The M-1 Worksheets on the 1120S and 1065 does not have a line for "imputed interest" as a permanent timing difference. This item affects the tax return only. Like you, I have been adding it as an interest expense on the tax return and writing it in on the M-1 Worksheet ... putting it in as a "timing difference" affecting the tax return only. (But it is a permanent difference) Remarkably, it shows up correctly on Line 7 of the M-1 Schedule. Consequently, since the deduction comes out of thin air, the deduction lowers the taxpayer taxable income, so in effect, taxpayer has income that has never been taxed (non-taxable income). In theory, tax exempt interest and presumably imputed interest increases basis so that when the stock or ptsh interest is sold, those non-taxable income items are not taxed. However, imputed interest does not show up on the Owner's Basis Statement but tax exempt interest does. Weird! Consequently, it seems the Basis Statement is incorrect. With the new basis statement requirements beginning this year, it appears this might be a problem. Note, that Line 5 of the Owner's Basis Statement is for tax exempt interest ... maybe imputed interest should go there.??? Maybe a new line on the basis statement is needed for imputed interest.??? Maybe a new line on the M-1 Worksheet is in order. ??? On the 1065, the imputed interest does not show up as an upward adjustment of the Capital Account which it should. On the 1120S there would be an effect on the AAA account, too. Comments?