Schedule M (Kentucky Form 740)

In this guide, we’ll provide you with step-by-step, line-by-line instructions on how to file and complete Schedule M, ensuring that you understand every line and comply with Kentucky tax laws.

Schedule M, also known as the “Modifications to Federal Adjusted Gross Income” form, is an integral part of the Kentucky state income tax return (Form 740). This form is used to report adjustments that either increase (additions) or decrease (subtractions) your federal adjusted gross income (AGI) to determine your Kentucky taxable income accurately. For example, income such as interest from non-Kentucky municipal bonds or certain federal depreciation allowances must be added to your federal AGI, while specific deductions, like income from U.S. government bonds or active-duty military pay, must be subtracted. Schedule M applies to Kentucky taxpayers who have income or deductions that differ between federal and state tax rules. The aim is to ensure that Kentucky taxes only the income subject to state taxation while allowing for state-specific deductions. Married couples filing jointly or separately, as well as taxpayers with complex income sources like partnerships, estates, trusts, or S corporations, must pay close attention to this form to avoid errors and maximize deductions.

How to File Schedule M (Kentucky Form 740)

  1. Eligibility Check:
    • You must file Schedule M if there are adjustments (additions or subtractions) to your federal adjusted gross income (AGI) that apply to Kentucky tax laws.
    • Common examples include interest from out-of-state bonds, U.S. government bond income, retirement income exclusions, and active-duty military pay.
  2. Attach Schedule M to Form 740:
    • This schedule must accompany your completed Form 740 when filing your Kentucky tax return.
  3. Keep Supporting Documentation:
    • Certain lines on Schedule M require additional forms or supporting documents, such as federal Form 4562 for depreciation adjustments, Schedule K-1 for resident adjustments, or Schedule KNOL for net operating losses. Ensure these are attached to avoid delays or rejections.
How to Complete Schedule M (Kentucky Form 740)

How to Complete Schedule M (Kentucky Form 740)

Header Section

  • Name(s) and Social Security Number:
    Enter your name(s) as they appear on Form 740 and provide your Social Security Number (SSN). If filing jointly, include both names and SSNs.

Part I: Additions to Federal Adjusted Gross Income

Line 1: Interest Income from Bonds Issued by Other States

  • Report any interest income from bonds issued by other states or their political subdivisions. This includes income from mutual funds that invest in non-Kentucky bonds.
  • Note: Interest from Kentucky bonds or its political subdivisions is exempt and should not be included here.

Line 2: Resident Adjustments from Partnerships, Fiduciaries, and S Corporations

  • Enter the resident adjustment amount from Kentucky Schedule K-1. This applies to partners, beneficiaries of estates or trusts, and S corporation shareholders. Refer to the K-1 instructions for details.

Line 3: Federal Depreciation from Form 4562

  • If you claimed special depreciation allowances (e.g., 30% or 50% bonus depreciation or increased Section 179 deductions) on federal Form 4562 for property placed in service after September 10, 2001, enter the total here.
  • Important: Kentucky does not conform to federal depreciation rules for these allowances, so adjustments are necessary.

Line 4: Federal Net Operating Loss (NOL)

  • Enter the federal NOL reported on federal Schedule 1, Line 8 of Form 1040 or 1040-SR. Kentucky requires adjustments to the NOL based on state-specific rules.

Line 5: Other Additions

  • List and total any other additions to federal AGI not specified above. Examples include:
    • Reservist and National Guard expenses.
    • Lump-sum distributions taxed at the federal capital gains rate.
    • Differences in depreciation or gains/losses for certain property.
    • Passive activity loss adjustments.
  • Attach a detailed schedule if necessary.

Line 6: Total Additions

  • Add lines 1 through 5 and enter the total here. Report this amount on Form 740, Page 1, Line 6.

Part II: Subtractions from Federal Adjusted Gross Income

Line 7: State Income Tax Refunds

  • If you reported a state income tax refund as income on your federal return, you can subtract that amount here.

Line 8: Interest Income from U.S. Government Bonds

  • Enter any interest income earned from U.S. government bonds or securities. Do not include interest from securities guaranteed but not issued by the U.S. government (e.g., FNMA, GNMA).

Line 9: Excludable Retirement Income

  • Subtract up to $31,110 of retirement income per taxpayer. This includes pensions, IRA distributions, and 401(k) income.
  • If your retirement income exceeds $31,110 or includes federal/military government pensions, complete and attach Schedule P.

Line 10: Taxable Social Security and Railroad Retirement Benefits

  • Enter the taxable portion of Social Security or Railroad Retirement benefits included in your federal AGI. These amounts are not taxable in Kentucky.

Line 11: Resident Adjustments from Partnerships, Fiduciaries, and S Corporations

  • Report resident adjustments from Kentucky Schedule K-1. Subtract the distributive share of net income from S corporations subject to franchise or capital stock taxes under Kentucky law.

Line 12: Kentucky Depreciation Adjustments

  • Enter Kentucky depreciation calculated on a specially prepared Kentucky Form 4562. This adjustment accounts for differences between federal and Kentucky depreciation rules.

Line 13: Active Duty Military Pay

  • Subtract active-duty military pay included in your federal AGI. Kentucky exempts all active-duty military pay from taxation.

Line 14: Other Subtractions

  • Enter any other allowable subtractions not listed above. Examples include:
    • Income earned by precinct election workers.
    • Capital gains from property taken by eminent domain.
    • Passive activity loss adjustments.
    • Military personnel income for those killed in the line of duty.
  • Attach a detailed schedule if applicable.

Line 15: Subtotal of Subtractions

  • Add lines 7 through 14 and enter the subtotal here.

Line 16: Kentucky Net Operating Loss Deduction

  • If you are claiming a Kentucky NOL, enter the amount from Schedule KNOL, Part II, Section A, Line 8. Attach Schedule KNOL to your return.

Line 17: Total Subtractions

  • Add lines 15 and 16. Enter the total here and on Form 740, Page 1, Line 8.

Key Takeaways

  • Schedule M Is Required: If you have adjustments to your federal AGI based on Kentucky tax rules, completing Schedule M is mandatory.
  • Attach Supporting Documents: Forms such as Schedule K-1, federal Form 4562, and Schedule KNOL must be attached when applicable.
  • Married Filing Jointly or Separately: Each spouse must calculate their own retirement income exclusion and other adjustments if filing separately.
  • Accurate Reporting: Ensure you include all applicable additions and subtractions to avoid penalties or delays in processing.
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