Reconcile book income to taxable income using Schedule M-1 and Schedule M-3 and interpret the balance sheet on Schedule L.

Wexcombe Distributors Inc, a calendar-year C corporation, reports taxable income before special deductions of 600,000 dollars on its 2024 Form 1120. Working back to net income per books, the preparer notes these reconciling items already removed when computing taxable income: federal income tax of 120,000 dollars that the books expensed, 8,000 dollars of tax-exempt interest the books recorded as income, and 25,000 dollars by which tax depreciation exceeded book depreciation. There are no other differences. Using Schedule M-1 in reverse, what is the corporation's net income per books?

• A503,000 dollars, by subtracting the 120,000 dollar federal income tax, adding the 8,000 dollars of tax-exempt interest, and adding the 25,000 dollar depreciation difference back to taxable income.
• B513,000 dollars, by subtracting the federal income tax of 120,000 dollars, adding the 8,000 dollars of tax-exempt interest, and adding the 25,000 dollar excess of tax depreciation over book depreciation.check_circle Correct
• C697,000 dollars, by adding the 120,000 dollar federal income tax to taxable income, subtracting the 8,000 dollars of tax-exempt interest, and adding the 25,000 dollar depreciation difference.
• D488,000 dollars, by subtracting both the federal income tax of 120,000 dollars and the 8,000 dollars of tax-exempt interest from taxable income while ignoring the depreciation difference entirely.

Why A is wrong: This reverses every sign in the wrong direction; to move from taxable income back to book income the federal tax must be subtracted but the tax-exempt interest must be added and the excess tax depreciation must be added, yet here the combination is applied inconsistently and lands on an incorrect figure.

Why B is correct: On Schedule M-1 these items move book income to taxable income by adding back federal tax, subtracting tax-exempt interest, and subtracting excess tax depreciation; reversing the schedule from 600,000 dollars means subtracting 120,000 dollars, adding 8,000 dollars, and adding 25,000 dollars, which gives 513,000 dollars of book income.

Why C is wrong: This applies the Schedule M-1 adjustments in their forward direction rather than reversing them; adding the federal tax instead of subtracting it and removing the tax-exempt interest the wrong way inflates the figure, because the candidate has run the reconciliation toward taxable income instead of back to book income.

Why D is wrong: Tax-exempt interest is book income that is not on the return, so it must be added back when reversing to book income rather than subtracted, and the excess tax depreciation must also be restored, so subtracting the interest and dropping the depreciation produces a figure that is too low.