Publication 538 |
2001 Tax Year |
Accounting Periods
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. The tax years you can use are:
- A calendar year.
- A fiscal year.
You adopt a tax year when you file your first income tax return.
You must adopt your first tax year by the due date (not including
extensions) for filing a return for that year.
The due date for individual and partnership returns is the 15th day
of the 4th month after the end of the tax year. Individuals include
sole proprietors, partners, and S corporation shareholders. The due
date for filing returns for corporations and S corporations is the
15th day of the 3rd month after the end of the tax year. If the 15th
day of the month falls on a Saturday, Sunday, or legal holiday, the
due date is the next business day.
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.
- Restrictions that apply to the accounting period of a
partnership, S corporation, or personal service corporation.
- Special situations that apply to corporations.
Calendar Year
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. 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 do not keep adequate records.
- You have no annual accounting period.
- Your present tax year does not qualify as a fiscal
year.
Fiscal Year
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.
52-53 Week 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 tax year will be 52 or 53 weeks long and
always end on the same day of the week. You can choose to have your
tax year end on the same day of the week that:
- Last occurs in a particular month, or
- Occurs nearest to the last day of a particular calendar
month.
For example, if you elect a tax year that always ends on the last
Monday in March, your 1999 tax year will end on March 27, 2000. If you
elect a tax year ending on the Thursday nearest to the end of April,
your 1999 tax year will end on April 27, 2000.
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, 2001. For this purpose, a 52-53 week tax year beginning on
June 24, 2001, is treated as beginning on July 1, 2001.
Change to or from 52-53 week tax year.
Under certain circumstances, you can change to a 52-53 week tax
year without IRS approval. However, in other cases, you must get
approval before changing to or from a 52-53 week tax year.
Approval not required.
You can change to a 52-53 week tax year without IRS approval as
long as the day chosen for the end of the 52-53 week tax year occurs
in the same calendar month in which your present tax year ends. You
must attach the statement explained in Election, earlier,
to the tax return for the year for which the election is made.
Example.
You do not need IRS approval to change from a calendar tax year to
a 52-53 week tax year ending on the Friday closest to December 31. You
make the election by attaching the required statement to your tax
return for the year of the change.
Approval required.
You must get IRS approval to change your tax year to a 52-53 week
tax year that ends in a calendar month different from the month in
which your present tax year ends. For example, you must get IRS
approval to change from a calendar year to a 52-53 week tax year
ending on the Saturday nearest the end of November.
You must also get approval to change from a 52-53 week tax year to
any other tax year.
See Change in Tax Year, later, for information on
getting IRS approval.
Short Tax Year
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):
- Are not in existence for an entire tax year, or
- Change your accounting period.
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, 2000. It elected the
calendar year as its tax year and its first tax return was due March
16, 2001. This short period return will cover the period from July 1,
2000, through December 31, 2000.
Example 2.
A calendar year corporation dissolved on July 23, 2001. Its final
return is due by October 15, 2001, and it will cover the short period
from January 1, 2001, to July 23, 2001.
Example 3.
Partnership YZ was formed on September 4, 2000, and elected to use
a fiscal year ending November 30. Partnership YZ must file its first
tax return by March 15, 2001. It will cover the short period from
September 4, 2000, to November 30, 2000.
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, 2001. Her final tax return must be filed by April 15, 2002. It will
cover the short period from January 1, 2001, to March 6, 2001.
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 total $12,400 and they can claim exemptions for
themselves, and their two children. Each exemption is $2,800. They
figure the tax on their joint return for that period as follows.
- $48,000 - $12,400 = $35,600
- $2,800 × 4 × 9/12 = $8,400
- $35,600 - $8,400 = $27,200 (modified taxable
income)
- $27,200 × 12/9 = $36,267 (annualized income)
- Tax on $36,267 = $5,441 (from 2000 tax rate schedule)
- $5,441 × 9/12 = $4,081 (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,
2000. 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 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 closest 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. 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.
Improper Tax Year
A calendar year is a tax year of 12 months that ends on December 31
and a fiscal year is a tax year of 12 months that ends on the last day
of any month other than December. A 52-53 week tax year is also
a fiscal year, but may not end on the last day of a month. If you
begin business operations on a day other than the first day of a
calendar month and adopt a tax year of exactly 12 months from the date
operations began, you will have adopted an improper tax year. You do
not meet the requirements for a calendar or fiscal tax year.
To change to a proper tax year, you must do one of the following.
- File an amended income tax return based on a calendar year,
if you meet the requirements of Revenue Procedure 85-15 in
Cumulative Bulletin 1985-1.
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.
- Request IRS approval to change to a tax year other than a
calendar year.
Change in Tax Year
You must, with certain exceptions, get IRS approval to change your
tax year. File a current Form 1128
by the 15th day of the 2nd calendar
month after the close of the short tax year to get IRS approval. (The
short tax year 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 include the correct user fee, if any, with Form 1128.
See User fees at the beginning of this publication.
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 August 15,
the 15th day of the 2nd calendar month after the close of the short
tax year.
A Form 1128 received within 90 days after the due date may qualify
for an extension and be considered timely filed. For more information,
see the form instructions and Revenue Procedure 2001-1, in
Internal Revenue Bulletin No. 2001-1 (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.
Husband and wife.
A husband and wife who have different tax years cannot file a joint
return. However, there is an exception to this rule if their tax years
begin on the same date and end on different dates because of the death
of either or both. If a husband and wife want to use the same tax year
so they can file a joint return, the method of changing a tax year
depends on whether they are newly married.
Newlyweds.
A newly married husband and wife with different tax years who wish
to file a joint return can change the tax year of one spouse without
first getting IRS approval. 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(e) 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, 2000. John filed his return
for the fiscal year ending June 30, 2000. 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 16, 2000, for the
short period January 1, 2000, through June 30, 2000, 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, 2001.
Spouses other than newlyweds.
A spouse who does not meet the earlier conditions must get IRS
approval to change to the other spouse's tax year in order to file a
joint return. Even though there is no substantial business purpose for
requesting the change, approval may be granted in certain cases.
Partnerships,
S Corporations,
and Personal Service
Corporations
Generally, partnerships, S corporations, and personal service
corporations must use a "required tax year." The entity does not
have to use the required tax year if it establishes a business purpose
for a different tax year or makes an election under section 444. These
issues are discussed later.
Partnership
A partnership must conform its tax year to its partners' tax years
unless the partnership can establish a business purpose for a
different period or it makes a section 444 election. 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, no formal application for a change in tax year is needed. Any
partnership that changes to a required tax year must notify the IRS by
writing at the top of the first page of its tax return for its first
required tax year, "FILED UNDER SECTION 806 OF THE TAX REFORM ACT OF
1986."
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 more
than one year qualifies as the tax year that has the least aggregate
deferral of income, the partnership can choose any year that
qualifies. 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.
Year End 12/31: |
Year End |
Profits Interest |
Months of Deferral |
Interest × Deferral |
A |
12/31 |
0.5 |
-0- |
-0- |
B |
11/30 |
0.5 |
11 |
5.5 |
Total Deferral |
5.5 |
Year End 11/30: |
Year End |
Profits Interest |
Months of Deferral |
Interest × Deferral |
A |
12/31 |
0.5 |
1 |
0.5 |
B |
11/30 |
0.5 |
-0- |
-0- |
Total Deferral |
0.5 |
When determination is made.
The determination of the tax year with the least aggregate deferral
of income 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 of income, it must attach a statement to 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 1.706-1T."
More information.
For more information on partnerships, see Publication 541.
S Corporation
If it meets the requirements, a small business corporation can
elect to be an S corporation. All S corporations, regardless of when
they became an S corporation, must use a "permitted tax year." A
permitted tax year is the calendar year or any other tax year for
which the corporation establishes a business purpose. For information
on S corporations, see the instructions for Form 1120-S.
Personal Service Corporation
A personal service corporation must use a calendar tax year unless
it can establish a business purpose for a different period or it makes
a section 444 election, discussed later. A corporation is a personal
service corporation if all the following conditions are met.
- The corporation is a C corporation.
- The corporation's principal activity during the testing
period, defined later, is the performance of personal services.
- Employee-owners of the corporation perform a substantial
part of the services during the testing period.
- Employee-owners own more than 10% of the corporation's stock
on the last day of the testing period.
Principal activity.
The principal activity of a corporation is considered to be the
performance of personal services if, during the testing period, the
corporation's compensation costs for personal service activities are
more than 50% of its total compensation costs.
Testing period.
Generally, the testing period for a tax year is the prior tax year.
Example.
Corporation A has been in existence since 1980. It has always used
a January 31 fiscal year for its accounting period. To determine
whether A is a personal service corporation for its tax year beginning
February 1, 2001, the testing period is A's tax year ending January
31, 2001.
New corporations.
The testing period for the first tax year of a new corporation
starts with the first day of the tax year and ends on the earlier of
the following dates.
- The last day of its tax year.
- The last day of the calendar year in which the tax year
begins.
Example.
B Corporation's first tax year begins June 1, 2001. B wants to use
a September 30 fiscal year for its accounting period. B's testing
period for its first tax year is from June 1, 2001, through September
30, 2001. If B wants to use a March 31 fiscal year, the testing period
is from June 1, 2001, through December 31, 2001.
Performance of personal services.
Any activity that involves the performance of services in the
fields of health, veterinary services, law, engineering, architecture,
accounting, actuarial science, performing arts, or certain consulting
services is considered the performance of personal services.
Employee-owner.
An employee-owner of a corporation is a person who:
- Is an employee of the corporation on any day of the testing
period, and
- Owns any outstanding stock of the corporation on any day of
the testing period.
Independent contractor.
A person who owns any outstanding stock of the corporation and who
performs personal services for or on behalf of the corporation is
treated as an employee of the corporation. This rule applies even if
the legal form of the person's relationship to the corporation is such
that the person would be considered an independent contractor for
other purposes.
More information.
For more information on the tax year of a personal service
corporation, see section 1.441-4T of the regulations.
Section 444 Election
A partnership, S corporation, or personal service corporation can
elect under section 444 to use a tax year other than its required tax
year. Certain restrictions apply to the election. In addition, a
partnership or S corporation may have to make a payment for the
deferral period. See Required payment for partnership or S
corporation, later. The section 444 election does not apply to
any partnership, S corporation, or personal service corporation that
establishes a business purpose for a different period, explained
later.
A partnership, S corporation, or personal service corporation 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 personal service corporation 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 personal service
corporation 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 personal service corporation
is 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:
- Three months, or
- The deferral period of the tax year being changed. This is
the tax year immediately preceding the year for which the partnership,
S corporation, or personal service corporation wishes to make the
section 444 election.
If the partnership, S corporation, or personal service
corporation'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,
2000. 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, 2000, 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 or the appropriate Form
1120 for the first tax year for which the election is made.
Example 1.
AB, a partnership, begins operations on September 11, 2001, and is
qualified to make a section 444 election to use a September 30 tax
year for its tax year beginning September 11, 2001. AB must file Form
8716 by January 15, 2002, which is the due date of the partnership's
tax return for the period from September 11, 2001, to September 30,
2001.
Example 2.
The facts are the same as Example 1 except that AB
begins operations on October 21, 2001. AB must file Form 8716 by March
15, 2002, 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 personal service
corporation for its tax year beginning September 1, 2001. B qualifies
to make a section 444 election to use a September 30 tax year for its
tax year beginning September 1, 2001. B must file Form 8716 by
December 17, 2001, the due date of the income tax return for the short
period from September 1, 2001, to September 30, 2001.
Extension of time for filing.
There is an automatic extension of 12 months to make this election.
See the form instructions for more information.
Effect of election.
A partnership or an S corporation that makes a section 444 election
must make certain required payments and a personal service corporation
must make certain distributions. These are discussed later.
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 the partnership, S corporation, or personal
service corporation does any of the following.
- Changes its tax year to a required tax year.
- Liquidates.
- Willfully fails to comply with the required payments or
distributions.
- Becomes a member of a tiered structure.
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 personal service corporation, the
personal service corporation can continue the section 444 election of
the S corporation.
- A personal service corporation ceases to be a personal
service corporation. If the personal service corporation elects to be
an S corporation, the S corporation can continue the election of the
personal service corporation.
Required payment for partnership or S corporation.
A partnership or an S corporation must make a "required payment"
for any tax year:
- The section 444 election is in effect.
- The required payment for that year (or any preceding tax
year) is more than $500.
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, 2001, Form 8752 must be filed
by May 15, 2002.
Required distribution for personal service corporation.
A personal service corporation 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 personal service corporation 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 personal service
corporation otherwise qualifies).
Making 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 is filed, type or print "FORM 1128 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, making the required payment with Form
8752,
and printing at the top of the form,
"ACTIVATING BACK-UP ELECTION." 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 personal service corporation 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."
Business Purpose Tax Year
A business purpose tax year is an accounting period that has a
substantial business purpose for its existence. See Natural
Business Year, later. In considering whether there is a business
purpose for a tax year, significant weight is given to tax factors. A
prime consideration is whether the change would create a substantial
distortion of income. The following are examples of income distortion.
- Deferring substantial income or shifting substantial
deductions from one year to another to significantly reduce tax
liability.
- Causing a similar deferral or shifting for any other person,
such as a partner or shareholder.
- Creating a short period in which there is a substantial net
operating loss.
The following nontax factors, based on the convenience of the
taxpayer, are generally not sufficient to establish a business purpose
for a particular tax year.
- Using a particular year for regulatory or financial
accounting purposes especially if the change is not based on the
taxpayer's own facts and circumstances.
- Using a particular 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.
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.
Natural business year.
One nontax factor that may be sufficient to establish a business
purpose for a tax year is an annual cycle of business activity, called
a "natural business year." A natural business year exists when a
business has a peak and a nonpeak period. The natural business year is
considered to end at or soon after the end of the peak period. A
business whose income is steady from month to month all year would not
have a natural business year.
A natural business year is considered a substantial business
purpose for an entity changing its accounting period. The IRS will
ordinarily approve this change unless it results in a substantial
distortion of income or other tax advantage.
Automatic approval.
The IRS provides a procedure for a partnership, an S corporation,
or a personal service corporation to retain or automatically change to
a natural business year as determined by the 25% test, discussed next.
It also allows an S corporation to adopt, retain, or change to a
fiscal year that satisfies the "ownership tax year test,"
discussed later. For more information, see Revenue Procedure
87-32, in Cumulative Bulletin 1987-2.
25% test.
The natural business year is determined by applying the 25% test to
the method of accounting used for the tax return for each year
involved. To figure the 25% test, take the following steps.
- Total the gross sales and services receipts for the most
recent 12-month period that includes the last month of the requested
fiscal year. Figure this for the 12-month period that ends before the
filing of the request. Also total the gross sales and services
receipts 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 fiscal year is the natural business year.
Special rules.
If the partnership, S corporation, or personal service corporation
qualifies for more than one natural business year, the fiscal year
producing the highest average of the three percentages is the natural
business year.
If the partnership, S corporation, or personal service corporation
does not have at least 47 months of gross receipts (which may include
a predecessor organization's gross receipts), it cannot use this
automatic procedure to obtain permission to use a fiscal year.
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% test.
Ownership tax year test.
An S corporation or corporation electing to be an S corporation
qualifies for automatic approval if it meets the ownership tax year
test. The test is met if the corporation is adopting, retaining, or
changing to a tax year and shareholders holding more than 50% of its
issued and outstanding shares of stock on the first day of the
requested tax year have, or are all changing to, the same tax year.
Shareholders desiring to change to the same tax year should follow
section 1.442-1(b)(1) of the regulations when requesting permission.
If, on the first day of any tax year, the S corporation no longer
meets the ownership tax year test, the corporation must change its tax
year to a permitted year.
Filing information.
To get automatic approval, a partnership, S corporation, or
corporation electing to be an S corporation must file a tax return for
the short period. The short period tax return must be filed by the due
date, including extensions.
Form 1128
must be filed by the 15th day of the
second calendar month following the close of the short period with the
director of the Internal Revenue Service Center where the entity files
its tax return. The envelope should be marked "Attention: ENTITY
CONTROL." Type or print "FILED UNDER REV. PROC. 87-32"
at the top of Form 1128.
In some cases, a late-filed Form 1128 may be accepted. However,
applications the IRS receives more than 90 days after the due date
will not be approved except in very unusual and compelling
circumstances.
A corporation that elects to be an S
corporation and requests to adopt, retain, or change its tax year must
file Form 2553, Election by a Small Business
Corporation. The form must be filed when the election request is
made. (In certain cases, an extension of time can be granted for
filing Form 2553.) The user fee is not due with the form. The IRS will
notify you when the fee is due. See User Fees, earlier.
For more information on these tax year requirements, see Revenue
Procedure 87-32 and Revenue Ruling 87-57 in Cumulative
Bulletin 1987-2.
Corporations
A new corporation establishes its tax year when it files its first
tax return. A newly reactivated corporation that has been inactive for
a number of years is treated as a new taxpayer for the purpose of
adopting a tax year. An S corporation or a personal service
corporation must use the required tax year rules, discussed earlier,
to establish a tax year.
Change in Tax Year
A corporation can change its tax year under section
1.442-1(c) of the regulations without getting IRS approval if
all the following conditions are met.
- It must not have changed its tax year within the 10 calendar
years ending with the calendar year in which the short tax year
resulting from the change begins.
- Its short tax year must not be a tax year in which it has a
net operating loss.
- Its taxable income for the short tax year, if figured on an
annual basis (annualized), is 80% or more of its taxable income for
the tax year before the short tax year.
- If a corporation is one of the following for either
the short tax year or the tax year before the short tax year, it
must have the same status for both the short tax year and
the prior tax year.
- Personal holding company.
- Exempt organization.
- Foreign corporation not engaged in a trade or business
within the United States.
- It must not apply to become an S corporation for the tax
year that would immediately follow the short tax year required to
effect the change.
Statement.
The corporation must file a statement with the IRS office where it
files its tax return. The statement must be filed by the due date
(including extensions) for the short tax year required by the change.
It must indicate the corporation is changing its annual accounting
period under section 1.442-1(c) of the regulations and show that
all the preceding conditions have been met. If, on examination, the
corporation does not meet all the conditions because of later
adjustments in establishing tax liability, the statement will still be
considered a timely application to change the corporation's annual
accounting period to the tax year indicated in the statement.
Automatic approval.
Certain C corporations can automatically change their tax year. The
corporation must, however, meet all the following criteria.
- It cannot meet the five conditions listed earlier under
Change in Tax Year.
- It has not changed its annual accounting period within 6
calendar years (or in any of the calendar years of existence, if less
than 6 years) ending with the calendar year that includes the
beginning of the short period required to effect the tax year change.
For a list of changes not considered a change in accounting
period, see Revenue Procedure 2000-11 in Internal Revenue
Bulletin 2000-3.
- It is not any of the following:
- A member of a partnership. See Caution
later.
- A beneficiary of a trust or an estate. See Caution
later.
- An S corporation (and does not attempt to make an S
corporation election for the tax year immediately following the short
period unless changing to a permitted tax year).
- A personal service corporation.
- An interest-charge domestic international sales corporation
(DISC) or foreign sales corporation (FSC) or a shareholder in either.
See Caution later.
- A controlled foreign corporation or foreign personal holding
company, or a minority shareholder in either. See Caution
later.
- A tax-exempt organization, except those exempt under section
521, 526, 527, or 528.
- Certain passive foreign investment companies (PFICs) and
their shareholders making an election under section 1295.
- A cooperative association with a loss in the short period
required to effect the tax year change unless more than 90% of the
patrons of the association are the same in the year before, of and
after the change.
- A corporation with a section 936 election in effect.
For exceptions to 3 a, b, e, and f, see Revenue Procedure
2000-11.
Corporations that qualify and want to change their tax year using
this automatic procedure must also comply with the following
conditions.
- The short period required to effect the tax year change must
begin with the day following the close of the previous tax year and
must end with the day preceding the first day of the new tax
year.
- The corporation must file a tax return for the short period
by the due date, including extensions.
- The books of the corporation must be closed as of the last
day of the new tax year. Returns for later years must be made on the
basis of a full 12 months (or 52-53 weeks) ending on the last day of
the new tax year. The corporation must figure its income and keep its
books and records, including financial reports and statements for
credit purposes, on the basis of the new tax year.
- Taxable income of the corporation for the short period must
be figured on an annual basis (except for a real estate investment
trust or a regulated investment company) and the tax must be figured
as shown under Figuring Tax for Short Year, earlier.
- If the corporation has a net operating loss (NOL) in the
short period required to effect the change, the NOL generally cannot
be carried back. However, a short period NOL can be carried back or
forward if it:
- Is $50,000 or less.
- Results from a short period of 9 or more months and is less
than the NOL for a full 12-month period beginning with the first day
of the short period.
- If there is any unused credit for the short period, the
corporation must carry the unused credit(s) forward. Unused credit(s)
cannot be carried back.
See Revenue Procedure 2000-11 for more information.
Form 1128.
To make this change, a corporation must file Form 1128 with the
director of the Internal Revenue Service Center where it files its
income tax return. It should mark the envelope "Attention: ENTITY
CONTROL." The form must be filed by the due date (including
extensions) of the short period return required for the change. It
should type or print "FILED UNDER REV. PROC. 2000-11" at
the top of Form 1128. If the request is denied, the service center
will return Form 1128 with an explanation of the denial.
The request will be denied if Form 1128 is not filed on time or if
the corporation fails to meet the requirements listed earlier. If a
corporation changes its tax year without first meeting all the
conditions, the tax year is considered changed without IRS approval.
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