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jgordosea, Enrolled Agent
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Experience:  I've prepared all types of taxes since 1987.
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How do you balance an 1120S form and schedule an M2?

Resolved Question:

Accounting - IRS Form 1120 S - M2 on page 4. Domestic Production Deduction. It seems logical that I must reduce balance by amount of deduction, but is it? How do I balance to Retained Earnings line 24 of balance sheet?

Submitted: 8 years ago.
Category: Tax
Expert:  jgordosea replied 8 years ago.


Since retained earnings (RE) on Schedule L is book basis there are often adjustments on Schedule M-1 to reconcile the book basis to the amount of RE for the tax return. In order to balance, you should verify that all the required entries (items not on return that are not on the books and items not on the books that are on return) are made on Schedule M-1 before making any M-2 adjustments. It may be that making an M-1 adjustment is all that is needed.

Also, please realize that Schedule M-2 is actually an analysis of the AAA, OAA, and PTI accounts and there may well be difference between these account totals and the tax basis RE as reported. In those cases an entry is simply made on M-2 as either "other additions" or "other reductions" with an appropriate description.

I hope this helps for preparing the Schedule M-1 and M-2 as needed.

Best wishes for a prosperous new year.

Customer: replied 8 years ago.

My question was not well written. What I want to understand is how one can ever balance line 8 of M2 with line 24 of balance sheet when one has a domestic production deduction?

Expert:  jgordosea replied 8 years ago.

As you may know, in 2002 the IRS issued new instructions providing that the balance sheet and Schedule M-1 are not required to be completed if the corporation's total receipts for the tax year AND its total assets at the end of the tax year are less than $250,000. So, if the form is not required one option is to disregard the M-2.

Net Income per Books on Schedule M-1 is generally income (from Schedule K, line 23) plus any amounts on Schedule M-1 lines 5 and 6, minus any amounts on Schedule M-1 lines 2 and 3. Line 8 of Schedule M-1 should equal line 24 of Schedule L when all the correct entries are included.

The domestic production deduction will be an adjustment on both Schedule M-1 and Schedule M-2 in order to match line 8 totals of the three columns to Schedule L retained earnings. Other than distributions M-2 often has the same entries as M-1.

But, please understand as it is not required in all circumstances that AAA will equal RE. The most common situation is when distributions are more than earnings since AAA cannot be less than zero.

In regard to how one balances line 8 of the M-2 when the M-1 adjustment is correctly made for an expense not on the books the M-2 will usually balance using the same adjustments as the M-1 for the year. Since the beginning balance next year will be the prior year adjusted balance of AAA, OAA, and PTI accounts there will only be the same annual adjustment needed for the deduction not on the books.

I hope this helps. Please ask if you need further assistance.

jgordosea, Enrolled Agent
Category: Tax
Satisfied Customers: 3159
Experience: I've prepared all types of taxes since 1987.
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