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11747: 1120S - M2 Does Not Reconcile Retained Earnings


1120S Sub S Corporate

Why doesn't the M2 reconcile to the retained earnings?

The 1120S schedule M-2 analyzes adjustments to the accumulated earnings account, other adjustments account, and previously taxed income account. It has no counterpart on Form 1120 because a C corporation does not have these accounts. It is not a reconciliation of retained earnings as the schedule M-2 is for an 1120.


The schedule is divided into four columns, which are designed to reconcile the accounts that affect a shareholder's basis. Column A is for accumulated adjustments account (AAA); Column B is for shareholders' undistributed taxable income previously taxed; Column C is for accumulated earnings & profits; and, Column D is for other adjustments.

Note: In Drake17 and prior, there were only 3 columns on the schedule M2. Column (a) is for the accumulated adjustments account; Column (b) is for the other adjustments account; and, Column (c) is for the shareholders' undistributed taxable income previously taxed account.

Distributions need to be entered on Line 16 of the Schedule K. Go to the DIST screen and enter distributions there. Distributions do not need to be entered directly on the M-2. If the distributions are keyed on the DIST screen they will flow to line 16d of the Schedule K to the K-1 and then to the M-2 (if they are allowed).

The AAA (Column A on the M-2) cannot be negative as a result of distributions. It can be negative if it arises from losses. The 1120S does not work like an 1120; Line 1 of the M-2 may, or may not, match line 24b of the Schedule L.

Column B of the M-2 cannot be negative. It is only active in an 1120S if the entity was ever an 1120 (thus it had Earnings & Profit, or E&P) or if it was a pre-1983 1120S. Drake Software will not allow Columns B to be a negative number. If an 1120 becomes an 1120S and has NOL, the NOL is suspended on the 1120S tax return because it cannot carry to an 1120S (IRS does not want the NOL to be used by the shareholders to offset income); it will either run out within the years allowable for the NOL by statute or will be used if the 1120S reverts to an 1120 within those years. 


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