NC CD-405 requires filling out balance sheet schedules when Form 1120 and NC doesn't require it.

[SunFoxNC]

When electronically filing a client's TY2023 Form 1120/NC Form CD-405 corporate tax returns, I got the following error message:

Details for your rejected filing.
Error message: [CD-405] Schedule M-2 line 8 must equal line 4 minus line 7.
Solution: For electronic filing, the ending balance on Sch. M-2 must equal the beginning balance plus an increases, less any decreases. Please ensure no overrides are present on the return .
Code: NCCD405-2340

Like the individual tax returns, North Carolina corporate tax returns start with the Federal tax return’s taxable income figure and then adjustments are made to come up with North Carolina’s take on taxable income due to the General Assembly explicitly passing legislation to decouple North Carolina from the Federal Internal Revenue Code for a given item.

In this case, Federal Form 1120 has three supporting schedules which can be a royal pain in the tuchus to translate from the accounting system into these schedules as it’s often not as straightforward a mapping as it should seem:

Schedule L – Balance Sheets per Books
Schedule M-1 – Reconciliation of Income (Loss) per Books With Income per Return
Schedule M-2 – Analysis of Unappropriated Retained Earnings per Books (Schedule L, Line 25)

However, Schedule K (Other Information) line 13 asks this question:

Are the corporation’s total receipts (page 1, line 1a, plus lines 4 through 10) for the tax year and its total assets at the end of the tax year less than $250,000?

If “Yes”, the corporation is not required to complete Schedules L, M-1, and M-2. Instead, enter the total amount of cash distributions and thebook value of property distributions (other than cash) made during this tax year.

Because the corporation in question is under that limit, the tax software I use to prepare returns allows me to suppress those three schedules on the Federal return even though they may have been populated from data imported from Quickbooks Online.

However, the error message in question was generated by North Carolina’s version of Schedules L/M-1/M-2 on the corporate tax return form CD-405 which I was forced to fill out even though it isn’t required on the Federal return for this taxpayer and I haven’t found anything explicitly decoupling North Carolina from the exemption from filling out those three schedules found in Form 1120, Schedule K, line 13.

I’m not totally convinced I should have been required to fill out North Carolina’s version of those schedules if the Federal 1120 didn’t require those schedules to be completed.

The only clue in the CD-405 instructions for tax year 2023 about these three schedules are these two notations:

Schedule L – Complete this schedule only if you do not attach a copy of federal Form 1120, Schedule L, along with all supporting schedules.
Schedules M-1/M-2 – Complete these schedules only if you do not attach a copy of federal Form 1120, Schedules M-1 and M-2, along with all supporting schedules.

In previous years when I’d file North Carolina corporate taxes on paper, the easiest way to avoid having to duplicate all of the info from the Form 1120 onto CD-405 was to do what these notes suggested which was to staple the full Form 1120 to the end of the package and mail it off to the NC Department of Revenue.

In over 20 years of doing corporate returns, DOR has never complained that the CD-405 Schedules L/M-1/M-2 were as blank as their counterparts on the attached Form 1120 which leads me to believe that they do consider those schedules just as optional for North Carolina’s tax law purposes as they are for corporations that can answer “Yes” on Form 1120 Schedule K, line 13.

With the number of tax returns I’m preparing in a given tax year, filing returns on paper isn’t really an option unless you happen to fall into one of the cracks in the system where they’ve not implemented a particular form and you have to force the system to allow you to paper file that return.

North Carolina participates in the combined Federal/State Electronic Filing programme which means that you can E-file both returns together which goes from your transmitter to the IRS computers first and then gets passed to North Carolina’s (from what I can tell, this happens once it passes the IRS schema validation/business rule edits if not has been fully accepted as the status message would indicate).

I don’t have access to the XML schema used by the software to produce the files that are electronically transmitted to the NC DOR computers so I haven’t a clue what is transmitted to North Carolina as part of the Modernized Electronic Filing (MeF).

But I did manage to find the business rules spreadsheet pertaining to processing electronically filed CD-405 returns in a spreadsheet that was buried on the NC DOR website which not only had the error I’d gotten with the rejected return but also this business rule that I didn’t see triggered in the status that strongly suggests that the electronic file sent to NC DOR contained a copy of the Form 1120 data that was sent to the IRS for processing:

NCCD405-1000 – [CD-405] A Federal 1120 return or a Federal 1120-F return must be provided with a CD-405.

So if NC DOR had the 1120 data available for processing, presumably they’d also have the the checkbox from Form 1120 Schedule K line 13 as specified in the XML stylesheet.

<!-- Schedule K, Line 13-->
<div style="width:187mm;">
<div class="styLNLeftNumBox" style="height:4mm;">13</div>
<div class="styLNDesc" style="width:167mm;height:4mm; ">
Are the corporation’s total receipts (page 1, line 1a, plus lines 4 through 10)
for the tax year <b>and</b> its total assets at the end of the
<span style="float:left;">tax year less than $250,000? </span>
<!--Dotted Line-->
<span class="styDotLn" style="float:right;padding-right:1mm;">...............................</span>
</div>
<div class="styGenericDiv">
<div class="styIRS1120LNYesNoBox"
style="padding-top:3mm;height:6mm;border-bottom-width:1px;">
<span style="font-weight:normal;">
<xsl:call-template name="PopulateYesBoxText">
<xsl:with-param name="TargetNode" select="$Form1120ScheduleK/TotalRcptsAssetsLessThanLmtInd"/>
</xsl:call-template>
</span>
</div>
<div class="styIRS1120LNYesNoBoxRB"
style="padding-top:3mm;height:6mm;border-right-width:0px;border-bottom-width:1px;">
<span style="font-weight:normal;">
<xsl:call-template name="PopulateNoBoxText">
<xsl:with-param name="TargetNode" select="$Form1120ScheduleK/TotalRcptsAssetsLessThanLmtInd"/>
</xsl:call-template>
</span>
</div>
</div>
</div>

I’m sure the nice gentleman in NC Department of Revenue’s corporate examination section I rang on Friday was wondering if he was suddenly starring in a new segment of “Tax Talk” reminiscent of Click and Clack’s “Stump the Chump”!

I’m waiting for an answer asking for official confirmation that North Carolina is not decoupled from the Federal 1120 exemption from having to fill out Schedules L/M-1/M-2 and thus should not be requiring them to be filled out for corporations that qualify for that Schedule K exemption.

As I said above, they never complained about those schedules being blank on both Forms 1120 and CD-405 when they were filed on paper which strongly suggests there is no such de-coupling.

Presuming I get the answer I’m expecting, then that would mean that ProConnect should not be requiring those schedules to be populated on NC Form CD-405 when the corporation answers “Yes” on Schedule K line 13 and that DOR should not reject a return during electronic filing processing where the corporation qualifies to be exempt from filling out those schedules and the entries for those schedules are blank in the file.

I would suggest that Intuit could fix this by allowing the Schedule L/M-1/M-2 suppression flag to also suppress populating the North Carolina schedules when it is set presuming North Carolina’s electronic filing processing can handle blanks in those schedules when the corporation is not required to produce them for Form 1120.

As it was, I ended up filling out those three schedules in CD-405 and fixing them so that they’d balance and pass the validation edits but it was not a fun experience spending a hour dealing with cryptic and bizarre error messages before I was able to finally figure out a way to make the software happy.

If I never have to deal with those schedules on Form 1120 or Form CD-405 ever again, I’ll be more than thrilled!

====

UPDATE:

It appears that we have in indeed found a bug in ProConnect with the official news from our friends at the NC Department of Revenue that confirms that as suspected, there is no de-coupling between North Carolina and the Federal Internal Revenue Code when it comes to Schedules L/M-1/M-2 being optional for businesses with receipts and assets less than $250,000.

"You asked whether corporate taxpayers are required to submit Schedules L and M when they are not required to submit federally (due to the small business threshold). I couldn’t find any source that said this information is required by NC when not required by the IRS. I also reached out to my supervisor, and he confirmed. If you are not required to submit those schedules on the federal return, you will not be required to submit them on the NC return.

Thanks and have a great tax day"
NC Dept of Revenue Official Response to Question Submitted on 12 Apr 2024

So there we have it…ProConnect should not have forced me to populate those schedules on NC Form CD-405 in order to electronically file the returns.

And there was much rejoicing in the hope that by the time my next corporate tax form preparation comes round in about three months that this bug will be squashed!