciable fixed assets in
2001. C was required to file Schedule M-3
for its 2007 tax year and is required to file
Schedule M-3 for its 2008 tax year. C’s
total depreciation expense for its 2008 tax
year for five of the assets is $50,000 for
financial accounting purposes and
$70,000 for U.S. income tax purposes.
C’s total annual depreciation expense for
its 2008 tax year for the other five assets
is $40,000 for financial accounting
purposes and $30,000 for U.S. income
tax purposes. In addition, C incurs $200
of meals and entertainment expenses that
C deducts in computing net income for
financial accounting purposes. All $200 of
the meals and entertainment expenses is
subject to the 50% limitation under
section 274(n). In its financial statements,
C treats the $50,000 depreciation and
$100 of the meals and entertainment as
other costs in computing cost of goods
sold. C must include on Form 8916-A and
on line 15, in column (a), the $50,000 of
depreciation and $100 of meals and
entertainment. C must also include a
temporary difference of $20,000 in
column (b), a permanent difference of
($50) in column (c), and $70,050 in
column (d) ($70,000 depreciation and $50
meals.) In addition, C must report on Part
III, line 25, for its 2008 tax year income
statement, depreciation expense of
$40,000 in column (a), a temporary
difference of ($10,000) in column (b), and
$30,000 in column (d); and on Part III, line
6, meals and entertainment expense of
$100 in column (a), a permanent
difference of ($50) in column (c), and $50
in column (d). All other cost of goods sold
items would be added to the amounts
included on line 15, detailed in this
example, and reported on Form 8916-A
and on line 15 in the appropriate columns.

Line 16. Sale Versus Lease (for
Sellers and/or Lessors)
Note. Also see the instructions at Part
III, line 28, Purchase Versus Lease (for
Purchasers and/or Lessees), on page 16.
Asset transfer transactions with
periodic payments characterized for
financial accounting purposes as either a
sale or a lease may, under some
circumstances, be characterized as the
opposite for tax purposes. If the
transaction is treated as a lease, the
seller/lessor reports the periodic
payments as gross rental income and
also reports depreciation expense or
deduction. If the transaction is treated as
a sale, the seller/lessor reports gross
profit (sale price less cost of goods sold)
from the sale of assets and reports the
periodic payments as payments of
principal and interest income.

On line 16, column (a), report the
gross profit or gross rental income for
financial accounting purposes for all sale
or lease transactions that must be given
the opposite characterization for tax
purposes. On line 16, column (d), report
the gross profit or gross rental income for
federal income tax purposes. Interest
income amounts for such transactions
must be reported on line 11, in column (a)
or (d), as applicable. Depreciation
expense for such transactions must be
reported on Part III, line 25, in column (a)
or (d), as applicable. Use columns (b) and
(c) of lines 11 and 16, and Part III, line 25,
as applicable, to report the differences
between column (a) and (d).
Example 17. Partnership M sells and
leases property to customers. M is a
calendar year partnership that was
required to file Schedule M-3 for its 2007
tax year and is required to file Schedule
M-3 for its 2008 tax year. For financial
accounting purposes, M accounts for
each transaction as a sale. For U.S.
income tax purposes, each of M’s
transactions must be treated as a lease.
In its financial statements, M treats the
difference in the financial accounting and
the U.S. income tax treatment of these
transactions as temporary. During 2008,
M reports in its financial statements
$1,000 of sales and $700 of cost of goods
sold with respect to 2008 lease
transactions. M receives periodic
payments of $500 in 2008 with respect to
these 2008 transactions and similar
transactions from prior years and treats
$400 as principal and $100 as interest
income. For financial accounting
purposes, M reports gross profit of $300
($1,000 − $700) and interest income of
$100 from these transactions. For U.S.
income tax purposes, M reports $500 of
gross rental income (the periodic
payments) and (based on other facts)
$200 of depreciation deduction on the
property. On its 2008 Schedule M-3, M
must report on line 11 $100 in column (a),
($100) in column (b), and zero in column
(d). In addition, M must report on line 16
$300 of gross profit in column (a), $200 in
column (b), and $500 of gross rental
income in column (d). Lastly, M must
report on Part III, line 25, $200 in column
(b) and (d).

Line 17. Section 481(a)
Adjustments
With the exception of a section 481(a)
adjustment that is required to be reported
on Part I, line 10, for reportable
transactions, any difference between an
income or expense item attributable to an
authorized (or unauthorized) change in
method of accounting made for U.S.
income tax purposes that results in a
section 481(a) adjustment must be
reported on line 17, regardless of whether
a separate line for that income or
expense item exists in Part II or Part III.
Example 18. Partnership N is a
calendar year partnership that was
required to file Schedule M-3 for its 2007

-13-

tax year and is required to file Schedule
M-3 for its 2008 tax year. N was
depreciating certain fixed assets over an
erroneous recovery period and, effective
for its 2008 tax year, N receives IRS
consent to change its method of
accounting for the depreciable fixed
assets and begins using the proper
recovery period. The change in method of
accounting results in a positive section
481(a) adjustment of $100,000 that is
required to be spread over four tax years,
beginning with the 2008 tax year. In its
financial statements, N treats the section
481(a) adjustment as a temporary
difference. N must report on line 17
$25,000 in columns (b) and (d) for its
2008 tax year and each of the
subsequent three tax years (unless N is
otherwise required to recognize the
remainder of the 481(a) adjustment
earlier). N must not report the section
481(a) adjustment on Part III, line 25.

Line 18. Unearned/Deferred
Revenue
Report on line 18, column (a), amounts of
revenues included on Part I, line 11, that
were deferred from a prior financial
accounting year. Report on line 18,
column (d), amounts of revenues
recognizable for U.S. income tax
purposes in the current tax year that are
recognized for financial accounting
purposes in a different year. Also report
on line 18, column (d), any amount of
revenues reported on line 18, column (a),
that are recognizable for U.S. income tax
purposes in the current tax year. Use
columns (b) and (c) of line 18, as
applicable, to report differences between
column (a) and (d).
Line 18 must not be used to report
income recognized from long-term
contracts. Instead, use line 19.

Line 19. Income Recognition
From Long-Term Contracts
Report on line 19 the amount of net
income or loss for financial statement
purposes (or books and records, if
applicable) or U.S. income tax purposes
for any contract accounted for under a
long-term contract method of accounting.

Line 20. Original Issue Discount
and Other Imputed Interest
Report on line 20 any amounts of original
issue discount (OID) and other imputed
interest. The term “original issue discount
and other imputed interest” includes, but
is not limited to:
1. The difference between issue price
and the stated redemption price at
maturity of a debt instrument, which may
be wholly or partially realized on the
disposition of a debt instrument under
section 1273;
2. Amounts that are imputed interest
on a deferred sales contract under
section 483;
3. Amounts treated as interest or OID
under the stripped bond rules under
section 1286; and

Page 14 of 17

Instructions for Schedule M-3 (Form 1065)

18:06 - 13-AUG-2008

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

4. Amounts treated as OID under the
below-market interest rate rules under
section 7872.

Line 21a. Income Statement
Gain/Loss on Sale, Exchange,
Abandonment, Worthlessness,
or Other Disposition of Assets
Other Than Inventory and
Pass-Through Entities
Report on line 21a, column (a), all gains
and losses on the disposition of assets
except for (a) gains and losses on the
disposition of inventory, and (b) gains and
losses allocated to the partnership from a
pass-through entity (for example, on
Schedule K-1) that are included in the net
income (loss) of the partnership reported
on Part I, line 11. Reverse the amount
reported in column (a) in column (b) or
(c), as applicable. The corresponding
gains and losses for U.S. income tax
purposes are reported on lines 21b
through 21g, as applicable.

Line 21b. Gross Capital Gains
From Schedule D, Excluding
Amounts From Pass-Through
Entities
Report on line 21b gross capital gains
reported on Schedule D, Capital Gains
and Losses, excluding capital gains from
pass-through entities, which must be
reported on lines 7, 8, or 9, as applicable.

Line 21c. Gross Capital Losses
From Schedule D, Excluding
Amounts From Pass-Through
Entities, Abandonment Losses,
and Worthless Stock Losses
Report on line 21c gross capital losses
reported on Schedule D, excluding capital
losses from (a) pass-through entities,
which must be reported on lines 7, 8, or 9,
as applicable; (b) abandonment losses,
which must be reported on line 21e; and
(c) worthless stock losses, which must be
reported on line 21f.

Line 21d. Net Gain/Loss
Reported on Form 4797, Line
17, Excluding Amounts From
Pass-Through Entities,
Abandonment Losses, and
Worthless Stock Losses
Report on line 21d the net gain or loss
reported on line 17 of Form 4797, Sales
of Business Property, excluding amounts
from (a) pass-through entities, which must
be reported on lines 7, 8, or 9, as
applicable; (b) abandonment losses,
which must be reported on line 21e; and
(c) worthless stock losses, which must be
reported on line 21f.

Line 21e. Abandonment Losses
Report on line 21e any abandonment
losses, regardless of whether the loss is
characterized as an ordinary loss or a
capital loss.

Line 21f. Worthless Stock
Losses
Report on line 21f any worthless stock
loss, regardless of whether the loss is
characterized as an ordinary loss or a
capital loss. Attach a schedule that
separately states and adequately
discloses each transaction that gives rise
to a worthless stock loss and the amount
of each loss.

Line 21g. Other Gain/Loss on
Disposition of Assets Other
Than Inventory
Report on line 21g any gains or losses
from the sale or exchange of property
other than inventory that are not reported
on lines 21b through 21f.

Line 22. Other Income (Loss)
Items With Differences
Separately state and adequately disclose
on line 22 all items of income (loss) with
differences that are not otherwise listed
on lines 1 through 21. Attach a schedule
that itemizes the type of income (loss)
and the amount of each item.
If any “comprehensive income” as
defined by Statement of Financial
Accounting Standards (SFAS) No. 130 is
reported on this line, describe the item(s)
in detail. Examples of sufficiently detailed
descriptions include “Foreign currency
translation adjustments” and “Gains and
losses on available-for-sale securities.”

Line 23. Total Income (Loss)
Items
Combine lines 1 through 22 and enter the
total on line 23.
Note. Line 15, Cost of goods sold,
columns (a) and (d), are negative
amounts that will affect the totals entered
on line 23.

Line 24. Total Expense/
Deduction Items
Report on line 24, columns (a) through
(d), as applicable, the negative of the
amounts reported on Part III, line 30,
columns (a) through (d). For example, if
Part III, line 30, column (a), reflects an
amount of $1 million, then report on line
24, column (a), ($1 million). Similarly, if
Part III, line 30, column (b), reflects an
amount of ($50,000), then report on line
24, column (b), $50,000.

Line 25. Other Items With No
Differences
If there is no difference between the
financial accounting amount and the
taxable amount of an entire item of
income, gain, loss, expense, or deduction
and the item is not described or included
on lines 1 through 22, or Part III, lines 1
through 29, report the entire amount of
the item in columns (a) and (d) of line 25.
If a portion of an item of income, loss,
expense, or deduction has a difference
and a portion of the item does not have a
difference, do not report any portion of the
item on line 25. Instead, report the entire
amount of the item (that is, both the

-14-

portion with a difference and the portion
without a difference) on the applicable
line of lines 1 through 22, or Part III, lines
1 through 29. See Example 11 on page
10.

Line 26. Reconciliation Totals.
Combine lines 23 through 25
If a partnership chooses not to complete
columns (a) and (d) of Parts II and III in
the first tax year the partnership is
required to file Schedule M-3 (or for any
year in which the partnership voluntarily
files Schedule M-3), line 26 is reconciled
by the partnership in the following
manner:
1. Report the amount from Part I, line
11, on line 26, column (a);
2. Leave blank lines 1 through 25,
columns (a) and (d);
3. Leave blank Part III, columns (a)
and (d); and
4. Report on line 26, column (d), the
sum of line 26, columns (a), (b), and (c).

Part III. Reconciliation of
Net Income (Loss) per
Income Statement of
Partnerships With Income
(Loss) per Return —
Expense/Deduction Items
Note. Expense amounts that reduce
financial income must be reported on Part
III, column (a), as positive amounts.
Deduction amounts that reduce taxable
income must be reported on Part III,
column (d), as positive amounts. Amounts
reported on Part II, line 24, must be the
negative of the amounts reported on Part
III, line 30.

Lines 1 Through 4. Income Tax
Expense
If the partnership does not distinguish
between current and deferred income tax
expense in its financial statements (or its
books and records, if applicable), report
income tax expense as current income
tax expense using lines 1 and 3, as
applicable.

Line 5. Equity-Based
Compensation
Report on line 5 any amounts for
equity-based compensation or
consideration that are reflected as
expense for financial accounting
purposes (column (a)) or deducted in the
U.S. income tax return (column (d)) other
than amounts reportable elsewhere on
Schedule M-3, Parts II and III. Examples
of amounts reportable on line 5 include
expense/deduction items attributable to
options to acquire capital interest units,
profits interest units, and other rights to
acquire partnership equity, regardless of
whether such payments are made to
employees or non-employees, or as

Page 15 of 17

Instructions for Schedule M-3 (Form 1065)

18:06 - 13-AUG-2008

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

payment for property or compensation for
services.

Line 6. Meals and
Entertainment
Report on line 6, column (a), any amounts
paid or accrued by the partnership during
the tax year for meals, beverages, and
entertainment that are accounted for in
financial accounting income, regardless of
the classification, nomenclature, or
terminology used for such amounts, and
regardless of how or where such amounts
are classified in the partnership’s financial
income statement or the income and
expense accounts maintained in the
partnership’s books and records. Report
only amounts not otherwise reportable
elsewhere on Schedule M-3, Parts II and
III (for example, Part II, line 15).

Line 7. Fines and Penalties
Report on line 7 any fines or similar
penalties paid to a government or other
authority for the violation of any law for
which fines or penalties are assessed. All
fines and penalties expensed in financial
accounting income (paid or accrued) must
be included on line 7, column (a),
regardless of the government or other
authority that imposed the fines or
penalties, regardless of whether the fines
and penalties are civil or criminal,
regardless of the classification,
nomenclature, or terminology used for the
fines or penalties by the imposing
authority in its actions or documents, and
regardless of how or where the fines or
penalties are classified in the
partnership’s financial income statement
or the income and expense accounts
maintained in the partnership’s books and
records. Also report on line 7, column (a),
the reversal of any overaccrual of any
amount described in this paragraph. See
sections 162(f) and 162(g) for additional
guidance.
Report on line 7, column (d), any such
amounts described in the preceding
paragraph that are includible in taxable
income, regardless of the financial
accounting period in which such amounts
were or are included in financial
accounting net income. Complete
columns (b) and (c), as appropriate.
Do not report on line 7 amounts
required to be reported in accordance
with instructions for line 8.
Do not report on line 7 amounts
recovered from insurers or any other
indemnitors for any fines and penalties
described above.

Line 8. Judgments, Damages,
Awards, and Similar Costs
Report on line 8, column (a), the amount
of any estimated or actual judgments,
damages, awards, settlements, and
similar costs, however named or
classified, included in financial accounting
income, regardless of whether the
amount deducted was attributable to an
estimate of future anticipated payments or
actual payments. Also report on line 8,

column (a), the reversal of any
overaccrual of any amount described in
this paragraph.
Report on line 8, column (d), any such
amounts described in the preceding
paragraph that are includible in taxable
income, regardless of the financial
accounting period in which such amounts
were or are included in financial
accounting net income. Complete
columns (b) and (c), as appropriate.
Do not report on line 8 amounts
required to be reported in accordance
with instructions for line 7.
Do not report on line 8 amounts
recovered from insurers or any other
indemnitors for any judgments, damages,
awards, or similar costs described above.

Line 9. Guaranteed Payments
Include on line 9, column (a), the amount
of guaranteed payments expense that is
included on Part I, line 11. Report in
column (d) the net amount of guaranteed
payments deduction. The net amount of
the deduction reported in column (d) is
the amount reported as a deduction on
Form 1065, page 1, line 10, or on Form
1065-B, page 1, line 13, reduced by the
amount reported as income on Schedule
K (Form 1065), line 4, or Schedule K
(Form 1065-B), line 7. The net amount of
the guaranteed payments reported in
column (d) will be zero if no guaranteed
payments are capitalized and all are
deducted on Form 1065, page 1, line 10,
or Form 1065-B, page 1, line 13, or a
negative amount (reported in
parentheses), if any of the guaranteed
payments are capitalized by the
partnership. Generally, if guaranteed
payments expense is recognized for
financial accounting purposes, the
amount reported in column (c) as a
permanent difference will be the negative
of the guaranteed payment income
reported on Schedule K (Form 1065), line
4, or Schedule K (Form 1065-B), line 7. If
no guaranteed payment expense is
recognized for financial accounting
purposes, the amount reported in column
(c) as a permanent difference generally
will be zero. Any amount of guaranteed
payments capitalized for tax purposes on
Form 1065 or Form 1065-B, page 1, but
not capitalized for financial accounting
purposes, generally will be reported as a
negative temporary difference amount in
column (b).
Example 19.
1. Partnership AZ has total income in
2008 of $5,000 for both financial
accounting and tax accounting purposes
before taking into account guaranteed
payments expense or deductions. Partner
A is paid a deductible guaranteed
payment of $3,000 for services rendered
to the partnership during the taxable year.
Partner Z is paid a $1,000 guaranteed
payment, which is capitalized to land for
tax accounting. Both guaranteed
payments, in the total amount of $4,000,
are treated as expenses in arriving at net
financial accounting income. There are no

-15-

other expenses or deductions for financial
accounting or tax accounting purposes.
The amount shown on Part I, line 11, Net
income (loss) per income statement of the
partnership, is $1,000 ($5,000 − $3,000 −
$1,000 = $1,000). The amount shown on
line 9, column (a), is $4,000, the amount
of guaranteed payments expenses for
financial accounting purposes. The
amount shown on line 9, column (d), is
($1,000), the net amount deducted after
taking into consideration the $4,000 of
total guaranteed payments allocated to
the partners as income on Schedule K,
netted against $3,000 deducted on Form
1065, page 1, line 10. The amount
reported on line 9, column (b), is a
temporary difference of ($1,000), the
negative of the amount of guaranteed
payments capitalized for Form 1065,
page 1. The amount reported on line 9,
column (c), is a permanent difference of
($4,000), equal to the guaranteed
payment income shown on Schedule K
(Form 1065), line 4, or Schedule K (Form
1065-B), line 7, expressed as a negative
amount. Part II, line 23, reports $5,000 in
column (a), 0 in column (b), 0 in column
(c), and $5,000 in column (d). Part II, line
24, reports ($4,000) in column (a), $1,000
in column (b), $4,000 in column (c), and
$1,000 in column (d). Part II, line 26,
reports $1,000 in column (a), $1,000 in
column (b), $4,000 in column (c), and
$6,000 in column (d).
2. Same facts as in Example 19.1,
except that no guaranteed payments
expense is recognized for financial
accounting purposes. The amount shown
on Part I, line 11, is $5,000. On line 9, AZ
reports 0 in column (a), ($1,000) in
column (b), 0 in column (c), and ($1,000)
in column (d). Part II, line 23, reports 0 in
column (a), $1,000 in column (b), 0 in
column (c), and $1,000 in column (d). On
Part II, line 25, AZ reports $5,000 in
column (a), $1,000 in column (b), 0 in
column (c), and $6,000 in column (d).

Line 10. Pension and
Profit-Sharing
Report on line 10 any amounts
attributable to the partnership’s pension
plans, profit-sharing plans, and any other
retirement plans.

Line 11. Other Post-Retirement
Benefits
Report on line 11 any amounts
attributable to other post-retirement
benefits not otherwise includible on line
10 (for example, retiree health and life
insurance coverage, dental coverage,
etc.).

Line 12. Deferred
Compensation
Report on line 12, column (a), any
compensation expense included in the
net income (loss) amount reported on
Part I, line 11, that is not deductible for
U.S. income tax purposes in the current
tax year and that was not reported
elsewhere on Schedule M-3, column (a).

Page 16 of 17

Instructions for Schedule M-3 (Form 1065)

18:06 - 13-AUG-2008

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

Report on line 12, column (d), any
compensation deductible in the current
tax year that was not included in the net
income (loss) amount reported on Part I,
line 11, for the current tax year and that is
not reportable elsewhere on Schedule
M-3, including any compensation
deductions deferred in a prior tax year.
For example, report originations and
reversals of deferred compensation
subject to section 409A on line 12.

tax-free reorganization not otherwise
reportable on Schedule M-3 (for example,
line 15 or 16). Report on this line any
legal and accounting fees paid or incurred
at any stage of the acquisition or
reorganization process including, for
example, fees paid or incurred to evaluate
whether to investigate an acquisition, fees
to conduct an actual investigation, and
fees to consummate the acquisition or
reorganization.

Line 14. Charitable Contribution
of Intangible Property

Line 19. Amortization/
Impairment of Goodwill

Report on line 14 any charitable
contribution of intangible property, for
example, contributions of:
• Intellectual property, patents (including
any amounts of additional contributions
allowable by virtue of income earned by
donees subsequent to the year of
donation), copyrights, trademarks;
• Securities (including stocks and their
derivatives, stock options, and bonds);
• Conservation easements (including
scenic easements or air rights);
• Railroad rights of way;
• Mineral rights; and
• Other intangible property.

Report on line 19 amortization of goodwill
or amounts attributable to the impairment
of goodwill.

Line 15. Organizational
Expenses as per Regulations
section 1.709-2(a)
Include on line 15, column (a),
organizational expenses as defined in
Regulations section 1.709-2(a). Include
on line 15, column (d), the amount of
organizational expense deducted per
section 709(b).

Line 16. Syndication Expenses
as per Regulations section
1.709-2(b)
Include on line 16 syndication expenses
as defined in Regulations section
1.709-2(b).

Line 17. Current Year
Acquisition/Reorganization
Investment Banking Fees
Report on line 17 any investment banking
fees paid or incurred in connection with a
taxable or tax-free acquisition of property
(for example, ownership interests or
assets) or a tax-free reorganization not
otherwise reportable on Schedule M-3
(for example, line 15 or 16). Report on
this line any investment banking fees paid
or incurred at any stage of the acquisition
or reorganization process including, for
example, fees paid or incurred to evaluate
whether to investigate an acquisition, fees
to conduct an actual investigation, and
fees to consummate the acquisition or
reorganization.

Line 18. Current Year
Acquisition/Reorganization
Legal and Accounting Fees
Report on line 18 any legal and
accounting fees paid or incurred in
connection with a taxable or tax-free
acquisition of property (for example,
ownership interests or assets) or a

Line 20. Amortization of
Acquisition, Reorganization,
and Start-Up Costs
Report on line 20 amortization of
acquisition, reorganization, and start-up
costs. For purposes of columns (b), (c),
and (d), include amounts amortizable
under section 167 or 195.

Line 21. Other Amortization or
Impairment Write-Offs
Report on line 21 any amortization or
impairment write-offs not otherwise
includible on Schedule M-3.

Line 22. Section 198
Environmental Remediation
Costs
Report on line 22, column (a), any
amounts attributable to environmental
remediation costs included on Part I, line
11. Report in columns (b), (c), and (d), as
applicable, any deductible amounts
attributable to environmental remediation
costs described in section 198 that are
paid or incurred during the current tax
year.

Line 23a. Depletion— Oil & Gas
Report on line 23a, column (a), any oil
and gas depletion included on Part I, line
11.
Note. Form 1065-B reports oil and gas
depletion on line 23b.

Line 23b. Depletion— Other
than Oil & Gas
Report on line 23b any depletion
expense/deduction other than oil and gas
that is not required to be reported
elsewhere on Schedule M-3 (for example,
on Part II, lines 7, 8, 9, or 15).
Note. Form 1065-B reports oil and gas
depletion on line 23b.

Line 24. Intangible Drilling and
Development Costs (IDC)
Intangible Drilling and Development Costs
(IDC) are costs of developing oil, gas, or
geothermal wells. Report on line 24,
column (a), the total amount of intangible
drilling and development costs (or such
equivalent costs as classified in the
partnership’s financial statements)
included on Part I, line 11, and report on
line 24, column (d), the total amount of

-16-

IDC paid or incurred during the current
tax year under section 263(c) and
Regulations section 1.612-4.

Line 25. Depreciation
Report on line 25 any depreciation
expense/deduction that is not required to
be reported elsewhere on Schedule M-3
(for example, on Part II, lines 7, 8, 9, or
15).

Line 26. Bad Debt Expense
Report on line 26, column (a), any
amounts attributable to an allowance for
uncollectible accounts receivable or
actual write-offs of accounts receivable
included on Part I, line 11. Report in
column (d), the amount of bad debt
expense deductible for federal income tax
purposes under section 166.

Line 27. Interest Expense
Attach Form 8916-A. Complete Part III
and enter the amounts shown on line 5,
columns (a) through (d), on Schedule
M-3, line 27, columns (a) through (d), as
applicable.
Report on line 27, column (a), the total
amount of interest expense included on
Part I, line 11, and report on line 27,
column (d), the total amount of interest
deduction included on Analysis of Net
Income (Loss), line 1, which is found on
page 5 of Form 1065, and page 4 of Form
1065-B, that is not reported elsewhere on
Schedule M-3. In columns (b) or (c), as
applicable, adjust for any amounts treated
for U.S. income tax purposes as interest
deduction that are treated as some other
form of expense for financial accounting
purposes, or vice versa. For example,
adjustments to interest expense/
deduction resulting from adjustments
made in accordance with instructions for
line 28 should be made in columns (b)
and (c), as applicable, of line 27.
Do not report on Form 8916-A and on
line 27 amounts reported in accordance
with instructions for (i) Part II, lines 7, 8
and 9, Income (loss) from U.S.
partnerships, foreign partnerships and
other pass-through entities, and (ii) Part
II, line 10, Items relating to reportable
transactions.

Line 28. Purchase Versus Lease
(for Purchasers and/or
Lessees)
Note. Also see the instructions for Part
II, line 16, for sellers and/or lessors.
Asset transfer transactions with
periodic payments characterized for
financial accounting purposes as either a
purchase or a lease may, under some
circumstances, be characterized as the
opposite for tax purposes.
If a transaction is treated as a lease,
the purchaser/lessee reports the periodic
payments as gross rental expense. If the
transaction is treated as a purchase, the
purchaser/lessee reports the periodic
payments as payments of principal and
interest and also reports depreciation

Page 17 of 17

Instructions for Schedule M-3 (Form 1065)

18:06 - 13-AUG-2008

The type and rule above prints on all proofs including departmental reproduction proofs. MUST be removed before printing.

expense or deduction with respect to the
purchased asset.
Report in column (a) gross rent
expense for a transaction treated as a
lease for financial accounting purposes
but as a sale for U.S. income tax
purposes. Report in column (d) gross
rental deductions for a transaction treated
as a lease for U.S. income tax purposes
but as a purchase for financial accounting
purposes. Report interest expense or
deduction amounts for such transactions
on line 27, in column (a) or (d), as
applicable. Report depreciation expense
or deductions for such transactions on
line 25, in column (a) or (d), as applicable.
Use columns (b) and (c) of lines 25, 27,
and 28, as applicable, to report the
differences between column (a) and (d)
for such recharacterized transactions.
Example 20. U.S. partnership X
acquired property in a transaction that, for
financial accounting purposes, X treats as
a lease. X is a calendar year partnership
that was required to file Schedule M-3 for
its 2007 tax year and is required to file
Schedule M-3 for its 2008 tax year.
Because of its terms, the transaction is
treated for U.S. income tax purposes as a
purchase, and X must treat the periodic
payments it makes partially as a payment
of principal and partially as a payment of
interest. In its financial statements, X
treats the difference between the financial
accounting and U.S. income tax treatment
of this transaction as a temporary
difference. During 2008, X reports in its
financial statements $1,000 of gross
rental expense that, for U.S. income tax
purposes, is recharacterized as a $700
payment of principal and a $300 payment
of interest, accompanied by a
depreciation deduction of $1,200 (based
on other facts). On its 2008 Schedule
M-3, X must report the following on line
28: column (a), $1,000, its financial
accounting gross rental expense; column
(b), ($1,000); and column (d), zero. On
line 27, X reports zero in column (a) and
$300 in columns (b) and (d) for the
interest deduction. On line 25, X reports
zero in column (a) and $1,200 in columns
(b) and (d) for the depreciation deduction.

Line 29. Other Expense/
Deduction Items With
Differences

Comprehensive income. If any
“comprehensive income” as defined by
SFAS No. 130 is reported on this line,
describe the item(s) in detail as, for
example, “Foreign currency translation
adjustments” and “Gains and losses on
available-for-sale securities.”
Reserves and contingent liabilities.
Report on line 29 amounts related to the
change in each reserve or contingent
liability that is not required to be reported
elsewhere on Schedule M-3. Report on
line 29, column (a), expenses included in
net income reported on Part I, line 11,
that are related to reserves and
contingent liabilities. Report on line 29,
column (d), amounts related to liabilities
for reserves and contingent liabilities that
are deductible in the current tax year for
U.S. income tax purposes. Examples of
items that must be reported on line 29
include warranty reserves, restructuring
reserves, reserves for discontinued
operations, and reserves for acquisitions
and dispositions. Only report on line 29
items that are not required to be reported
elsewhere on Schedule M-3, Parts II and
III. For example, the expense for a
reserve for inventory obsolescence must
be reported on Part II, line 15.
The schedule of details attached to the
return for line 29 must separately state
and adequately disclose the nature and
amount of the expense related to each
reserve and/or contingent liability. The
appropriate level of disclosure depends
upon each taxpayer’s operational activity
and the nature of its accounting records.
For example, if a partnership’s net income
amount reported in the income statement
includes anticipated expenses for a
discontinued operation as a single
amount, and its general ledger or other
books, records, and workpapers provide
details for the anticipated expenses under
more explanatory and defined categories
such as employee termination costs,
lease cancellation costs, loss on sale of
equipment, etc., a supporting schedule
that lists those categories of expenses
and their details will satisfy the
requirement to separately state and
adequately disclose. In order to
separately state and adequately disclose
the employee termination costs, it is not

Report on line 29 all items of expense/
deduction that are not otherwise listed on
lines 1 through 28.

-17-

required that an anticipated termination
cost amount be listed for each employee,
or that each asset (or category of asset)
be listed along with the anticipated loss
on disposition.
Example 21. Partnership Q is a
calendar year partnership that was
required to file Schedule M-3 for its 2007
tax year and is required to file Schedule
M-3 for its 2008 tax year. On July 1 of
each year, Q has a fixed liability for its
annual insurance premiums that provides
a 12-month coverage period beginning
July 1 through June 30. In addition, Q
historically prepays 12 months of
advertising expense on July 1. On July 1,
2008, Q prepays its insurance premium of
$500,000 and advertising expenses of
$800,000. For financial accounting
purposes, Q capitalizes and amortizes the
prepaid insurance and advertising over 12
months. For U.S. income tax purposes, Q
deducts the insurance premium when
paid and amortizes the advertising over
the 12-month period. In its financial
statements, Q treats the differences
attributable to the financial statement
treatment and U.S. income tax treatment
of the prepaid insurance and advertising
as temporary differences. Q must
separately state and adequately disclose
on line 29 its prepaid insurance premium
and report $250,000 in column (a)
($500,000/12 months X 6 months),
$250,000 in column (b), and $500,000 in
column (d). Q must also separately state
and adequately disclose on Part II, line
22, Other items with no differences, its
prepaid advertising and report $400,000
in column (a) and (d).

Line 30. Total Expense/
Deduction Items
Enter on Part II, line 24, columns (a)
though (d), as applicable, positive
amounts from line 30 as negative (in
parentheses) and negative amounts as
positive. For example, if line 30, column
(a), reflects an amount of $1 million, then
report on Part II, line 24, column (a), ($1
million). Similarly, if line 30, column (b),
reflects an amount of ($50,000), then
report on Part II, line 24, column (b),
$50,000.