| Pub. 538, Accounting Periods and Methods |
2006 Tax Year |
Publication 538 - Main Contents
The IRS charges a user fee for certain requests to change an accounting period or method. The fee is reduced in certain situations,
such as a
request for identical accounting method changes for members of a consolidated group, a request involving a personal tax issue
from a person with gross
income of less than $250,000, and a request involving a business-related tax issue from a person with gross income of less
than $1 million. No fee is
charged for changes permitted to be made by a published automatic change revenue procedure.
For information about user fees charged to change an accounting period, see the Form 1128 instructions. For information about
user fees charged to
change an accounting method, see the Form 3115 instructions. See also Revenue Procedure 2004–1, in Internal Revenue Bulletin
No. 2004–1,
or its successor, for more information. For information on user fees for tax-exempt organizations, see Revenue Procedure 2004–8,
in Internal
Revenue Bulletin No. 2004–1, or its successor.
You must figure taxable income on the basis of a tax year. A “tax year” is an annual accounting period for keeping records and reporting
income and expenses. An annual accounting period does not include a short tax year (discussed later). The tax years you can
use are:
Unless you have a required tax year, you adopt a tax year by filing your first income tax return using that tax year. A required
tax year is a tax
year required under the Internal Revenue Code and the Income Tax Regulations. You have not adopted a tax year if you merely did any of the
following.
-
Filed an application for an extension of time to file an income tax return.
-
Filed an application for an employer identification number.
-
Paid estimated taxes for that tax year.
This section discusses:
-
A calendar year.
-
A fiscal year (including a period of 52 or 53 weeks).
-
A short tax year.
-
An improper tax year.
-
A change in tax year.
-
Special situations that apply to individuals.
-
Restrictions that apply to the accounting period of a partnership, S corporation, or personal service corporation.
-
Special situations that apply to corporations.
A calendar year is 12 consecutive months beginning January 1 and ending December 31.
If you adopt the calendar year, you must maintain your books and records and report your income and expenses from January
1 through December 31 of
each year.
If you file your first tax return using the calendar tax year and you later begin business as a sole proprietor, become a
partner in a partnership,
or become a shareholder in an S corporation, you must continue to use the calendar year unless you get IRS approval to change
it or are otherwise
allowed to change it without IRS approval. See Change in Tax Year, later.
Generally, anyone can adopt the calendar year. However, if any of the following apply, you must adopt the calendar year.
-
You keep no books.
-
You have no annual accounting period.
-
Your present tax year does not qualify as a fiscal year.
-
You are required to use a calendar year by a provision of the Internal Revenue Code or the Income Tax Regulations.
A fiscal year is 12 consecutive months ending on the last day of any month except December. A 52-53-week tax year is a fiscal
year that varies from
52 to 53 weeks but may not end on the last day of a month.
If you adopt a fiscal year, you must maintain your books and records and report your income and expenses using the same tax
year.
You can elect to use a 52-53-week tax year if you keep your books and records and report your income and expenses on that
basis. If you make this
election, your 52-53-week tax year must always end on the same day of the week. Your 52-53-week tax year must always end on:
-
Whatever date this same day of the week last occurs in a calendar month, or
-
Whatever date this same day of the week falls that is nearest to the last day of the calendar month.
For example, if you elect a tax year that always ends on the last Monday in March, your 2002 tax year will end on March 31,
2003. If you elect a
tax year ending on the Thursday nearest to the end of April, your 2002 tax year will end on May 1, 2003.
Election.
To make the election, attach a statement with the following information to your tax return for the 52-53-week tax
year.
-
The month in which the new 52-53-week tax year ends.
-
The day of the week on which the tax year always ends.
-
The date the tax year ends. It can be either of the following dates on which the chosen day:
-
Last occurs in the month in (1), above, or
-
Occurs nearest to the last day of the month in (1), above.
When you figure depreciation or amortization, a 52-53-week tax year is generally considered a year of 12 calendar
months.
To determine an effective date (or apply provisions of any law) expressed in terms of tax years beginning, including,
or ending on the first or
last day of a specified calendar month, a 52-53-week tax year is considered to:
-
Begin on the first day of the calendar month beginning nearest to the first day of the 52-53-week tax year, and
-
End on the last day of the calendar month ending nearest to the last day of the 52-53-week tax year.
Example.
Assume a tax provision applies to tax years beginning on or after July 1, 2003. For this purpose, a 52-53-week tax year beginning
on June 25, 2003,
is treated as beginning on July 1, 2003.
Change to or from a 52-53-week tax year.
You must get IRS approval if you want to make the following changes.
-
From your current tax year to a 52-53-week tax year, even if such 52-53-week tax year ends with reference to the same calendar
month as your
current tax year.
-
From one 52-53-week tax year to another 52-53-week tax year.
-
From a 52-53-week tax year to any other tax year.
See Change in Tax Year, later, for information on getting IRS approval.
Example.
You want to change from a 52-53-week tax year ending on the Thursday closest to December 31 to a 52-53-week tax year ending
on the Friday closest
to December 31. You must get IRS approval to make this change in your tax year.
You can get approval for certain 52-53-week tax year changes automatically if you qualify under any of the revenue procedures
listed in the general
discussion on automatic approval under Change in Tax Year, later.
A short tax year is a tax year of less than 12 months. A short period tax return may be required when you (as a taxable entity):
Tax on a short period tax return is figured differently for each situation.
Not in Existence Entire Year
Even if you (a taxable entity) were not in existence for the entire year, a tax return is required for the time you were in
existence. Requirements
for filing the return and figuring the tax are generally the same as the requirements for a return for a full tax year (12
months) ending on the last
day of the short tax year.
Example 1.
Corporation X was organized on July 1, 2002. It elected the calendar year as its tax year and its first tax return was due
March 17, 2003. This
short period return will cover the period from July 1, 2002, through December 31, 2002.
Example 2.
A calendar year corporation dissolved on July 23, 2003. Its final return is due by October 15, 2003, and it will cover the
short period from
January 1, 2003, to July 23, 2003.
Example 3.
Partnership YZ was formed on September 4, 2002, and elected to use a fiscal year ending November 30. Partnership YZ must file
its first tax return
by March 17, 2003. It will cover the short period from September 4, 2002, to November 30, 2002.
Death of individual.
When an individual dies, a tax return must be filed for the decedent by the 15th day of the 4th month after the close
of the individual's regular
tax year. The decedent's final return will be a short period tax return unless he or she dies on the last day of the regular
tax year.
Example.
Agnes Green was a single, calendar year taxpayer. She died on March 6, 2003. Her final tax return must be filed by April 15,
2004. It will cover
the short period from January 1, 2003, to March 6, 2003.
Figuring Tax for Short Year
If the IRS approves a change in your tax year or you are required to change your tax year, you must figure the tax and file
your return for the
short tax period. The short tax period begins on the first day after the close of your old tax year and ends on the day before
the first day of your
new tax year.
You figure tax for a short year under the general rule, explained next. You may then be able to use a relief procedure, explained
later, and claim
a refund of part of the tax you paid.
General rule.
Income tax for a short tax year is figured on an annual basis. However, self-employment tax is figured on the actual
self-employment income for the
short period.
Individuals.
An individual must figure income tax for the short tax year as follows.
-
Determine your adjusted gross income for the short tax year and then subtract your actual itemized deductions for the short
tax year. (You
must itemize deductions when you file a short period tax return.)
-
Multiply the dollar amount of your exemptions by the number of months in the short tax year and divide the result by 12.
-
Subtract the amount in (2) from the amount in (1). This is your modified taxable income.
-
Multiply the modified taxable income in (3) by 12, then divide the result by the number of months in the short tax year. This
is your
annualized income.
-
Figure the total tax on your annualized income using the appropriate tax rate schedule.
-
Multiply the total tax by the number of months in the short tax year and divide the result by 12. This is your tax for the
short tax
year.
Example.
Mike and Sara Smith have an adjusted gross income of $48,000 for their short tax year. Their itemized deductions for January
1 through September
30, 2002, total $12,400 and they can claim exemptions for themselves, and their two children. Each exemption is $3,000. They
figure the tax on their
joint return for that period as follows.
-
$48,000 - $12,400 = $35,600
-
$3,000 × 4 × 9/12 = $9,000
-
$35,600 - $9,000 = $26,600 (modified taxable income)
-
$26,600 × 12/9 = $35,467 (annualized income)
-
Tax on $35,467 = $4,720 (from 2002 tax rate schedule)
-
$4,720 × 9/12 = $3,540 (tax for short tax year)
Corporations.
A corporation figures tax for the short tax year under the general rule described earlier for individuals except there
is no adjustment for
personal exemptions.
Example.
Because a calendar year corporation changed its tax year, it must file a short period tax return for the 6-month period ending
June 30, 2002. For
the short tax year, it had income of $40,000 and no deductions. The corporation's annualized income is $80,000 ($40,000 ×
12/6). The tax on
$80,000 is $15,450. The tax for the short tax year is $7,725 ($15,450 × 6/12).
52-53-week tax year.
If you change the month in which your 52-53-week tax year ends, you must file a return for the short tax year if it
covers more than 6 but fewer
than 359 days.
If the short period created by the change is 359 days or more, treat it as a full tax year. If the short period created
is 6 days or fewer, it is
not a separate tax year. Include it as part of the following year.
For example, if you use a calendar year and the IRS approves your change to a 52-53-week tax year ending on the Monday
nearest to September 30, you
must file a return for the short period from January 1 to September 30.
Figure the tax for the short tax year as shown previously, except that you prorate on a daily basis, rather than
monthly. Use 365 days (regardless
of the number of days in the calendar year) instead of 12 months and the number of days in the short tax year instead of the
number of months.
Relief procedure.
Individuals and corporations can use a relief procedure to figure the tax for the short tax year. It may result in
less tax. Under this procedure,
the tax is figured by two separate methods. If the tax figured under both methods is less than the tax figured under the general
rule, you can file a
claim for a refund of part of the tax you paid. For more information, see section 443(b)(2).
Alternative minimum tax.
To figure the alternative minimum tax (AMT) due for a short tax year:
-
Figure the annualized alternative minimum taxable income (AMTI) for the short tax period by doing the following.
-
Multiply the AMTI by 12.
-
Divide the result by the number of months in the short tax year.
-
Multiply the annualized AMTI by the appropriate rate of tax under section 55(b)(1). The result is the annualized AMT.
-
Multiply the annualized AMT by the number of months in the short tax year and divide the result by 12.
For information on the alternative minimum tax for individuals, see the instructions for Form 6251, Alternative Minimum
Tax–Individuals. For information on the alternative minimum tax for corporations, see Publication 542, or the instructions to Form 4626,
Alternative Minimum Tax–Corporations.
Tax withheld from wages.
You can take a credit against your income tax liability for federal income tax withheld from your wages. Federal income
tax is withheld on a
calendar year basis. The amount withheld in any calendar year is allowed as a credit for the tax year beginning in the calendar
year.
Taxpayers that have adopted an improper tax year must change to a proper tax year under the requirements of Revenue Procedure
85–15 in
Cumulative Bulletin 1985–1. For example, if a taxpayer began business on March 15 and adopted a tax year ending on March 14
(a period of exactly
12 months), this would be an improper tax year. See Accounting Periods, earlier, for a description of permissible tax years.
To change to a proper tax year, you must do one of the following.
-
If you are requesting a change to a calendar tax year, file an amended income tax return based on a calendar tax year
that corrects the most recently filed tax return that was filed on the basis of an improper tax year. Attach a completed Form
1128 to the amended tax
return. Write “FILED UNDER REV. PROC. 85–15” at the top of Form 1128 and file the forms with the Internal Revenue Service Center where you
filed your original return.
-
If you are requesting a change to a fiscal tax year, file Form 1128 in accordance with the form instructions to request IRS
approval for the
change.
Generally, you must file Form 1128 to request IRS approval to change your tax year. See the instructions for Form 1128 for
exceptions. If you
qualify for an automatic approval request, a user fee is not required. If you do not qualify for automatic approval, a ruling
must be requested and a
user fee is required. See the instructions for Form 1128 for information about user fees if you are requesting a ruling.
Certain taxpayers can get automatic approval to change their tax year by filing Form 1128. You should determine whether you
can get approval
automatically before submitting an application under the ruling request procedures, discussed next. You can get approval automatically
if you qualify
under any of the following.
-
Revenue Procedure 2003–62, which provides automatic approval procedures for certain individuals.
-
Revenue Procedure 2002–37, which provides automatic approval procedures for certain corporations.
-
Revenue Procedure 2002–38, which provides automatic approval procedures for certain partnerships, S corporations, electing
S
corporations, and personal service corporations.
-
Revenue Procedure 85–58 and Revenue Procedure 76–10, as modified by Revenue Procedure 79–3, which provide automatic
approval procedures for certain exempt organizations.
Revenue Procedure 2003–62 is in Internal Revenue Bulletin 2003–32. Revenue Procedures 2002–37 and 2002–38 are in
Internal Revenue Bulletin 2002–22. Revenue Procedure 85–58 is in Internal Revenue Bulletin 1985–18. Revenue Procedure 76–10
is
in Cumulative Bulletin 1976–1. Revenue Procedure 79–3 is in Cumulative Bulletin 1979–1.
For information on the procedures by which certain individuals, pass-through entities, and corporations can get automatic
approval to change their
tax year, see the specific discussions on automatic approval for each of those entities, later.
File a current Form 1128 with the IRS national office in Washington, DC, no earlier than the day following the end of the
short period and no later
than the due date (not including extensions) of the tax return for the short period. (The short period begins on the first
day after the end of your
present tax year and ends on the day before the first day of your new tax year.) You must file the return for the short period
within the time that
applies for filing a return for a full tax year (12 months) ending on the last day of the short tax period. See Revenue Procedure
2002–39, in
Internal Revenue Bulletin 2002–22, for more information. See also Revenue Procedure 2003–34, in Internal Revenue Bulletin
2003–18,
which modifies the restrictions in Revenue Procedure 2002–39 against carrying back net operating losses and capital losses
generated in the
short period.
You must include the correct user fee, if any, with Form 1128. See User Fees at the beginning of this publication. See also the
instructions for Form 1128 for information on where to file Form 1128.
A Form 1128 received within 90 days after the due date may qualify for an extension and be considered timely filed. An extension
request, however,
must be filed under section 301.9100–3 of the regulations (see Revenue Procedure 2004–1). For more information, see the form
instructions
and Revenue Procedure 2004–1, in Internal Revenue Bulletin 2004–1, or any successor.
Your application must contain all requested information. Do not change your tax year until the IRS has approved your request.
If your application
is approved, you must file an income tax return for the short period. There are special rules for figuring tax when you file
a short period return
because you changed your tax year. See Figuring Tax for Short Year, earlier.
Example.
Steve Adams, a sole proprietor, files his return using a calendar year. For business purposes, he wants to change his tax
year to a fiscal year
ending June 30. Steve will have a short tax year for the period from January 1 to June 30. He must file Form 1128 by October
15, the 15th day of the
4th calendar month after the close of the short tax year, which is the due date for the short period return.
Most individuals adopt the calendar year. An individual can adopt a fiscal year provided that the individual maintains his
or her books and records
on the basis of the adopted fiscal year.
Individuals that want to change their tax year must generally file Form 1128 to get IRS approval either under the automatic
approval procedures or
the ruling request procedures.
Special rule for newlyweds.
A husband and wife who have different tax years cannot file a joint return, except for a husband and wife whose tax
years begin on the same date
and end on different dates because of the death of either or both. However, a newly married husband or wife with a different
tax year is permitted to
change his or her tax year to be the same as the other spouse in order to file a joint return. The spouse making this change
is not required to file
Form 1128. They can file a joint return for the first tax year ending after the date of marriage if both of the following
conditions are met.
-
The due date for filing the required separate short period tax return of the spouse changing tax years falls on or after the
date of the
marriage. The due date for the short period tax return is the 15th day of the 4th month following the end of the short tax
year.
-
The spouse changing tax years files a timely short period tax return. It must include a statement that the tax year is being
changed under
section 1.442–1(d) of the regulations.
If the due date for filing the required short period tax return passed before the date the couple marries, they cannot
file a joint return until
the end of the second tax year after the date of marriage. They can file a joint return for the second tax year only if the
spouse changing his or her
tax year files a timely short period tax return.
Example.
John and Jane were married on July 30, 2002. John filed his return for the fiscal year ending June 30, 2002. Jane uses the
calendar year, but wants
to change to John's fiscal year so they can file a joint return. If Jane files a separate return by October 15, 2002, for
the short period January 1,
2002, through June 30, 2002, she will have changed her accounting period to a fiscal year ending June 30. Then she and John
can file a joint return
for their tax year ending June 30, 2003.
Automatic approval.
An individual (which includes both spouses in the case of a husband and wife filing jointly) can use automatic approval
procedures to change from a
fiscal year to a calendar year. However, these procedures are generally not available to individuals deriving income from
interests in pass-through
entities. This includes individuals who are members of a partnership, beneficiaries of a trust or estate, or S corporation
shareholders.
However, interests in pass-through entities will be disregarded in certain circumstances. For example, an interest
in a pass-through entity will be
disregarded if the pass-through entity would be required under the Internal Revenue Code or Income Tax Regulations to change
its tax year to the new
calendar year of the individual. See Revenue Procedure 2003–62 in Internal Revenue Bulletin 2003–32 for other circumstances
in which
interests in pass-through entities will be disregarded.
In addition, individuals that qualify and want to change their tax year using these automatic procedures must comply
with the following conditions.
-
If the individual has a net operating loss (NOL) in the short period required to effect the change, the NOL generally cannot
be carried back
but must be carried over. However, a short period NOL can be carried back or carried over if it is either:
-
$50,000 or less, or
-
Less than the NOL for the full 12-month period beginning with the first day of the short period.
-
If there is any unused credit for the short period, the individual must carry the unused credit(s) forward. Unused credit(s)
cannot be
carried back.
-
If an individual's interest in a pass-through entity is disregarded as mentioned earlier in this discussion because the related
entity will
be required to change its tax year to the individual's new calendar tax year, the related entity must concurrently change
its tax year under the
applicable automatic approval procedures.
Form 1128.
To get automatic approval to change its tax year to a calendar year, an individual must file Form 1128 by the due
date (including extensions) for
filing the tax return for the short period required to effect such change.
Form 1128 must be filed with the Director, Internal Revenue Service Center, Attention: ENTITY CONTROL, where the individual's
return is filed. At
the top of page 1 of the Form 1128, type or print “ FILED UNDER REV. PROC. 2003–62.” No copies of Form 1128 are to be sent to the
IRS national office. However, a copy must be attached to the tax return filed for the short period required to effect the
change.
Ruling request.
Individuals that do not qualify for automatic approval to change their tax year must get IRS approval under Revenue
Procedure 2002–39, in
Internal Revenue Bulletin 2002–22, as modified by Revenue Procedure 2003–34 in Internal Revenue Bulletin 2003–18. In addition,
see
the general discussion under Ruling request on page 5.
Partnerships, S Corporations, and Personal Service Corporations (PSCs)
Generally, partnerships, S corporations (including electing S corporations), and PSCs must use a “required tax year.” A required tax year is a
tax year that is required under the Internal Revenue Code and Income Tax Regulations. The entity does not have to use the
required tax year if it
receives IRS approval to use another permitted tax year or makes an election under section 444. The following discussions
provide the rules for
partnerships, S corporations, and PSCs.
A partnership must conform its tax year to its partners' tax years unless any of the following apply.
-
The partnership makes a section 444 election. (See page 8 for details.)
-
The partnership elects to use a 52-53-week tax year that ends with reference to either its required tax year or a tax year
elected under
section 444. (See page 10 for details.)
-
The partnership can establish a business purpose for a different tax year. (See page 10 for details.)
The rules for the required tax year for partnerships are as follows.
-
If one or more partners having the same tax year own a majority interest (more than 50%) in partnership profits and capital,
the partnership
must use the tax year of those partners.
-
If there is no majority interest tax year, the partnership must use the tax year of all its principal partners. A principal
partner is one
who has a 5% or more interest in the profits or capital of the partnership.
-
If there is no majority interest tax year and the principal partners do not have the same tax year, the partnership generally
must use a tax
year that results in the least aggregate deferral of income to the partners.
If a partnership changes to a required tax year because of these rules, it can get automatic approval by filing Form 1128.
See Automatic
Approval on page 11 for information on the applicable filing requirements.
Least aggregate deferral of income.
The tax year that results in the least aggregate deferral of income is determined as follows.
-
Figure the number of months of deferral for each partner using one partner's tax year. Find the months of deferral by counting
the months
from the end of that tax year forward to the end of each other partner's tax year.
-
Multiply each partner's months of deferral figured in step (1) by that partner's share of interest in the partnership profits
for the year
used in step (1).
-
Add the amounts in step (2) to get the aggregate (total) deferral for the tax year used in step (1).
-
Repeat steps (1) through (3) for each partner's tax year that is different from the other partners' years.
The partner's tax year that results in the lowest aggregate (total) number is the tax year that must be used by the
partnership. If the calculation
results in more than one tax year qualifying as the tax year with the least aggregate deferral, the partnership can choose
any one of those tax years
as its tax year. However, if one of the tax years that qualifies is the partnership's existing tax year, the partnership must
retain that tax year.
Example.
A and B each have a 50% interest in partnership P, which uses a fiscal year ending June 30. A uses the calendar year and B
uses a fiscal year
ending November 30. P must change its tax year to a fiscal year ending November 30 because this results in the least aggregate
deferral of income to
the partners, as shown in the following table.
When determination is made.
The determination of the tax year under the least aggregate deferral rules must generally be made at the beginning
of the partnership's current tax
year. However, the IRS can require the partnership to use another day or period that will more accurately reflect the ownership
of the partnership.
This could occur, for example, if a partnership interest was transferred for the purpose of qualifying for a particular tax
year.
Short period return.
When a partnership changes its tax year, a short period return must be filed. The short period return covers the months
between the end of the
partnership's prior tax year and the beginning of its new tax year.
If a partnership changes to the tax year resulting in the least aggregate deferral, it must file a Form 1128 with
the short period return showing
the computations used to determine that tax year. The short period return must indicate at the top of page 1, “ FILED UNDER SECTION
1.706–1.”
More information.
For more information about accounting periods for partnerships, see the instructions for Form 1128. For information
about changing a partnership's
tax year, see Revenue Procedure 2002–38 for automatic approval requests and Revenue Procedure 2002–39 for ruling requests.
All S corporations, regardless of when they became an S corporation, must use a “permitted tax year.” A permitted tax year is any of the
following.
-
The calendar year.
-
A tax year elected under section 444. (See below for details.)
-
A 52-53-week tax year ending with reference to the calendar year or a tax year elected under section 444. (See page 10 for
details.)
-
Any other tax year for which the corporation establishes a business purpose. (See page 10 for details.)
If an electing S corporation wishes to adopt a tax year other than a calendar year, it must request IRS approval using Form 2553,
Election by a Small Business Corporation, instead of filing Form 1128. For information about changing an S corporation's tax year, see the
instructions for Form 1128. See also Revenue Procedure 2002–38 for automatic approval requests and Revenue Procedure 2002–39
for ruling
requests.
Personal Service Corporation
A PSC must use a calendar tax year unless any of the following apply.
-
The corporation makes an election under section 444. (See below for details.)
-
The corporation elects to use a 52-53-week tax year ending with reference to the calendar year or a tax year elected under
section 444. (See
page 10 for details.)
-
The corporation establishes a business purpose for a fiscal year. (See page 10 for details.)
See the instructions for Form 1120 for general information about PSCs. For information on adopting or changing tax years for
PSCs, see the
instructions for Form 1128. See also Revenue Procedure 2002–38 for automatic approval requests and Revenue Procedure 2002–39
for ruling
requests.
A partnership, S corporation, electing S corporation, or PSC can elect under section 444 to use a tax year other than its
required tax year.
Certain restrictions apply to the election. A partnership or an S corporation that makes a section 444 election must make
certain required payments
and a PSC must make certain distributions (discussed later). The section 444 election does not apply to any partnership, S
corporation, or PSC that
establishes a business purpose for a different period, explained later.
A partnership, S corporation, or PSC can make a section 444 election if it meets all the following requirements.
-
It is not a member of a tiered structure (defined in section 1.444-2T of the regulations).
-
It has not previously had a section 444 election in effect.
-
It elects a year that meets the deferral period requirement.
Deferral period.
The determination of the deferral period depends on whether the partnership, S corporation, or PSC is retaining its
tax year or adopting or
changing its tax year with a section 444 election.
Retaining tax year.
Generally, a partnership, S corporation, or PSC can make a section 444 election to retain its tax year only if the
deferral period of the new tax
year is 3 months or less. This deferral period is the number of months between the beginning of the retained year and the
close of the first required
tax year.
Adopting or changing tax year.
If the partnership, S corporation, or PSC is adopting or changing to a tax year other than its required year, the
deferral period is the number of
months from the end of the new tax year to the end of the required tax year. The IRS will allow a section 444 election only
if the deferral period of
the new tax year is less than the shorter of:
If the partnership, S corporation, or PSC's tax year is the same as its required tax year, the deferral period is zero.
Example 1.
BD Partnership uses a calendar year, which is also its required tax year. BD cannot make a section 444 election because the
deferral period is
zero.
Example 2.
E, a newly formed partnership, began operations on December 1, 2002. E is owned by calendar year partners. E wants to make
a section 444 election
to adopt a September 30 tax year. E's deferral period for the tax year beginning December 1, 2002, is 3 months, the number
of months between September
30 and December 31.
Making the election.
You make a section 444 election by filing Form 8716, Election To Have a Tax Year Other Than a Required Tax Year,
with the Internal Revenue Service Center where the entity will file its tax return. Form 8716 must be filed by the
earlier of:
-
The due date (not including extensions) of the income tax return for the tax year resulting from the section 444 election,
or
-
The 15th day of the 6th month of the tax year for which the election will be effective. For this purpose, count the month
in which the tax
year begins, even if it begins after the first day of that month.
Attach a copy of Form 8716 to Form 1065, Form 1120S, or Form 1120 for the first tax year for which the election is
made.
Example 1.
AB, a partnership, begins operations on September 13, 2003, and is qualified to make a section 444 election to use a September
30 tax year for its
tax year beginning September 13, 2003. AB must file Form 8716 by January 15, 2004, which is the due date of the partnership's
tax return for the
period from September 13, 2003, to September 30, 2003.
Example 2.
The facts are the same as in Example 1 except that AB begins operations on October 21, 2003. AB must file Form 8716 by March 15, 2004,
the 15th day of the 6th month of the tax year for which the election will first be effective.
Example 3.
B is a corporation that first becomes a PSC for its tax year beginning September 1, 2003. B qualifies to make a section 444
election to use a
September 30 tax year for its tax year beginning September 1, 2003. B must file Form 8716 by December 15, 2003, the due date
of the income tax return
for the short period from September 1, 2003, to September 30, 2003.
Extension of time for filing.
There is an automatic extension of 12 months to make this election. See the Form 8716 instructions for more information.
Ending the election.
The section 444 election remains in effect until it is terminated. If the election is terminated, another section
444 election cannot be made for
any tax year.
The election ends when any of the following applies to the partnership, S corporation, or PSC.
-
The entity changes to its required tax year.
-
The entity liquidates.
-
The entity becomes a member of a tiered structure.
-
The IRS determines that the entity willfully failed to comply with the required payments or distributions.
The election will also end if either of the following events occur.
-
An S corporation's S election is terminated. However, if the S corporation immediately becomes a PSC, the PSC can continue
the section 444
election of the S corporation.
-
A PSC ceases to be a PSC. If the PSC elects to be an S corporation, the S corporation can continue the election of the PSC.
Required payment for partnership or S corporation.
A partnership or an S corporation must make a “ required payment” for any tax year:
This payment represents the value of the tax deferral the owners receive by using a tax year different from the required
tax year.
Form 8752, Required Payment or Refund Under Section 7519,
must be filed each year the section 444 election is in effect, even if no payment is due. If the required payment is
more than $500 (or the required payment for any prior year was more than $500), the payment must be made when Form 8752 is
filed. If the required
payment is $500 or less and no payment was required in a prior year, Form 8752 must be filed showing a zero amount.
Form 8752 must be filed and the required payment made (or zero amount reported) by May 15 of the calendar year following
the calendar year in which
the applicable election year begins. Any tax year a section 444 election is in effect, including the first year, is called
an “ applicable election
year.” For example, if a partnership's applicable election year begins July 1, 2003, Form 8752 must be filed by May 17, 2004.
Required distribution for PSC.
A PSC with a section 444 election in effect must distribute certain amounts to employee-owners by December 31 of each
applicable year. If it fails
to make these distributions, it may be required to defer certain deductions for amounts paid to owner-employees. The amount
deferred is treated as
paid or incurred in the following tax year.
For information on the minimum distribution, see the instructions for Part I of Schedule H (Form 1120), Section 280H Limitations for a
Personal Service Corporation (PSC).
Back-up election.
A partnership, S corporation, or PSC can file a back-up section 444 election if it requests (or plans to request)
permission to use a business
purpose tax year, discussed later. If the request is denied, the back-up section 444 election must be activated (if the partnership,
S corporation,
or PSC otherwise qualifies).
Making back-up election.
The general rules for making a section 444 election, as discussed earlier, apply. When filing Form 8716,
type or print “ BACK-UP ELECTION” at the top of the form. However, if Form 8716 is filed on or after the date Form
1128 (or Form 2553) is filed, type or print “ FORM 1128 (or FORM 2553) BACK-UP ELECTION” at the top of Form 8716.
Activating election.
A partnership or S corporation activates its back-up election by filing the return required and making the required
payment with Form 8752.
The due date for filing Form 8752 and making the payment is the later of the following dates.
-
May 15 of the calendar year following the calendar year in which the applicable election year begins.
-
60 days after the partnership or S corporation has been notified by the IRS that the business year request has been denied.
A PSC activates its back-up election by filing Form 8716 with its original or amended income tax return for the tax
year in which the election is
first effective and printing on the top of the income tax return, “ ACTIVATING BACK-UP ELECTION.”
A partnership, S corporation, or PSC can use a tax year other than its required tax year if it elects a 52-53-week tax year
that ends with
reference to either its required tax year or a tax year elected under section 444 (discussed earlier).
A newly formed partnership, S corporation, or PSC can adopt a 52-53-week tax year ending with reference to either its required
tax year or a tax
year elected under section 444 without IRS approval. However, if the entity wishes to change to a 52-53-week tax year or change
from a 52-53-week tax
year that references a particular month to a non-52-53-week tax year that ends on the last day of that month, it must request
IRS approval by filing
Form 1128. For more information, see the discussion on the 52-53-week tax year on page 3. See also Automatic Approval on page 11.
Business Purpose Tax Year
A partnership, S corporation, or PSC establishes the business purpose for a tax year by filing Form 1128. The rules for establishing
business
purpose are different for automatic approval requests and ruling requests.
Automatic approval requests.
For automatic approval requests, the requirement to establish a business purpose for a tax year is satisfied if the
requested tax year coincides
with the entity's required tax year, ownership tax year (for S corporations only), or natural business year. For purposes
of automatic approval
requests, an entity must satisfy the 25-percent gross receipts test to establish a natural business year.
25-percent gross receipts test.
To apply this test, take the following steps.
-
Total the gross receipts from sales and services for the most recent 12-month period that ends with the last month of the
requested tax
year. Figure this for the 12-month period that ends before the filing of the request. Also total the gross receipts from sales
and services for the
last 2 months of that 12-month period.
-
Determine the percentage of the receipts for the 2-month period by dividing the total of the last 2-month period by the total
for the entire
12-month period. Carry the percentage to two decimal places.
-
Figure the percentage following steps (1) and (2) for the two 12-month periods just preceding the 12-month period used in
(1).
If the percentage determined for each of the three years equals or exceeds 25%, the requested tax year is the natural
business year.
If one or more tax years (other than the requested tax year) produce higher averages of the three percentages than
the requested tax year, then the
requested tax year will not qualify as the natural business year under the 25-percent gross receipts test.
To apply the 25-percent gross receipts test for any particular year, the entity must use the method of accounting
used to prepare its tax return.
See Accounting Methods, later.
If the entity (including any predecessor organization) does not have at least 47 months of gross receipts (36-month
period for requested tax year
plus additional 11-month period for comparing requested tax year with other potential tax years), it cannot establish a natural
business year using
the 25-percent gross receipts test.
If the requested tax year is a 52-53-week tax year, the calendar month ending nearest the last day of the 52-53-week
tax year is treated as the
last month of the requested tax year for purposes of computing the 25-percent gross receipts test.
Ownership tax year.
An S corporation or corporation electing to be an S corporation can get automatic approval to adopt, change to, or
retain its ownership tax year.
An ownership tax year is the tax year that, as of the first day of the requested tax year, constitutes the tax year of one
or more shareholders
(including shareholders changing to that tax year) holding more than 50% of the corporation's issued and outstanding shares
of stock. For this
purpose, a shareholder that is tax-exempt under section 501(a) is disregarded if such shareholder is not subject to tax on
any income attributable to
the S corporation. The IRS will not apply this rule to require an S corporation to change its tax year for any tax year beginning
before 2003.
However, a tax-exempt shareholder is not disregarded if the S corporation is wholly owned by such tax-exempt entity. Shareholders
that want to change
their tax year must, when requesting permission, follow section 1.442-1(b) of the regulations, Revenue Procedure 2002–39 in
Internal Revenue
Bulletin 2002–22, or any other applicable IRS administrative procedure.
Ruling requests.
For ruling requests, the requirement to establish a business purpose for a tax year is satisfied if the requested
tax year coincides with the
entity's natural business year. For purposes of ruling requests, the natural business year of an entity can be determined
under any of the following 3
tests:
The entity can also establish a business purpose based on all the relevant facts and circumstances (see Facts and circumstances
test, later). However, the Service anticipates that such entity will be granted permission to adopt, change, or retain a tax year
only in rare
and unusual circumstances.
Annual business cycle test.
Apply this test if the entity's gross receipts from sales and services for the short period and the three immediately
preceding tax years indicate
that the entity has a peak and a non-peak period of business. The natural business year is considered to end at or one month
after the end of the
highest peak period. A business whose income is steady from month to month throughout the year will not meet this test.
Seasonal business test.
Apply this test if the entity's gross receipts from sales and services for the short period and the three immediately
preceding tax years indicate
that the entity's business is operational for only part of the year (due to weather conditions, for example). As a result,
during the period the
business is not operational, it has gross receipts equal to or less than 10% of its total gross receipts for the year. The
natural business year is
considered to end at or one month after the end of operations for the season.
Facts and circumstances test.
A taxpayer can establish a business purpose based on all the relevant facts and circumstances. This method of establishing
a business purpose does
not apply to automatic approval requests. Administrative and convenience business reasons such as the following are not sufficient to
establish a business purpose for a particular tax year.
-
Using a particular year for regulatory or financial accounting purposes.
-
Using a hiring pattern, such as typically hiring staff during certain times of the year.
-
Using a particular year for administrative purposes, such as:
-
Admission or retirement of partners or shareholders.
-
Promotion of staff.
-
Compensation or retirement arrangements with staff, partners, or shareholders.
-
Using a price list, model year, or other item that changes on an annual basis.
-
Deferring income to partners or shareholders.
-
Using a particular year used by related entities and competitors.
For examples of situations in which a business purpose is not shown as well as examples in which a substantial business
purpose has been
established, see Revenue Ruling 87–57 in Cumulative Bulletin 1987–2.
A partnership, S corporation, or PSC can request automatic approval to:
-
Change to a required tax year or to a 52-53-week tax year ending with reference to such required tax year.
-
Change to or retain a natural business year that satisfies the 25-percent gross receipts test or to a 52-53-week tax year
ending with
reference to such natural tax year.
-
Change from a non-52-53-week tax year to a 52-53-week tax year ending with reference to the same calendar month.
-
Change from a 52-53-week tax year that references a particular calendar month to a non-52-53-week tax year that ends on the
la |
|
