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taxmap/pubs/p538-001.htm#TXMP46a48f7d Accounting Periods

Accounting Period

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:

• A calendar year.
• A fiscal year (including a 52-53-week tax year).

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.

taxmap/pubs/p538-001.htm#TXMP4c497963 Calendar Year

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 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.

taxmap/pubs/p538-001.htm#TXMP5e6b37bf 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.

taxmap/pubs/p538-001.htm#TXMP4ce798a0 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 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.

taxmap/pubs/p538-001.htm#TXMP64102709 Election.

To make the election, attach a statement with the following information to your tax return for the 52-53-week tax year.

1. The month in which the new 52-53-week tax year ends.
2. The day of the week on which the tax year always ends.
3. The date the tax year ends. It can be either of the following dates on which the chosen day:
   1. Last occurs in the month in (1), above, or
   2. 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.

taxmap/pubs/p538-001.htm#TXMP7dc36e07
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.

taxmap/pubs/p538-001.htm#TXMP46638c47 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.

taxmap/pubs/p538-001.htm#TXMP0697525d
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.

taxmap/pubs/p538-001.htm#TXMP49678d29 Short Tax Year

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.

taxmap/pubs/p538-001.htm#TXMP36d45089 Not in Existence Entire Year

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.

taxmap/pubs/p538-001.htm#TXMP40b90a7d
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.

taxmap/pubs/p538-001.htm#TXMP4428ab08
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.

taxmap/pubs/p538-001.htm#TXMP3f27ab1f
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.

taxmap/pubs/p538-001.htm#TXMP3f2aba2a 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.

taxmap/pubs/p538-001.htm#TXMP1d580782
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.

taxmap/pubs/p538-001.htm#TXMP07203df7 Figuring Tax for Short Year

Short Tax 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.

taxmap/pubs/p538-001.htm#TXMP5448890f 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.

taxmap/pubs/p538-001.htm#TXMP74b8153a Individuals.

An individual must figure income tax for the short tax year as follows.

1. 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.)
2. Multiply the dollar amount of your exemptions by the number of months in the short tax year and divide the result by 12.
3. Subtract the amount in (2) from the amount in (1). This is your modified taxable income.
4. 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.
5. Figure the total tax on your annualized income using the appropriate tax rate schedule.
6. 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.

taxmap/pubs/p538-001.htm#TXMP5d86b115
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.

1. $48,000 − $12,400 = $35,600
2. $3,000 × 4 × 9/12 = $9,000
3. $35,600 − $9,000 = $26,600 (modified taxable income)
4. $26,600 × 12/9 = $35,467 (annualized income)
5. Tax on $35,467 = $4,720 (from 2002 tax rate schedule)
6. $4,720 × 9/12 = $3,540 (tax for short tax year)

taxmap/pubs/p538-001.htm#TXMP7556df46 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.

taxmap/pubs/p538-001.htm#TXMP3bd1c745
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).

taxmap/pubs/p538-001.htm#TXMP1078f2dd 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.

taxmap/pubs/p538-001.htm#TXMP43043226 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).

taxmap/pubs/p538-001.htm#TXMP2ce39a6a Alternative minimum tax.

To figure the alternative minimum tax (AMT) due for a short tax year:

1. Figure the annualized alternative minimum taxable income (AMTI) for the short tax period by doing the following.
   1. Multiply the AMTI by 12.
   2. Divide the result by the number of months in the short tax year.
2. Multiply the annualized AMTI by the appropriate rate of tax under section 55(b)(1). The result is the annualized AMT.
3. 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.

taxmap/pubs/p538-001.htm#TXMP218d247f 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.

taxmap/pubs/p538-001.htm#TXMP34daff1c Improper Tax Year

Improper Tax 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.

taxmap/pubs/p538-001.htm#TXMP7209e380 Change in Tax Year

Tax Year, 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.

taxmap/pubs/p538-001.htm#TXMP1470beba Automatic Approval

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.

taxmap/pubs/p538-001.htm#TXMP02c0ce71 Ruling Request

Ruling Request

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.

taxmap/pubs/p538-001.htm#TXMP55cfcef3
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.

taxmap/pubs/p538-001.htm#TXMP06add08b Individuals

Individuals

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.

taxmap/pubs/p538-001.htm#TXMP60139c37 Change in Tax Year

Tax Year, Change

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.

taxmap/pubs/p538-001.htm#TXMP165a7cb8 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.

taxmap/pubs/p538-001.htm#TXMP11c82229
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.

taxmap/pubs/p538-001.htm#TXMP657feadc 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.

1. 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:
   1. $50,000 or less, or
   2. Less than the NOL for the full 12-month period beginning with the first day of the short period.
2. 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.
3. 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.

taxmap/pubs/p538-001.htm#TXMP077f04cd 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.

taxmap/pubs/p538-001.htm#TXMP3d377179 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.

taxmap/pubs/p538-001.htm#TXMP2f83fa79 Partnerships,   S Corporations,   and Personal Service   Corporations (PSCs)

Partnerships, S Corporations, and Personal Service Corporations

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.

taxmap/pubs/p538-001.htm#TXMP18eedf15 Partnership

Partnership

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.

taxmap/pubs/p538-001.htm#TXMP2a08ed3c Least aggregate deferral of income.

The tax year that results in the least aggregate deferral of income is determined as follows.

1. 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.
2. 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).
3. Add the amounts in step (2) to get the aggregate (total) deferral for the tax year used in step (1).
4. 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.

taxmap/pubs/p538-001.htm#TXMP6a7292a7
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

taxmap/pubs/p538-001.htm#TXMP09d2205f 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.

taxmap/pubs/p538-001.htm#TXMP42e70ef6 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."

taxmap/pubs/p538-001.htm#TXMP3d4efb46 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.

taxmap/pubs/p538-001.htm#TXMP07a7b4a8 S Corporation

S Corporation

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.

taxmap/pubs/p538-001.htm#TXMP046cff78 Personal Service Corporation

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.

taxmap/pubs/p538-001.htm#TXMP59b7d438 Section 444 Election

Section 444 Election

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.

taxmap/pubs/p538-001.htm#TXMP5182763b 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.

taxmap/pubs/p538-001.htm#TXMP391bf10c 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.

taxmap/pubs/p538-001.htm#TXMP6e571724 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:

• 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 PSC wishes to make the section 444 election.

If the partnership, S corporation, or PSC's tax year is the same as its required tax year, the deferral period is zero.

taxmap/pubs/p538-001.htm#TXMP3608cab0
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.

taxmap/pubs/p538-001.htm#TXMP3b320d97
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.

taxmap/pubs/p538-001.htm#TXMP51c1fcd4 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.

taxmap/pubs/p538-001.htm#TXMP24a0448c
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.

taxmap/pubs/p538-001.htm#TXMP4ac9f16d
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.

taxmap/pubs/p538-001.htm#TXMP2b1ea71e
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.

taxmap/pubs/p538-001.htm#TXMP7f736afc 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.

taxmap/pubs/p538-001.htm#TXMP79fa18c8 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.

taxmap/pubs/p538-001.htm#TXMP1540beff 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, 2003, Form 8752 must be filed by May 17, 2004.

taxmap/pubs/p538-001.htm#TXMP171bcb8a 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).

taxmap/pubs/p538-001.htm#TXMP16a2ae79 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).

taxmap/pubs/p538-001.htm#TXMP60dfdeb5 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.

taxmap/pubs/p538-001.htm#TXMP1c732b66 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."

taxmap/pubs/p538-001.htm#TXMP4c9256a1 52-53-Week Tax Year

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.

taxmap/pubs/p538-001.htm#TXMP4373b033 Business Purpose Tax Year

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.

taxmap/pubs/p538-001.htm#TXMP672776e2 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.

taxmap/pubs/p538-001.htm#TXMP1196923c 25-percent gross receipts test.

To apply this test, take the following steps.

1. 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.
2. 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.
3. 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.

taxmap/pubs/p538-001.htm#TXMP5dab0c3b 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.

taxmap/pubs/p538-001.htm#TXMP175a112f 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:

• Annual business cycle test.
• Seasonal business test.
• 25-percent gross receipts test (discussed earlier).

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.

taxmap/pubs/p538-001.htm#TXMP35a90ee1 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.

taxmap/pubs/p538-001.htm#TXMP7faa22f3 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.

taxmap/pubs/p538-001.htm#TXMP2666961c 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.

1. Using a particular year for regulatory or financial accounting purposes.
2. Using a hiring pattern, such as typically hiring staff during certain times of the year.
3. Using a particular year for administrative purposes, such as:
   1. Admission or retirement of partners or shareholders.
   2. Promotion of staff.
   3. Compensation or retirement arrangements with staff, partners, or shareholders.
4. Using a price list, model year, or other item that changes on an annual basis.
5. Deferring income to partners or shareholders.
6. 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.

taxmap/pubs/p538-001.htm#TXMP6675aa84 Automatic Approval

A partnership, S corporation, or PSC can request automatic approval to:

1. Change to a required tax year or to a 52-53-week tax year ending with reference to such required tax year.
2. 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.
3. Change from a non-52-53-week tax year to a 52-53-week tax year ending with reference to the same calendar month.
4. 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 last day of the same calendar month.

An S corporation or electing S corporation can request automatic approval to adopt, change to, or retain its ownership tax year or a 52-53-week tax year ending with reference to such ownership tax year. For more information, see pages 7 through 10 of this publication and section 4.01 of Revenue Procedure 2002–38.

taxmap/pubs/p538-001.htm#TXMP0a658d5e Eligibility for automatic approval requests.

A partnership, S corporation, or PSC is not eligible to request automatic approval if:

• It is under examination, unless it obtains IRS consent as provided in section 7.03(1) of Revenue Procedure 2002–38.
• It is before an appeals office with respect to any income tax issue and its tax year is an issue under consideration by the appeals office.
• It is before a federal court with respect to any income tax issue and its tax year is an issue under consideration by the federal court.
• On the date a partnership or S corporation would otherwise file Form 1128 (or Form 2553), the entity's tax year is an issue under consideration in the examination of a partner's or shareholder's federal income tax return or an issue under consideration by an appeals office or federal court with respect to a partner's or shareholder's income tax return.
• It is requesting a change to, or retention of, a natural business year (as discussed earlier) and it has changed its tax year at any time in the most recent 48-month period ending with the last month of the requested tax year. For this purpose, prior tax year changes do not include changes (1), (3), and (4) listed above, a change to an ownership tax year by an S corporation, or a change in tax year by an S corporation or PSC to comply with the common tax year requirements of sections 1.1502-75(d)(3)(v) and 1.1502-76(a)(1) of the regulations.

taxmap/pubs/p538-001.htm#TXMP42b748d4 Filing information.

To get automatic approval, a partnership, S corporation, or electing 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.

To get automatic approval to adopt, change, or retain its tax year, the entity must file a current Form 1128 or Form 2553 (used by electing S corporations to request approval to adopt a tax year other than a calendar year). See the instructions for Forms 1128 and 2553 for information on when and where to file.

Form 1128 must be filed no earlier than the day following the end of the first tax year for which the adoption, change, or retention is effective (first effective year) and no later than the due date (including extensions) for filing the tax return for the first effective year. In the case of a change, the first effective year is the short period required to effect the change.

taxmap/pubs/p538-001.htm#TXMP1930c507 Ruling Request

Ruling Request

If a partnership, S corporation, or PSC is requesting to adopt, change, or retain a tax year and does not qualify for automatic approval, the entity can request a ruling under Revenue Procedure 2002–39. The eligibility requirements for an entity to request a ruling are generally the same as for automatic approval requests, except that the prior change restriction (the last item listed under Eligibility for automatic approval requests, earlier) does not apply. See Ruling Request on page 5 for more information. For filing information, see the instructions for Forms 1128 or 2553 for details.

taxmap/pubs/p538-001.htm#TXMP6ba0c73e Corporations (Other Than S   Corporations and PSCs)

Corporations (Other Than S Corporations and PSCs)

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 PSC must use the required tax year rules, discussed earlier, to establish a tax year.

taxmap/pubs/p538-001.htm#TXMP789eb48d Change in Tax Year

Tax Year, Change

A corporation that wants to change its tax year must generally get IRS approval either under the automatic approval procedures or the ruling request procedures.

taxmap/pubs/p538-001.htm#TXMP4a28c4cb Automatic approval.

Certain C corporations can get automatic approval for a tax year change, including a change to (or from) a 52-53-week tax year. The corporation must, however, meet all the following criteria.

1. It has not changed its annual accounting period within the most recent 48-month period ending with the last month of the requested tax year. For a list of changes not considered a change in accounting period, see Revenue Procedure 2002–37.
2. It is not any of the following:
   1. A member of a partnership. See Caution, later.
   2. A beneficiary of a trust or an estate. See Caution, later.
   3. 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).
   4. A PSC.
   5. An interest-charge domestic international sales corporation (IC–DISC) or foreign sales corporation (FSC) or a shareholder in either. See Caution, later.
   6. A controlled foreign corporation or foreign personal holding company. See Caution, later.
   7. A tax-exempt organization, except those exempt under section 521, 526, 527, or 528.
   8. 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 and after the change and in the short period.
   9. A corporation with a section 936 election in effect.
   10. A corporation not described in items (2a) through (2i), listed above, that has a required tax year.

For exceptions to items (2a), (2b), (2e), and (2f), listed above, see Revenue Procedure 2002–37.