SEE - Special Enrollment Exam Quiz: Book To Tax Reporting
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Book To Tax ReportingQuestion 1 of 15

Alder Manufacturing, a calendar-year C corporation, keeps its books on GAAP. For 2025, Alder's financial statement net income is $500,000 after recording federal income tax expense of $100,000. Book income includes $20,000 of interest on state bonds that is excludible under IRC § 103 and $10,000 of life insurance proceeds received by Alder on the death of a key employee. Book expenses include $40,000 of business meals, all subject to the 50% deduction limit, and a $25,000 penalty paid to a state agency for a violation of state law. Tax depreciation exceeds book depreciation by $30,000.

Based on these facts, what amount should be reported as income per return on Alder's 2025 Schedule M-1?

$585,000
$615,000
$595,000
$645,000
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SEE - Special Enrollment Exam Quiz

SEE - Special Enrollment Exam Quiz: Book To Tax Reporting

Practice Book To Tax Reporting in SEE - Special Enrollment Exam with focused quiz questions that help you check what you know, review explanations, and build confidence with test-style prompts.

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Question 1

Alder Manufacturing, a calendar-year C corporation, keeps its books on GAAP. For 2025, Alder's financial statement net income is $500,000 after recording federal income tax expense of $100,000. Book income includes $20,000 of interest on state bonds that is excludible under IRC § 103 and $10,000 of life insurance proceeds received by Alder on the death of a key employee. Book expenses include $40,000 of business meals, all subject to the 50% deduction limit, and a $25,000 penalty paid to a state agency for a violation of state law. Tax depreciation exceeds book depreciation by $30,000.

Based on these facts, what amount should be reported as income per return on Alder's 2025 Schedule M-1?

  1. $585,000 (correct answer)
  2. $615,000
  3. $595,000
  4. $645,000
Explanation: Form 1120, Schedule M-1 instructions; IRC §§ 103, 101(a), 274(n), 162(f), and 168. Start with book net income (500,000),andaddbackfederalincometaxperbooks(500,000), and add back federal income tax per books (100,000) plus book expenses that are not deductible for tax: the nondeductible half of meals (20,000)andthestate−lawpenalty(20,000) and the state-law penalty (25,000). Then subtract book income that is not taxable: tax-exempt state bond interest (20,000)andlifeinsurancedeathproceeds(20,000) and life insurance death proceeds (10,000), and subtract tax depreciation in excess of book depreciation ($30,000). The result is $500,000 + $100,000 + $20,000 + $25,000 - $20,000 - $10,000 - $30,000 = $585,000, so Choice A is correct. Choice B results from omitting one of the two $30,000 subtractions (the nontaxable income or the excess tax depreciation); both omissions produce the same $615,000 figure. Choice C results from subtracting the bond interest and the excess tax depreciation but not the life insurance proceeds. Choice D results from making none of the Schedule M-1 subtractions.

Question 2

Northwoods Corp, a calendar-year C corporation that manufactures goods, uses GAAP for its books. During 2025, Northwoods incurred $80,000 of § 263A costs that were included in its financial statement cost of goods sold. For tax purposes, these costs were capitalized into ending inventory under § 263A and were not included in 2025 cost of goods sold. The inventory to which the costs relate is still on hand at December 31, 2025.

What is the correct 2025 Schedule M-1 treatment of the $80,000?

  1. Report no adjustment, because § 263A costs must be treated the same for financial statement and tax purposes.
  2. Subtract $80,000 from book income, because tax ending inventory is higher than book ending inventory.
  3. Add $80,000 to book income, because tax cost of goods sold is lower than book cost of goods sold. (correct answer)
  4. Defer the adjustment until the inventory is sold, because an increase in ending inventory is a permanent difference.
Explanation: IRC § 263A; Schedule M-1 instructions. The uniform capitalization rules require certain costs to be included in inventory for tax even if they are expensed for financial reporting. Because tax ending inventory is $80,000 higher than book ending inventory, tax cost of goods sold is $80,000 lower and taxable income is $80,000 higher; the current-year Schedule M-1 adjustment is an addition. Choice B has the correct observation about ending inventory but the wrong direction. Choice A ignores the required difference. Choice D is wrong because the difference is recognized in the year incurred and reverses, rather than being permanent, when the inventory is sold.

Question 3

Iron River Corp, a calendar-year C corporation, deducted $50,000 of charitable contributions on its 2025 financial statements. Its taxable income for purposes of the corporate charitable contribution limit is $300,000, computed without regard to the charitable contribution deduction and the dividends-received deduction. Iron River also has a $100,000 dividends-received deduction on the 2025 return.

Which of the following correctly describes the tax deduction for the charitable contribution and the required 2025 Schedule M-1 adjustment?

  1. Deduct $20,000 on the return; add $30,000 to book income; carry over $30,000.
  2. Deduct $50,000 on the return; no Schedule M-1 adjustment; no carryover.
  3. Deduct $30,000 on the return; add $20,000 to book income; carry over $20,000. (correct answer)
  4. Deduct $30,000 on the return; subtract $20,000 from book income; carry over $20,000.
Explanation: IRC § 170(b)(2). A C corporation's charitable contribution deduction is limited to 10% of taxable income computed without regard to the charitable contribution, the dividends-received deduction, NOL carrybacks, and capital loss carrybacks. The limit is 10% of $300,000, or $30,000. Because the books deducted $50,000, the $20,000 excess is added on Schedule M-1 and carried over. Choice A incorrectly applies the limit after subtracting the dividends-received deduction, reaching a $20,000 limit and a $30,000 addition. Choice D has the correct deduction but the wrong M-1 direction. Choice B ignores the 10% limit.

Question 4

Balsam Falls Corp, a calendar-year C corporation, has a $75,000 net operating loss carryover from 2023 that is allowed in full on its 2025 return. In its 2023 financial statements, Balsam recognized the tax benefit of that loss; for 2025 financial reporting, the carryover provides no additional book tax benefit. Balsam has no other book-tax differences and includes Schedule M-1 with its 2025 Form 1120.

How should the $75,000 NOL deduction be treated on Balsam Falls's 2025 Schedule M-1?

  1. Add it as a book expense not deducted on the return.
  2. Subtract it as a tax return deduction not charged against book income.
  3. Make no Schedule M-1 adjustment, because Schedule M-1 reconciles to taxable income before the NOL deduction. (correct answer)
  4. Report it on Schedule M-2 as an adjustment to unappropriated retained earnings.
Explanation: Form 1120, Schedule M-1, line 10, and page 1, lines 28 and 29a. Schedule M-1 ends at line 10, "Income (page 1, line 28)," and line 28 is taxable income before the net operating loss deduction and special deductions. The NOL deduction is taken on line 29a, after the reconciliation ends, so it is never a Schedule M-1 reconciling item. That the 2023 financial statements recognized the loss's tax benefit affects deferred tax expense, not Schedule M-1. Choice C is correct. Choice A treats the NOL as a book expense not deducted on the return. Choice B treats it as a return deduction that Schedule M-1 must subtract, but the reconciliation stops before the NOL deduction. Choice D moves it to Schedule M-2, which reconciles unappropriated retained earnings.

Question 5

Pinecone Corp, a calendar-year C corporation, has the following items for 2025: book depreciation of $80,000 and tax depreciation of $120,000 on the same equipment; a $30,000 nondeductible portion of business meals; a dividends-received deduction of $18,000 for dividends from a domestic corporation; and premiums of $20,000 on a key-person life insurance policy under which Pinecone is the beneficiary.

Which of the following is correct regarding the book-tax classification of these items for Schedule M-1?

  1. The dividends-received deduction is a permanent difference; the life insurance premiums are a temporary difference because the policy proceeds will be taxable when received.
  2. The $30,000 nondeductible meals portion is a temporary difference because it will be allowed when the meals are paid; the dividends-received deduction is also a temporary difference.
  3. The $40,000 excess of tax depreciation over book depreciation is a permanent difference; the nondeductible life insurance premiums are a temporary difference.
  4. The $40,000 excess of tax depreciation over book depreciation is a temporary difference; the dividends-received deduction is a permanent difference. (correct answer)
Explanation: Schedule M-1 instructions; IRC §§ 168, 243, 274(n), 264(a)(1). A temporary difference reverses in a later year; a permanent difference does not. The $40,000 excess of tax depreciation over book depreciation will reverse as book depreciation exceeds tax depreciation in later years, so it is a temporary difference. The dividends-received deduction, the 50% meals disallowance, and premiums on a life insurance policy under which the corporation is the beneficiary are permanent differences. Choice B misclassifies the meals disallowance as temporary and misclassifies the dividends-received deduction as temporary. Choice C reverses the depreciation classification and also misclassifies the life insurance premiums as temporary. Choice A correctly identifies the dividends-received deduction as permanent but misclassifies the life insurance premiums as temporary; the premium disallowance under § 264(a)(1) does not reverse, regardless of the later tax treatment of the proceeds.

Question 6

For 2025, a calendar-year C corporation is reconciling book net income to income per return on Form 1120, Schedule M-1. Which item is a permanent book-tax difference (a difference that will not reverse in a later year) that causes income per return to be lower than book net income?

  1. Excess tax depreciation over book depreciation reduces income per return this year, but the difference reverses in later years.
  2. A current net capital loss recognized on the books is added back on Schedule M-1 and may be carried to another tax year.
  3. Interest on state and local government bonds included in book income is subtracted on Schedule M-1 and never creates a later taxable amount. (correct answer)
  4. Fines and penalties recorded as book expenses are added back on Schedule M-1 and do not reverse in a later year.
Explanation: Form 1120, Schedule M-1 instructions; IRC § 103(a). Interest on state and local government bonds is excluded from gross income, and the exclusion is permanent. The interest is included in book net income, so on Schedule M-1 it is subtracted as income recorded on the books but not included on the return; income per return is therefore lower than book net income. Choice A is a temporary difference: it lowers income per return this year, but it will reverse as book depreciation exceeds tax depreciation in later years. Choice B is a current-year add-back because a C corporation cannot deduct a net capital loss in the current year; it may be carried back or forward under IRC § 1212(a), making it temporary, and it increases income per return. Choice D is a permanent difference, but because fines and penalties are not deductible under IRC § 162(f), it is added back and increases income per return, not lowers it.

Question 7

RST Partnership is a calendar-year partnership. In 2022, Partner R contributed land to RST when its adjusted tax basis was $60,000 and its fair market value was $100,000. RST recorded the land on its books at $100,000. On July 1, 2025, RST sold the land for $120,000. RST had no other income, gain, loss, or expense during 2025, and its financial statements report book gain of $20,000 from the sale.

How much should RST report on Form 1065, Schedule M-1 as an addition to book income in reconciling book income to income per return for 2025?

  1. $20,000
  2. $40,000 (correct answer)
  3. $60,000
  4. $80,000
Explanation: IRC § 723 and IRC § 704(c); Form 1065, Schedule M-1 instructions. A partnership takes a carryover basis in contributed property, so RST's tax basis in the land is $60,000, not $100,000. The tax gain on the sale is $120,000 - $60,000 = $60,000, while the book gain is $120,000 - $100,000 = $20,000. The $40,000 difference is the built-in gain at contribution that IRC § 704(c) requires to be taken into account on the tax return and allocated to Partner R. Because the $40,000 is included in Schedule K income but was not recorded on RST's books, it is an addition on Schedule M-1. Choice A uses the book gain as the adjustment and ignores the carryover tax basis. Choice C uses the full $60,000 tax gain as the adjustment; book income already includes the $20,000 book gain, so only the $40,000 excess is added. Choice D double counts the book gain by adding the $20,000 book gain to the full $60,000 tax gain.

Question 8

Maple Corporation is a calendar-year C corporation. For 2025, Maple's financial statements show net income per books of $520,000, after deducting federal income tax expense of $70,000. The $520,000 includes $18,000 of interest on general obligation state and local government bonds and $200,000 of proceeds from a life insurance policy on its CFO, for which Maple is the named beneficiary. The $520,000 also reflects an $8,500 penalty for late payment of payroll taxes as an expense. For tax purposes, Maple's depreciation deduction is $27,000 more than the depreciation recorded on its books. Maple has no net operating loss deduction and no dividends-received deduction for 2025.

What amount should Maple report as income per return on Form 1120, Schedule M-1, line 10?

  1. $353,500 (correct answer)
  2. $371,500
  3. $380,500
  4. $553,500
Explanation: Form 1120, Schedule M-1 instructions. Schedule M-1 starts with book net income and reconciles it to income per return. Maple must add back the $70,000 federal income tax expense because it reduced book income but is not deductible on the return. It must also add back the $8,500 payroll penalty because IRC § 162(f) disallows deductions for fines and penalties. It must subtract the $18,000 bond interest (IRC § 103(a)) and the $200,000 life insurance proceeds (IRC § 101(a)) because both are included in book income but are not taxable. It must subtract the 27,000excesstaxdepreciationbecausethatamountisdeductedonthereturnbutwasnotchargedagainstbookincomethisyear.Working:520,000+70,000+8,500−18,000−200,000−27,000=353,500.ChoiceAiscorrect.ChoiceB(27,000 excess tax depreciation because that amount is deducted on the return but was not charged against book income this year. Working: 520,000 + 70,000 + 8,500 - 18,000 - 200,000 - 27,000 = 353,500. Choice A is correct. Choice B (371,500) results from failing to subtract the municipal bond interest. Choice C (380,500)resultsfromfailingtosubtracttheexcesstaxdepreciation.ChoiceD(380,500) results from failing to subtract the excess tax depreciation. Choice D (553,500) results from failing to subtract the life insurance proceeds.

Question 9

For 2025, which of the following statements about book-tax differences reported on a corporation's Schedule M-1 is correct?

  1. A temporary difference, such as the excess of tax depreciation over book depreciation, is reported in only the year it arises and is never adjusted in a later year.
  2. A permanent difference, such as tax-exempt interest, is subtracted from book income each year it is included in book income and never reverses in a later year. (correct answer)
  3. A temporary difference may arise from an item that affects book income but never affects taxable income, such as life insurance proceeds received on the death of an insured employee.
  4. A permanent difference may arise from an item that affects book income in one year and taxable income in a later year, such as a warranty expense accrued for financial reporting purposes.
Explanation: Schedule M-1 (Form 1120) instructions: Schedule M-1 starts with net income per books and reconciles it to income per the return. Tax-exempt interest is included in book income but excluded from gross income under IRC § 103, so it is entered as a subtraction from book income; it is a permanent difference because it will not reverse. Choice A misstates the treatment of a temporary difference: excess tax depreciation is a subtraction in the originating year and reverses in later years when book depreciation exceeds tax depreciation. Choice C misstates the nature of life insurance proceeds; proceeds excluded under IRC § 101(a) are a permanent difference, not a temporary difference. Choice D misstates a warranty accrual; a book expense deducted for tax only when paid is a temporary difference that reverses, not a permanent difference.

Question 10

A calendar-year C corporation's 2025 financial statements report net income per books of $350,000 after federal income tax expense. The financial statements include federal income tax expense of $42,000 and $8,000 of tax-exempt municipal bond interest. Tax depreciation exceeds book depreciation by $25,000. The financial statements deduct $20,000 of business meal costs, but only $10,000 is deductible for tax. What is the corporation's taxable income as reconciled on Schedule M-1?

  1. $369,000 (correct answer)
  2. $331,000
  3. $419,000
  4. $385,000
Explanation: Schedule M-1 (Form 1120) instructions: begin with net income per books of $350,000. Add back the $42,000 of federal income tax expense per books. Subtract the $8,000 of tax-exempt interest because it is not taxable under IRC § 103. Subtract the $25,000 excess of tax depreciation over book depreciation because the return claims a larger deduction than the books. Add the $10,000 meals disallowance because only $10,000 of the $20,000 book meals expense is deductible under IRC § 274(n). The net adjustment is an increase of $19,000, producing taxable income of $369,000. Choice B subtracts the net $19,000 adjustment instead of adding it. Choice C adds the excess tax depreciation instead of subtracting it. Choice D adds the tax-exempt interest instead of subtracting it.

Question 11

A C corporation's 2025 financial statements report net income per books after federal income taxes. The income tax provision shown on the financial statements consists of a $30,000 current federal income tax expense and a $9,000 deferred federal income tax expense. Which statement is correct for completing Schedule M-1?

  1. Only the $30,000 current expense is added to book income on Schedule M-1 because the $9,000 deferred expense is not a current tax liability.
  2. The $9,000 deferred expense is treated as a permanent difference and is not included in the Schedule M-1 reconciliation.
  3. The entire $39,000 of federal income tax expense is added to book income on Schedule M-1, and any originating temporary difference is then separately adjusted on the schedule. (correct answer)
  4. Neither amount is added to book income on Schedule M-1 because federal income tax is not deductible in computing taxable income.
Explanation: Schedule M-1 (Form 1120) instructions: line 1 begins with net income per books, which is reported after federal income taxes. To reconcile to income per the return, the federal income tax expense per books is added back on line 2. That amount includes both current and deferred federal income tax expense recognized in the financial statements, and the originating temporary differences are then adjusted separately elsewhere on Schedule M-1. Choice A is incorrect because the M-1 addback is not limited to the current tax expense. Choice B is incorrect because deferred tax expense is not a permanent difference; it reflects timing differences. Choice D is incorrect because the tax expense must be added back when net income per books is stated after tax.

Question 12

Fairport Freight, a calendar-year C corporation, has always used the cash method for tax and the accrual method for its financial statements. In 2025, with IRS consent, Fairport changes to the accrual method for tax. The § 481(a) adjustment is positive because accounts receivable were not included in income under the cash method. Fairport takes the adjustment into account in taxable income over the applicable § 481(a) adjustment period.

How should the amount of the positive § 481(a) adjustment taken into account in taxable income for 2025 be treated on Fairport's Schedule M-1?

  1. Report it as an addition on Schedule M-1, because the adjustment is included in taxable income but is not reflected in book income for 2025. (correct answer)
  2. Report it as a subtraction on Schedule M-1, because the adjustment represents expenses that were deducted for tax before they were recognized on the books.
  3. Report it as a permanent difference, because accounting-method changes never create timing differences.
  4. Do not report it on Schedule M-1; the adjustment is reported directly on Form 1125-A and bypasses the book-to-tax reconciliation.
Explanation: Treas. Reg. § 1.481-1; Schedule M-1 instructions. A positive § 481(a) adjustment prevents the omission of income when a taxpayer changes from the cash method to the accrual method. The amount taken into account for 2025 is taxable income that is not reflected in book income for that year, so Fairport reports it as an addition on Schedule M-1. Choice B is incorrect because the adjustment is an income item, not an expense item; a subtraction on Schedule M-1 would be used only for a negative adjustment. Choice C is incorrect because a § 481(a) adjustment is a timing difference recognized over a limited period, not a permanent difference. Choice D is incorrect because the adjustment is reconciled on Schedule M-1; Form 1125-A concerns cost of goods sold, not § 481(a) adjustments.

Question 13

Which of the following is correct regarding Schedule M-2 for a corporation filing Form 1120?

  1. Schedule M-2 reconciles beginning and ending unappropriated retained earnings per books and is separate from the calculation of earnings and profits. (correct answer)
  2. Schedule M-2 reconciles beginning and ending accumulated earnings and profits and is used to determine the taxable status of distributions to shareholders.
  3. Schedule M-2 is required only when the corporation files Schedule M-3 and has a negative unappropriated retained earnings balance.
  4. Schedule M-2 reports the corporation's tax-basis balance sheet, while Schedule L reports its book-basis balance sheet.
Explanation: Schedule M-2 (Form 1120) instructions: Schedule M-2 is titled "Analysis of Unappropriated Retained Earnings per Books." It reconciles the beginning and ending unappropriated retained earnings balances shown on the corporation's books and is not an earnings-and-profits schedule. Earnings and profits are computed separately to determine the tax treatment of distributions. Choice B misstates the schedule by substituting the earnings-and-profits computation. Choice C invents conditions not required for Schedule M-2. Choice D confuses Schedule M-2 with Schedule L; Schedule L reports the book-basis balance sheet, while Schedule M-2 reports only the retained earnings analysis.

Question 14

A corporation that is required to file Schedule M-3 with its Form 1120 asks how Schedule M-3 differs from Schedule M-1. Which statement is correct?

  1. Schedule M-3 is filed in addition to Schedule M-1 and is used only by corporations with total assets above a threshold specified in the instructions.
  2. Schedule M-3 is filed instead of Schedule M-1 only when the corporation has audited financial statements; otherwise Schedule M-1 remains required.
  3. Schedule M-3 replaces Schedule M-1 but reports only the net amount of each book-tax difference, whereas Schedule M-1 requires itemization by category.
  4. Schedule M-3 replaces Schedule M-1 and reports income items and expense items separately, with both temporary and permanent difference columns in each part. (correct answer)
Explanation: Schedule M-3 (Form 1120) instructions: a corporation required to file Schedule M-3 does not complete Schedule M-1. Schedule M-3 uses Part II for income and loss reconciliation items and Part III for expense and deduction items, and each part has columns for the book amount, temporary difference, permanent difference, and tax amount. Choice A misstates the filing relationship: Schedule M-3 is filed instead of Schedule M-1, not in addition to it. Choice C misstates the level of detail: Schedule M-3 requires more detail, not less. Choice B invents an audited-financial-statement condition; the Schedule M-3 filing requirement is not based on whether the financial statements are audited.

Question 15

Superior Services, Inc., an S corporation, uses GAAP. For 2025, its book net income is $320,000. The books include $12,000 of interest on state bonds that is exempt from federal tax and is separately stated on Schedule K. The books also include an $8,000 fine paid for a violation of state law, which is not deductible for federal tax purposes.

Which of the following is the correct Schedule M-1 treatment of the fine and the tax-exempt interest?

  1. Add both the $8,000 fine and the $12,000 interest to book income.
  2. Add the $8,000 fine to book income and subtract the $12,000 tax-exempt interest. (correct answer)
  3. Subtract both the $8,000 fine and the $12,000 interest from book income.
  4. Make no adjustment for either item because they are separately stated on Schedule K.
Explanation: Instructions for Form 1120-S, Schedule M-1; IRC §§ 103 and 162(f). Schedule M-1 reconciles net income per books to income (loss) on Schedule K, line 18. Neither item enters line 18. The nondeductible fine is reported on Schedule K, line 16c, and as an expense recorded on the books but not included on Schedule K in arriving at line 18, it is added back on Schedule M-1, line 3. The tax-exempt interest is reported on Schedule K, line 16a, and as income recorded on the books but not included in line 18, it is subtracted on Schedule M-1, line 5a. Choice B is correct. Choice A is wrong because adding the tax-exempt interest would treat it as if it were missing from book income; it is already in book income and must be removed because it is not part of line 18. Choice C is wrong because subtracting the fine treats it as deductible; the fine reduced book income but is not deductible under IRC § 162(f), so it is added back. Choice D is wrong because both items are reported on Schedule K, line 16, which is outside the line 18 income (loss) that Schedule M-1 reconciles to, so both must be reconciled.