Discussion:S-Corporation M-2 -- Book or "Tax"

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Discussion Forum Index --> Basic Tax Questions --> S-Corporation M-2 -- Book or "Tax"

Discussion Forum Index --> Tax Questions --> S-Corporation M-2 -- Book or "Tax"

JCD (talk|edits) said:

27 April 2011
I fully understand that the real AAA for an S-Corp does not directly reconcile to either the current year book income or (always) the tax basis increase/decrease.

Why then do I see most returns having an M-2 that reconciles to the current year book income (i.e., lines 2-6 of the M-2 = book income)?

This is true for the Big 4 returns I've seen as well as the small sole proprietors.

The firm I "grew up" in always reconciled to book income. They're typically pretty straightforward with their stuff, so I'm assuming there is some regulation or Rev Proc that allows this practice, but I have been unsuccessful in finding the authority for it.


Captcook (talk|edits) said:

27 April 2011
The M-2 for an accrual based taxpayer with "books" on an accrual basis will/should always tie to book income. A cash basis taxpayer with "books" on the accrual basis will not. It is the basis of accounting that creates the discrepancy. I doubt you'll find any specific ruling or reference, but I suppose I could be wrong...

Doug M (talk|edits) said:

27 April 2011
I don't follow.

Line 2 is per tax return

Captcook (talk|edits) said:

28 April 2011
Lines 2-6 show all items of income and expense (including non-deductible items). Unless there are accounting basis items as I've described above and would not impact AAA (e.g. accrual to cash adjustments), these should account for all changes in retained earnings, except distributions, which is what Lines 2-6 are supposed to reflect. That kind of sounds like a circular argument to me, but I think it is valid.

Notax (talk|edits) said:

28 April 2011
I've never posted temporary differences to the M-2.

JR1 (talk|edits) said:

April 28, 2011
I think we need to straighten out terms. M1 is for reconciling book to tax. M2 is for reconciling the RE/AAA.

DAJCPA (talk|edits) said:

28 April 2011
M-1 should reconcile current year book income to current year tax income.

M-2 reports those item that increase AAA, OAA, and PTUI. Current year S-corp tax basis income will always increase (or a loss will reduce) the M-2 balance and so will permanent differences such as nondeductibles and nontaxable items. Distributions from AAA, of course will reduce it. However, M-2 will not always agree with Sch L Retained Earnings due to a variety or items that can increase/decrease book retained earnings that do not or only partailly affect AAA (such as prior C-Corp Retained Earnings, temporary book-tax differences, stock redemptions, etc). Our firm always tries to keep an ongoing record of the differences between M-2 and Retained Earnings as M-2, itself, does not reconcile AAA, OAA, and PTUI to Sch L Retained Earnings.

JCD (talk|edits) said:

28 April 2011
I think Captcook and I have been doing the same thing -- although, I don't make a distinction between cash and accrual, I've always made the M-2 tie to R/E... and I was told at one point by someone I would expect to know that there was authority of some sort for this practice.

DAJCPA (and others) look to be doing what I think is probably the correct (or at least mostly correct) answer.

The thing is, I don't think most people really know what tax basis is much less AAA and what to do when this distinction is relevant. But that's whole different can of beans

Captcook (talk|edits) said:

28 April 2011
That's my point. If there is a $50K accrual to cash adjustment, then lines 2-6 will differ from book income by $50K. Notwithstanding such an adjustment or any other temporary adjustment, the two should be equal. However, now that I think about it further, there would almost always be a book-tax depreciation adjustment which would not be accounted for on lines 2-6 of M-2. I agree with Notax, that temporary differences should not be posted to M-2.

JCD (talk|edits) said:

3 May 2011
I've got a follow up -- on California's M-2, line 9 is labeled
    Retained earnings at end of year. Add line 8, column (a) through column (c)

Column a-c are the California AAA, OAA and Other retained earnings amounts. When they say retained earnings, do they REALLY mean 'modified retained earnings'? Because if we calculate AAA and OAA correctly on the "tax" basis, it's very unlikely to equal retained earnings on the Schedule L.

I'm sure I'm being particularly dense, but I've been doing it the "book" way for so long, it feels wrong not to now.

Bigbrother (talk|edits) said:

4 May 2011
Wow, I've seen so many accountants messing up the M-2, it's not even funny. They'll start at a $0 balance even though it doesn't match the previous year's ending balance, or they won't including Sch. K distributions, etc., etc.

When we do accounting for the client, we almost always use the same method of accounting used on the tax return, exactly to avoid this kind of book-to-tax discrepancies. This way, R/E is almost always equal to the sum of AAA and OAA. But if your client insists on a different method of accounting for the books (or you need to for other reasons like DCAA, etc.), then DAJCPA is right.

Mr cheese (talk|edits) said:

5 May 2011
This debate and confusion regarding the AAA is closely related to the histeria regarding the Schedule L discussions that have been posted on other threads. The AAA is the accumulated adjustements account. It is not the book RE account..It does not have to match the book retained earnings number on schedule L, nor often times should it match. The AAA is a tax number. It does not have to be tracked unless the S-corp previously had C-corp earnings & Profits. The IRS recommends that the AAA be tracked regardless just in case Sec. 381(a) applies later on, like if there is a merger between an S-corp and a C-corp in some future year.

I track the AAA, but I know that it won't necessarily match Line 24 of my schedule L. I can reconcile the AAA with book Retained earnings on an excel worksheet if I so choose, but I'm not going to kill myself and prepare a tax return in "such a way" just so all the schedules on page 4 of the 1120S match and tie in perfectly, which in many cases, they shouldn't anyways. As for M-1, it's a reconciliation between book income(loss) and tax income(loss) or more accurately, Schedule K income (Loss)......

We can go on, and on, and on about why M-2 doesn't perfectly match line 24 of schedule L or why it should or shouldn't match line 24, just like we can go on, and on, and on about how the schedule L should be recorded.

I can't blame you if you don't like to enter tax/book differences on a tax return...they can get pretty loopdy at times. However, accountant's seem to have this notion that everything is about "numbers" and everything should somehow tie-in and balance with something else, and the world is somehow not in proper harmony unless everything ties-in perfectly and equilibrium is reached 100% of the time. This is all true, equilibrium should always be strived for....just not always on the tax return. Congress sets the laws and the IRS invents and continues to reinvent the tax return.......For those of us that took and passed corp & partnership taxation in college, remember what the professor used to say when some confused kid in the back row used to ask, "It doesn't make any sense so why is it done that way?"

....."because that's how congress wrote the law".

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