A taxpayer came to me looking for a second opinion on how his company’s 2011 and 2012 IRS Form 1120-S were prepared, signed and filed because the retained earnings reported on Schedule L was ($100,000) – as in negative – AND the Accumulated Adjustment Account (AAA) on Schedule M-2 was also reported at ($100,000) as well.
The taxpayer and his wife each owned 50% of the corporation’s shares outstanding. In 2012 each shareholder took a distribution of $150,000 causing a retained earnings reduction to ($400,000) while the AAA or Schedule M-2 remained at ($100,000) and ultimately the taxpayers were concerned that their tax guy wasn’t completely confident in his reporting for either year.
Aside from the fact that perfectly round 6 digit numbers on ANY tax return look suspicious to me there were a few other lessons that could be taken away from working this file:
1. For S-Corps IRS Form 1120-S Schedule M-2 Accumulated Adjustment Account (AAA) does not necessarily need to match IRS Form 1120-S Schedule L mostly because Schedule M-2 is not a reconciliation of equity.
2. Schedule M-2 is based on IRC §1.1368-2(a)(3)(iii) which precludes any entry below zero if reduced to that point by distributions. Read more