S-Corporation Schedule M-2 Frequently Asked Questions in Lacerte

Schedule M-2 is used to track the Accumulated Adjustments Account (AAA) for an S-Corporation. This article answers common questions about how Lacerte calculates, allocates, and reports AAA amounts using Screen 32, Schedule M-2.

Use the sections below to understand how to enter AAA information, resolve common diagnostics, and interpret Schedule M-2 results—especially in complex situations such as shareholder changes, disproportionate allocations, distributions, and final-year returns.

What is the Accumulated Adjustments Account (AAA)?

The Accumulated Adjustments Account (AAA) tracks the corporation’s cumulative taxable income and losses that have already been passed through to shareholders. It is used to determine the taxability of distributions made to shareholders.

AAA generally includes:

• Ordinary business income or loss
• Separately stated income and deductions (excluding tax-exempt income)
• Distributions made during the year

AAA does not include retained earnings from C-Corporation years or tax-exempt income.

How do I enter or adjust AAA amounts in Lacerte?

AAA information is entered and calculated on Screen 32, Schedule M-2. Lacerte automatically computes current-year changes to AAA based on the return data, but beginning balances and certain adjustments may require manual entry.

You may need to manually enter or review AAA amounts when:

• The return is the first year prepared in Lacerte
• The corporation converted from a C-Corporation
• Prior-year AAA balances were tracked outside the program
• Corrections are required due to amended or superseded returns

Lacerte uses the amounts entered on Screen 32 along with current-year activity to calculate the ending AAA balance reported on Schedule M-2.

How does Lacerte calculate AAA distributions?

When distributions are entered, Lacerte applies them in the following general order:

• First against the Accumulated Adjustments Account (AAA)
• Then against Other Adjustments Account (OAA), if applicable
• Then against accumulated Earnings & Profits (E&P), if present

If distributions exceed the available AAA balance, the excess may be treated as taxable dividends or return of basis, depending on the corporation’s E&P and the shareholder’s stock basis.

Lacerte calculates AAA distributions automatically based on the distribution entries and the shareholder allocation percentages.

Why am I getting Diagnostic Ref. #25213 (Total Allocation Factor Not Equal to 100%)?

This diagnostic appears when the total allocation percentages for shareholders do not equal 100% for the period being reported. Because AAA activity is allocated among shareholders, incorrect or incomplete ownership percentages can cause Schedule M-2 and shareholder amounts to calculate incorrectly.

Common causes include:

• Ownership changes during the year without corresponding date ranges
• Missing or incorrect allocation percentages
• Final-year or short-year returns

To resolve the diagnostic, review the shareholder information and allocation entries to ensure the total equals 100% for the applicable period.

How is AAA handled in the final year of an S-Corporation?

In a final-year return, AAA may be reduced to zero depending on distributions and the corporation’s remaining balances. It is possible for AAA or retained earnings to appear negative if losses or distributions exceed available balances.

When preparing a final return, carefully review:

• Final distributions to shareholders
• Remaining AAA and E&P balances
• Shareholder stock basis

Negative balances should be reviewed to ensure they accurately reflect the corporation’s activity and history.

Related Help

• Entering Information for the Accumulated Adjustments Account for an S-Corporation
• S Corporate Diagnostic Total Allocation Factor for the Shareholders Not Equal to 100% (Ref. #25213)
• Understanding how Lacerte calculates S-Corporate AAA distributions
• Final Year S-Corporation Return and Negative AAA / Retained Earnings