Key Takeaways
Form 8858 Schedule M Essentials:
- Schedule M reports transactions between the FDE and its tax owner (and related parties)
- Covers sales, services, rents, royalties, interest, and other related-party transactions
- Transactions must be reported at arm’s length prices
- Material transactions require detailed supporting documentation
- Inconsistencies between Schedule M and other forms trigger IRS scrutiny
Table of Contents
Introduction
Schedule M is the most scrutinized part of Form 8858. While the main form captures your foreign disregarded entity’s basic information, Schedule M reveals the economic substance of transactions between the FDE and related parties.
The IRS uses Schedule M to identify potential transfer pricing issues, unreported income, and inappropriate shifting of profits between U.S. and foreign entities. Getting Schedule M right requires understanding both the reporting requirements and the underlying transfer pricing rules.
This guide walks through Schedule M line by line, explains common transaction types, and highlights the documentation you’ll need to support your reported amounts.
What is Schedule M?
Schedule M (Form 8858), titled “Transactions Between Foreign Disregarded Entity of a Foreign Tax Owner and the Filer or Other Related Entities,” captures all material transactions between:
- The FDE and its tax owner
- The FDE and other entities related to the tax owner
- The FDE and other FDEs under common ownership
Who Must File Schedule M:
If you file Form 8858, you generally must also file Schedule M when the FDE has transactions with related parties. The only exception is when the FDE had no intercompany transactions during the tax year.
Purpose of Schedule M:
Schedule M serves several IRS objectives:
- Track intercompany transactions for transfer pricing compliance
- Verify arm’s length pricing on related-party dealings
- Identify potential profit shifting between jurisdictions
- Cross-reference information reported on other forms (Form 5471, Form 5472, Form 8865)
Relationship to Other Forms:
Schedule M on Form 8858 is similar to:
- Schedule M on Form 5471 (for CFCs)
- Schedule M on Form 8865 (for foreign partnerships)
- Form 5472 (for foreign-owned U.S. corporations)
The IRS cross-references these schedules to ensure consistent reporting of intercompany transactions.
Schedule M Line-by-Line Instructions
Schedule M is organized by transaction type. Each line captures a specific category of intercompany transaction, with columns for amounts received by the FDE and amounts paid by the FDE.
Line 1: Sales of Inventory
Report the value of inventory (goods held for sale) sold between the FDE and related parties.
Column (a) – Received from FDE: Value of inventory the FDE sold to related parties Column (b) – Paid to FDE: Value of inventory the FDE purchased from related parties
Examples:
- U.S. parent manufactures products and sells to German FDE for distribution
- Mexican FDE sells raw materials to U.S. parent for manufacturing
- FDE purchases finished goods from sister company for resale
Valuation Methods:
- Cost plus method (cost of production plus arm’s length markup)
- Resale price method (resale price minus arm’s length margin)
- Comparable uncontrolled price method (prices in comparable third-party transactions)
Line 2: Sales of Property Other Than Inventory
Report sales of tangible property other than inventory, such as equipment, vehicles, or real estate.
Column (a) – Received from FDE: Proceeds from property the FDE sold to related parties Column (b) – Paid to FDE: Amounts the FDE paid to purchase property from related parties
Examples:
- FDE sells used equipment to U.S. parent
- U.S. parent transfers machinery to FDE
- FDE purchases real property from related entity
Report at fair market value. Document with appraisals if values are significant.
Line 3: Platform Contribution Transactions
Report amounts related to platform contribution transactions under cost sharing arrangements.
This line captures buy-in payments when a party joins an existing cost sharing arrangement and must compensate other parties for pre-existing intangibles.
When This Applies:
- FDE joins a cost sharing arrangement with U.S. parent
- FDE makes platform contribution payment for access to existing IP
- Buy-in payments under Treasury Regulations Section 1.482-7
Line 4: Cost Sharing Transaction Payments
Report ongoing payments under qualified cost sharing arrangements.
Column (a): Payments the FDE received from related parties for cost sharing Column (b): Payments the FDE made to related parties for cost sharing
Examples:
- R&D cost sharing between U.S. parent and FDE
- Allocation of development costs based on anticipated benefits
- Periodic true-up payments under cost sharing agreements
Line 5: Compensation Received/Paid for Services
Report amounts paid for services performed between the FDE and related parties.
Column (a): Service fees the FDE received Column (b): Service fees the FDE paid
Common Service Types:
- Management services
- Administrative support
- Technical services
- Back-office functions (HR, IT, accounting)
- Consulting services
Valuation Considerations:
Services must be priced at arm’s length. Common methods include:
- Comparable uncontrolled services price
- Cost plus method (costs plus arm’s length markup)
- Gross services margin method
The IRS scrutinizes management fees closely. Ensure you have:
- Written service agreements
- Documentation of services actually performed
- Arm’s length pricing analysis
Line 6: Commissions Received/Paid
Report sales commissions paid between the FDE and related parties.
Examples:
- FDE acts as sales agent for U.S. parent’s products
- U.S. parent pays FDE commission on sales generated
- FDE pays commission to related sales company
Commission rates should reflect what would be paid to unrelated agents performing similar functions in similar markets.
Line 7: Rents, Royalties, and License Fees
Report intellectual property payments and property rentals between the FDE and related parties.
Column (a): Rents, royalties, and license fees received by the FDE Column (b): Rents, royalties, and license fees paid by the FDE
Types of Payments:
- Patent royalties
- Trademark licensing fees
- Copyright royalties
- Trade secret licensing
- Software licensing
- Equipment rentals
- Property rentals
Transfer Pricing Focus:
IP licensing is a high-risk area for transfer pricing examination. The IRS looks for:
- Royalty rates consistent with arm’s length standards
- Proper allocation of IP ownership
- Economic substance in licensing arrangements
- Compliance with cost sharing regulations for developed IP
Line 8: Hybrid Dividends
Report hybrid dividend payments under IRC Section 245A(e).
A hybrid dividend is a payment that:
- Is treated as a dividend for U.S. tax purposes
- Is deductible by the foreign payor (creating a deduction/no inclusion mismatch)
This line captures transactions designed to exploit differences between U.S. and foreign tax treatment.
Line 9: Interest
Report interest payments between the FDE and related parties.
Column (a): Interest received by the FDE Column (b): Interest paid by the FDE
Sources of Intercompany Interest:
- Intercompany loans
- Cash pooling arrangements
- Trade receivables financing
- Notes payable to related parties
Imputed Interest Rules:
Even if no interest is charged, the IRS may impute interest on intercompany loans under IRC Section 482 and Section 7872. Use the applicable federal rate (AFR) at minimum for intercompany debt.
Lines 10-14: Other Categories
Line 10: Other amounts received by FDE Line 11: Other amounts paid by FDE Line 12: Totals received from FDE Line 13: Totals paid to FDE Line 14: Net amounts
These lines capture:
- Insurance premiums
- Guarantee fees
- Technical assistance fees
- Any other intercompany payments not covered above
Common Schedule M Transactions
Understanding typical intercompany arrangements helps you categorize transactions correctly.
Management Services from U.S. Parent to FDE
A common structure involves the U.S. parent providing centralized management services to foreign subsidiaries and FDEs.
Typical Arrangement:
U.S. Parent provides:
- Strategic planning
- Financial oversight
- HR administration
- IT infrastructure
FDE pays annual management fee based on cost plus markup or percentage of revenue
Schedule M Reporting:
- Line 5, Column (b): Management fee paid by FDE
- Documentation: Service agreement, cost allocation study, benchmark analysis
IP Licensing to FDE
Many structures involve the FDE licensing intellectual property from a U.S. or foreign related party.
Typical Arrangement:
U.S. Parent owns global trademarks FDE licenses trademarks for European market FDE pays royalty based on net sales
Schedule M Reporting:
- Line 7, Column (b): Royalty paid by FDE
- Documentation: License agreement, royalty rate benchmark study, evidence of IP ownership
Intercompany Sales of Goods
Manufacturing and distribution structures often involve inventory transactions between FDEs and related parties.
Typical Arrangement:
U.S. Parent manufactures products German FDE acts as limited risk distributor FDE purchases products at cost plus 5%, sells to third parties
Schedule M Reporting:
- Line 1, Column (b): Purchase price paid by FDE for inventory
- Documentation: Transfer pricing study, comparable margin analysis
Cash Pooling and Intercompany Loans
Multinational groups often centralize cash management, creating intercompany receivables and payables.
Typical Arrangement:
U.S. Parent operates global cash pool FDE deposits excess cash with parent FDE earns interest at pool rate
Schedule M Reporting:
- Line 9, Column (a): Interest received by FDE
- Documentation: Cash pooling agreement, interest rate analysis
Transfer Pricing Basics
Schedule M transactions are subject to transfer pricing rules under IRC Section 482 and corresponding Treasury Regulations.
Arm’s Length Standard
All transactions between the FDE and related parties must be priced as if the parties were unrelated, dealing at arm’s length. The IRS can adjust reported prices if they don’t meet this standard.
What Arm’s Length Means:
The price or terms that would be agreed upon between independent parties in comparable circumstances. This requires analyzing:
- Functions performed by each party
- Assets used in the transaction
- Risks assumed by each party
- Comparable transactions between unrelated parties
Transfer Pricing Methods
The regulations specify acceptable methods for determining arm’s length prices:
Comparable Uncontrolled Price (CUP): Compare to prices in transactions between unrelated parties
Resale Price Method: Start with resale price, subtract arm’s length gross margin
Cost Plus Method: Start with costs, add arm’s length markup
Comparable Profits Method: Compare to operating profits of comparable companies
Profit Split Method: Divide combined profits based on relative contributions
Documentation Requirements
Treasury Regulations Section 1.6662-6 requires contemporaneous documentation to avoid penalties on transfer pricing adjustments. While there’s no explicit documentation requirement for Form 8858, maintaining documentation protects you if the IRS questions your Schedule M amounts.
Documentation Should Include:
- Description of the business and industry
- Organizational structure showing relationships
- Description of controlled transactions
- Selection and application of transfer pricing method
- Economic analysis supporting arm’s length pricing
- Background documents (contracts, agreements, financial data)
For more on related-party reporting, see our Form 5472 Reportable Transactions Guide.
Common Mistakes to Avoid
Inconsistent Reporting Across Forms
The IRS cross-references Schedule M on Form 8858 with:
- Schedule M on Form 5471 (if the FDE is owned by a CFC)
- Form 5472 (if there are foreign-related party transactions)
- Schedule M on Form 8865 (if the FDE is owned by a foreign partnership)
Amounts must be consistent. If the FDE paid $100,000 to a CFC, both forms should reflect that amount.
Missing Transactions
Don’t overlook transactions that seem immaterial. Common missed items include:
- Informal loans (even if no note exists)
- Services provided without formal agreement
- Use of parent’s IP without license agreement
- Allocated costs from shared services
Incorrect Valuations
Using book values instead of arm’s length values for intercompany transactions creates audit exposure. Even if you haven’t done a formal transfer pricing study, make reasonable efforts to price transactions consistently with arm’s length standards.
Failing to Update for Business Changes
Intercompany arrangements should reflect actual business operations. If the FDE’s functions, assets, or risks change, transaction pricing should be reviewed and potentially updated.
Not Maintaining Documentation
If the IRS questions Schedule M amounts, you’ll need documentation to support your positions. Create and maintain:
- Intercompany agreements
- Transfer pricing analyses
- Correspondence about intercompany matters
- Financial records supporting reported amounts
Schedule M and IRS Audits
Schedule M receives significant attention in international tax examinations.
Why IRS Examines Schedule M Closely
- Intercompany transactions are a primary means of shifting profits
- Transfer pricing adjustments can generate substantial tax assessments
- Cross-border transactions are harder to verify than domestic ones
- Schedule M provides a roadmap of related-party dealings
Common Audit Triggers
- Large intercompany balances relative to total activity
- Significant changes in intercompany amounts year over year
- Royalty payments to low-tax jurisdictions
- Management fees without clear economic substance
- Interest payments on thin capitalization structures
- Inconsistencies between Schedule M and other international forms
Documentation to Maintain
Keep these records for at least seven years (longer if returns remain open):
- All intercompany agreements
- Transfer pricing documentation
- Economic analyses supporting pricing
- Correspondence regarding intercompany matters
- Board resolutions authorizing intercompany arrangements
- Financial statements of the FDE
Statute of Limitations Considerations
The statute of limitations doesn’t begin until you file a substantially complete Form 8858. If Schedule M is incomplete or materially misstated, the IRS may argue the form isn’t substantially complete, keeping the statute open indefinitely.
Frequently Asked Questions
Do I file Schedule M if the FDE has no transactions?
If your FDE had no transactions with related parties during the year, you can skip Schedule M or file it with zeros. However, ensure you haven’t overlooked implicit transactions like allocated costs or services.
How do I value intercompany services?
Services should be priced at arm’s length. Common approaches include cost plus method (actual costs plus arm’s length markup, typically 5-10% for routine services) or comparable pricing from third-party service arrangements.
What if I don’t have formal transfer pricing documentation?
You can still file Schedule M using reasonable estimates of arm’s length pricing. However, you face penalty exposure if the IRS adjusts your prices. Consider preparing at least basic transfer pricing documentation for material transactions.
Can Schedule M be amended?
Yes. If you discover errors on a previously filed Schedule M, you can file an amended Form 8858 with corrected Schedule M. Voluntary correction before IRS contact typically results in better outcomes.
How does Schedule M relate to Form 5472?
Form 5472 reports transactions between a U.S. corporation and foreign related parties. If your FDE transacts with a U.S. corporation that files Form 5472, the reported amounts should be consistent.
What’s the penalty for incorrect Schedule M?
Incorrect Schedule M can result in Form 8858 penalties ($10,000 to $50,000) and transfer pricing penalties (20-40% of underpayments attributable to transfer pricing adjustments).
When to Get Professional Help
Consider professional assistance when:
- Complex intercompany structures involve multiple transaction types
- Material transaction values create significant transfer pricing exposure
- You lack transfer pricing documentation and need to develop a defensible position
- The IRS is examining your international returns
- Intercompany arrangements are changing and need restructuring analysis
SDO CPA prepares Schedule M as part of our Form 8858 filing services and can help you develop appropriate transfer pricing documentation.
Conclusion
Schedule M is where the IRS looks for transfer pricing issues and inappropriate profit shifting. Getting it right requires:
- Complete identification of all intercompany transactions
- Proper categorization by transaction type
- Arm’s length pricing supported by documentation
- Consistent reporting across all international forms
Don’t treat Schedule M as an afterthought. The transactions reported here receive significant IRS scrutiny, and errors can result in substantial penalties and transfer pricing adjustments.
Get Help with Form 8858 Schedule M
Related Resources
- Form 8858 Foreign Disregarded Entity Guide
- Form 8858 vs Form 5471 Comparison
- Form 5472 Reportable Transactions Guide
- Form 5472 Foreign-Owned Business Guide
- Form 8858 Penalties and Relief
- Form 8858 Filing Services
- International Tax Services
This article is for informational purposes only and does not constitute tax or legal advice. Consult a qualified tax professional for advice specific to your situation.