Schedule M-2, Analysis of Partner's Capital Accounts is the section in Form 1065, U.S. Return of Partnership Income where the partnership reports to the IRS what caused the changes to the partners' capital accounts on the partnership's books and records. This section of the tax return is used by the IRS to verify the accuracy of the tax reporting because analyzing the changes to the capital accounts should be consistent with the income reporting and the balance sheet (Schedule L). The amounts on Schedule M‑2 should equal the total of the amounts reported in Part II, Item L of all the partners' Schedules K-1s.
Not all partnerships have to do this analysis, and many smaller partnerships do not complete Schedule M‑2.
When Schedule M-2 is NOT required to be completed:
A partnership has to complete a Schedule L (Balance Sheet), Schedule M-1 (Reconciliation of Income), and Schedule M-2 (Analysis of Partner’s Capital Accounts) unless it can satisfy ALL of the following four requirements:
- The partnership’s total receipts were less than $250,000 for the tax year
- The partnership’s total assets were less than $1 million at the end of the tax year,
- Schedule K-1s are filed with the return and furnished to the partners on or before the due date (including extensions),
- The partnership is not filing or required to file Schedule M-3.
If the partnership satisfies these four requirements, the preparer will answer YES to the Question "Does This Partnership Meet All Four Requirements?' found on Schedule B (Form 1065) Line 4. (Note: prior to 2018, the question was found on Schedule B (Form 1065), Line 6.)
This question can be accessed in TaxSlayer Pro from the main menu of the 1065 return by selecting Schedule B, then changing the answer to the question, "Does This Partnership Meet All Four Requirements?' to YES. This question is defaulted to a No answer in the program and the user must affirmatively change the answer to YES to electronically file the return without including a Schedules L, M‑1, and M‑2.
When Schedule M-2 is required to be completed:
If the partnership does not meet the four requirements in Schedule B (Form 1065), Line 4, the partnership is required to complete Schedule M-2 and submit the changes during the tax year in the partners' capital accounts as reflected on the partnership's books and records. As a practical matter, Schedule M-2 is normally completed after Schedules L and M-1 because certain items on the Schedule M-2 must match entries that are calculated on Schedules L and M‑1.
To complete Schedule M-2, from the Main Menu of the tax return (Form 1065) select Schedule M-2 – Analysis.
To assist in the entry of amounts on the Schedule M-2, each line of this menu is described below. At the Schedule M-2 Menu the user can enter the items that impact the capital accounts of the partners. The only amount that TaxSlayer Pro automatically pulls to this schedule is the Net Income (Loss) per Books, which is reconciled to the Income (Loss) on the Tax Return on Schedule M-1.
- Balance at Beginning of Year - This beginning balance amount should match the ending balance amount from last year's tax return, if the partnership was required to complete Schedule M-2 in the previous tax year. This beginning balance amount is reported on Line 1 of Schedule M-2. The beginning balance amount should also match two other entries that have been made on Form 1065 which are discussed below.
On Form 1065, the beginning balance amount should normally match the amount entered as the beginning balance on Schedule L, Line 21. If the return was completed the the previous year in TaxSlayer Pro and included Schedule L, the beginning capital account amount this year will pull from the ending capital account amount last year. Otherwise, to enter the Beginning Capital on Schedule L, Line 21, from the Main Menu of the tax return select:
- Schedule L
- Total Liabilities & Capital
- Partners Capital - enter the beginning and ending amounts. If is a difference between the beginning amount entered here and the amount entered on Schedule L, Line 21, an explanation of the differences should be included with the tax return.
- Schedule K - Distributive Share Items
- Schedule K-1 Input - Select a partner
- Analysis of Partner's Capital Account
- Cash Contributed - In this section the user will enter the total of all cash (including any marketable securities) contributed by any of the partners to the partnership during the year. This cash contributed amount is reported on Line 2a of Schedule M-2.
- Property Contributed - In this section the user will enter the total of all non-cash property contributed by any of the partners to the partnership during the year. This property contributed amount is reported on Line 2b of Schedule M-2.
The combined amounts reported on the Schedule M-2 as Cash Contributed and Property Contributed on Schedule M-2, Lines 2a and 2b should match the sum of the amounts reported as Capital Contributed During Year in Part II, Item L of all the partner Schedules K-1s.
- Net Income (Loss) per Books (Sch. M-1, Line 1) - This amount is pulled from the reconciled book income (loss) amount from the Schedule M-1. Any adjustments to this amount must be made on the Schedule M-1 menu. This book net income or loss is reported on Line 3 of Schedule M-2.
- Other Increases - In this section the preparer will itemize any item other than Net Income recognized by the partnership in their accounting records or any cash and/or property contributed. An entry in this field is uncommon. Select this line, then select New, enter a description of the item, then enter the amount. These "Other Increases" are itemized and reported on Line 4 of Schedule M‑2.
- Net Increases in Capital Accounts - This is amount is the sum of the preceding lines and is reported on Line 5 of Schedule M-2.
- Cash Distributions - Enter the total of all cash (including any marketable securities) distributed to the partners by the partnership during the year. This cash distributed amount is reported on Line 6a of Schedule M-2 and it should match the amount reported on Schedule K, Line 19a. These cash distributions will include any amounts withdrawn or paid to one of the partners during the year.
- Property Distributions - Enter the total of all non-cash property distributed to any of the partners by the partnership during the year. This includes any property distributed to a partner for personal use or otherwise withdrawn from the partnership. This property distributed amount is reported on Line 6b of Schedule M-2 and it should match the amount reported on Schedule K, Line 19a.
The combined amounts reported on the Schedule M-2 as Cash Distributions and Property Distributions should also match the sum of "Withdrawals and Distributions" in Part II, Item L of all the partner Schedule1 K-1s.
- Other Decreases - In this section the user will itemize any item recognized by the partnership that reduced the capital accounts of the partners. An entry in this field is uncommon. Select this line, select New, enter a description of the item, then enter the amount. These "Other Decreases" are itemized and reported on Line 7 of Schedule M-2.
- Net Decreases in Capital Accounts - This is amount is the sum of the distributions and other decreases and is reported on Line 8 of Schedule M-2.
- Balance at End of Year - This amount is equal to the net increases minus the net decreases and prints on Line 9 of Schedule M-2. As with the beginning balance, this ending balance must match two other entries on the tax return:
- The ending balance on Schedule L, Line 21.
- The sum of the ending capital accounts entered in Part II, Item L of all of the partner K-1s.
- Schedule L, Line 21 - This amount is pulled from the balance sheet and should equal the calculated ending capital account balance on Schedule M-2.
- Schedule L, Line 21 Minus Balance at End of Year - This line should equal zero. Any other amount indicates a discrepancy between the partnership's accounting records and what is being reported to the IRS. A return with a discrepancy here can be electronically filed, but such a discrepancy is indicative of errors in either the return or the partnership accounting records.
Note: This is a guide on entering Form 1065, U.S. Return of Partnership Income, Schedule M-2 - Analysis of Partners' Capital Accounts into TaxSlayer Pro. This is not intended as tax advice.