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Phillip B, EA
Phillip B, EA, Enrolled Agent
Category: Tax
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Experience:  Practicing since 2004. Expert in 1040, small business, represent vs. IRS, & int'l tax mattters.
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How to complete Schedule M 2?

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Form 1120S - How to complete the Schedule M-2?

The line 7 is for "Distributions other than dividend distributions" so is correct to leave this line blank if "other than dividend distributions" were not paid?

And what about the cash distributions?

Is the line 2 minus line 5 considered as the cash distributions? And is required to follow a formal procedure to take the money?

And what if the only owner just was taking money (writing checks from the company's account to pay all his personal expenses) over the year? The total of that checks approximately equals the net income of the company.

Does the figures in this schedule affect the tax the owner must pay?

And the amounts in Schedule M-1 and M-2 need to match with some other in the Schedule L?

And what if nothing has been made in previous years and the total in line 6 shows a very big amount (the sum of net income from several years)?

Line 2 will include the net income from your S-Corporation (Line 21 from page 1 of form 1120S).

Line 3 additions would include other taxable and tax exempt income (See Schedule K lines 1-10 of form 1120S)

Line 4 would be the loss (if any) from line 21 of page 1 on from 1120S.

Line 5 reductions would include any other negative amounts from lines 1-10 of schedule K from form 1120S, certain deductions, and non-deductible expenses (like personal expenses of a shareholder). (See lines 11 and 12, and line 16c of Schedule K) This needs to be expressed as a negative.

Line 6 is the sum of lines 1-5. The amount here needs should be above zero. If it is not above zero, you will not enter any of your distributions (cash or non-cash) in line 7.

Line 7 will be cash or non-cash distributions if up to the amount in line 6.)

Line 8 is the difference between subtracting line 6 and 7. This can't be less than zero.

The M-2 generally has no effect on what you are being taxed on. The shareholders are (in a majority of circumstances) only taxed on taxable income of the corporation. Those items include:

For a list of the taxable income items, see schedule K of the 1120S, lines 1-10.

If there are additional questions, please reply to this answer so that I may assist you further.

Customer: replied 4 years ago.
The a) was partially answered
The form says "Distributions other than dividend distributions" so the cash distributions are not dividend distributions?
a) The line 7 is for "Distributions other than dividend distributions" so is correct to leave this line blank if "other than dividend distributions" were not paid?
The b) was not answered
b) And what about the cash distributions? Is the line 2 minus line 5 considered as the cash distributions? And is required to follow a formal procedure to take the money?
The c) was not answered
c) And what if the only owner just was taking money (writing checks from the company's account to pay all his personal expenses) over the year? The total of that checks approximately equals the net income of the company.
The d) was answered but now I have a question about that: If that schedule is not affecting the tax on, why is there? And what is its real purpose for?
d) And does the figures in this schedule affect the tax the owner must pay?
The e) was not answered
e) And the amounts in Schedule M-1 and M-2 need to match with some other in the Schedule L?
The f) was not answered
f) And what if nothing has been made in previous years and the total in line 6 shows a very big amount (the sum of net income from several years)?

“The a) was partially answered
The form says "Distributions other than dividend distributions" so the cash distributions are not dividend distributions?
a) The line 7 is for "Distributions other than dividend distributions" so is correct to leave this line blank if "other than dividend distributions" were not paid?”
Answer: Although this line says "other than dividend", I had seen zero S-corp distributions that would not be entered here if the balance is not at zero after the other adjustments.

“The b) was not answered
b) And what about the cash distributions? Is the line 2 minus line 5 considered as the cash distributions? And is required to follow a formal procedure to take the money?”
Answer: No. Each line accounts for different items of income and expense (deductible and non-deductible). The sum of lines 2 though 5 determine what distributions will be entered in this schedule. However, the distributions that are taken may not match the actual distributions that were taken.
The Schedule M2 on Form 1120S is used to track the accumulated adjustments account (AAA) of an S-corporation. For an S-corporation that always remains an S-corp and does not otherwise merge into an S-corp with E&P (only S-Corps that were once operating as c-corps have E&P, not S-corps), the AAA may never be needed for anything. Nevertheless, it is suggested that Schedule M2 be filled out in case the need for an accurate AAA balance arises. Unlike the M-1, the M-2 doesn't (technically) have to reconcile to retained earnings or any other part of the return. The balance can tie to retained earnings on the balance sheet if you make sure distributions are not more than the AAA (accumulated adjustments account).

“The c) was not answered
c) And what if the only owner just was taking money (writing checks from the company's account to pay all his personal expenses) over the year? The total of that checks approximately equals the net income of the company.”
Answer: The checks written from the corporate account that paid the shareholders personal expenses directly will need to be reported as non-deductible expenses on schedule K line 16c. Then that amount will be a Other Reduction on line 5 column A.
This may make the balance in column a, for AAA, zero. If this is the case, no distributions will be recorded in the M-2.

“The d) was answered but now I have a question about that: If that schedule is not affecting the tax on, why is there? and what is its real purpose for?
d) And does the figures in this schedule affect the tax the owner must pay?”
Answer There is a catch that all S-Corp owners should know about. If distributions that were taken exceeded the shareholders' basis in the corp, as determined for each shareholder individually (shareholders are required to track their own outside basis in their S-corp shares/loans from year to year, as that does not appear on the Form 1120S or Schedule K-1), then there could be gain for the shareholders to recognize on the distributions. Negative AAA tends to implicate (not prove) that perhaps the shareholders' basis has been reduced to nothing also, even though not necessarily (it is possible for an s- corp to have negative AAA and a shareholder to have positive outside basis in his/her stock). That maybe one major reason that the IRS requests the M-2 is filed by all S-corps.

“The e) was not answered
e) And the amounts in Schedule M-1 and M-2 need to match with some other in the Schedule L?”
Answer: The M-1 needs to reconcile the retained earnings account in the schedule L, the M-2 doesn't need to reconcile to either. The M-2 does take alot of information from schedule K and the line 21 net income from page 1 of the 1120S.

“The f) was not answered
f) And what if nothing has been made in previous years and the total in line 6 shows a very big amount (the sum of net income from several years)?”
That may not be accurate if distributions have not been recorded, but it is not a problem either.

IRS code section 1368 may be helpful explaining this section as well. http://www.law.cornell.edu/uscode/text/26/1368

Customer: replied 4 years ago.

Just one additional question in the letter c).

Is valid that the checks written for personal expenses of the owner can be handled as "draws" and not as non-deductible expenses?

They should be treated as distributions or nondeductible expenses -- either way would work.
Let me know if there is anything else that I can do for you?
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