Schedule L and M-2: balance sheet and retained earnings tie-outs
Schedule L is the IRS schedule corporations use to report their balance sheet per books on Form 1120. Schedule M-2 rolls unappropriated retained earnings on Schedule L, line 25 from the opening to the closing balance, and with Schedule M-1 the three schedules tie book figures to taxable income.
“The balance sheets should agree with the corporation’s books and records.” IRS, Instructions for Form 1120 (2025)
What are Schedules L, M-1 and M-2 on Form 1120?
Schedules L, M-1 and M-2 are the three book-to-tax schedules on Form 1120. Schedule L reports the balance sheet per books at the beginning and end of the year, Schedule M-1 reconciles net income per books to taxable income, and Schedule M-2 analyzes unappropriated retained earnings, the balance on Schedule L, line 25.
The Instructions for Form 1120 (2025) say the balance sheets should agree with the corporation's books and records, so Schedule L is a book balance sheet. Its line 15, column (d) is also the total assets figure in Item D on page 1.
The three schedules tie to each other and to page 1. Schedule M-1, line 10 is labeled "Income (page 1, line 28)," so the reconciliation lands on taxable income before NOL and special deductions. Schedule M-2 adds book income to opening retained earnings, subtracts distributions, and must end on the closing Schedule L, line 25 balance. At $10 million of total assets, Schedule M-3 replaces Schedule M-1, while Schedules L and M-2 stay.
Which corporations can skip Schedules L, M-1 and M-2?
A Form 1120 filer can skip Schedules L, M-1 and M-2 when its total receipts for the year and its total assets at year end are both under $250,000 and it answers "Yes" to Schedule K, question 13, according to the Instructions for Form 1120 (2025). On Form 1120 the question sits in Schedule K, and total receipts means page 1, line 1a plus lines 4 through 10.
| Return | Question | Test for 2025 | Schedules skipped |
|---|---|---|---|
| Form 1120 | Schedule K, question 13 | Total receipts and year-end total assets both under $250,000 | L, M-1 and M-2 |
| Form 1120-S | Schedule B, question 11 | Total receipts and year-end total assets both under $250,000 | L and M-1 |
| Form 1065 | Schedule B, question 4 | Total receipts under $250,000, total assets under $1 million, K-1s furnished on time, and no Schedule M-3 | L, M-1, M-2, Item F and K-1 item L |
The Form 1120-S question exempts only Schedules L and M-1. Its Schedule M-2, which tracks the accumulated adjustments account, is still required. The Form 1065 question has four conditions, and a partnership that answers "Yes" also skips Item F on page 1 and item L on each Schedule K-1.
A Form 1120 corporation that answers "Yes" to question 13 must still enter the total cash distributions and the book value of property distributions made during the year on the line provided under question 13. A corporation that crosses either limit needs a full balance sheet for the year.
Where does each source document go on Schedules L, M-1 and M-2?
Schedules L, M-1 and M-2 draw on the year-end trial balance, the prior-year return and a handful of supporting workpapers. The trial balance supplies Schedule L, column (d), the prior-year return supplies column (b), and the income statement supplies the starting figure on both Schedule M-1 and Schedule M-2.
| Source document | What it supports | Schedule and line |
|---|---|---|
| Year-end trial balance or financial statements | Balance sheet per books | L, 1 to 28, column (d) |
| Prior-year Form 1120, Schedule L, column (d) | Opening balance sheet | L, column (b) |
| Income statement | Net income per books | M-1, 1; M-2, 2 |
| Tax provision or federal tax expense account | Federal income tax per books | M-1, 2 |
| Form 1099-INT, box 8; municipal bond statements | Tax-exempt interest | M-1, 7; Schedule K, item 9 |
| Book and tax fixed asset reports | Depreciation differences | M-1, 5a or 8a |
| Meals and entertainment ledger detail | Nondeductible travel and entertainment | M-1, 5c |
| Board minutes, dividend checks, bank statements | Cash, stock and property distributions | M-2, 5a to 5c |
Schedule L, line 5 includes tax-exempt securities, such as state and local obligations whose interest is excludable under section 103(a). The interest from those holdings is the tax-exempt interest that the Instructions for Form 1120 send to Schedule M-1, line 7 and to Schedule K, item 9, so the three amounts should be traceable to the same brokerage statements.
Schedule M-1, line 5c covers the travel and entertainment expenses listed in the instructions, including meals not deductible under section 274(n), nondeductible club dues and gifts over $25. Line 26 of Schedule L takes equity adjustments such as unrealized gains on available-for-sale securities and foreign currency translation, which change equity without passing through retained earnings.
What does a C corporation tie-out look like?
For example, a calendar-year C corporation has total assets of $2,905,000 at the end of 2025, so it completes Schedules L, M-1 and M-2 but not Schedule M-3. Its books show net income of $386,000 after $98,000 of federal income tax expense, and it paid $150,000 of cash dividends. Opening retained earnings on last year's Schedule L, line 25, column (d) were $1,240,000.
| Step | Schedule and line | Amount |
|---|---|---|
| Opening retained earnings | M-2, 1 = L, 25(b) | $1,240,000 |
| Net income per books | M-2, 2 | $386,000 |
| Cash dividends paid | M-2, 5a | ($150,000) |
| Closing retained earnings | M-2, 8 = L, 25(d) | $1,476,000 |
| Net income per books | M-1, 1 | $386,000 |
| Federal income tax per books | M-1, 2 | $98,000 |
| Nondeductible meals | M-1, 5c | $12,000 |
| Tax-exempt interest | M-1, 7 | ($9,000) |
| Tax depreciation over book depreciation | M-1, 8a | ($41,000) |
| Taxable income, equal to page 1, line 28 | M-1, 10 | $446,000 |
Schedule M-2 rolls $1,240,000 forward to $1,476,000, which matches Schedule L, line 25, column (d). Schedule M-1, line 6 is $496,000 and line 9 is $50,000, so line 10 is $446,000, the figure on page 1, line 28. The year-end balance sheet totals $2,905,000 of assets against $1,329,000 of liabilities, $100,000 of common stock and $1,476,000 of retained earnings, so line 15 equals line 28.
What do reviewers check on Schedules L, M-1 and M-2?
A reviewer checking Schedules L, M-1 and M-2 confirms six tie-outs, each taken from the Form 1120 schedules or the Instructions for Form 1120 (2025). The prior-year return is the first document to pull, because both the opening balance sheet and opening retained earnings come from it.
Two further checks catch errors the six above can miss, and neither needs anything beyond the current return. Net income per books should be the same figure on Schedule M-1, line 1 and Schedule M-2, line 2, since both lines carry the same label. A corporation that answered "Yes" to Schedule K, question 13 should show receipts and assets that actually fall under $250,000, because the answer is what allows the schedules to be left blank.
Every line checked against the documents the client sent
Filed reads the client's trial balance, financial statements and prior-year return, then checks every line of Schedules L, M-1 and M-2 against them. Anything that doesn't tie comes back as a review item with a citation to the source.
Book a demoSchedule M-2, line 8 shows $1,476,000. Schedule L, line 25, column (d) shows $1,451,000. Confirm whether the $25,000 difference is a prior-period adjustment that belongs on Schedule M-2, line 3 or line 6.
Common questions
Does a small corporation have to complete Schedule L?
A small corporation filing Form 1120 does not have to complete Schedule L if its total receipts and its year-end total assets are both under $250,000 and it answers "Yes" to Schedule K, question 13. It then skips Schedules M-1 and M-2 too, but still reports its cash and property distributions on that question.
Does Schedule M-2 have to match Schedule L?
Yes. Schedule M-2 has to match Schedule L at both ends of the year. Its heading ties it to Schedule L, line 25, so line 1 equals the opening unappropriated retained earnings in column (b) and line 8 equals the closing balance in column (d). Entries posted directly to retained earnings go on line 3 or line 6.
When does Schedule M-3 replace Schedule M-1?
Schedule M-3 replaces Schedule M-1 when a corporation reports total assets of $10 million or more at the end of its tax year. A required filer with less than $50 million of total assets can complete Schedule M-3, Part I and then Schedule M-1 instead of Parts II and III. Schedules L and M-2 are still required.