Tax Accounting:
Accounting Periods
Chapter 10
Tax Year Period
12-Month Period
Generally, a tax year may not exceed 12 calendar months.
52- to 53-Week Period
If certain requirements are met under Code Sec. 441(f), a
taxpayer may elect to use an annual period that varies from 52
to 53 weeks. In that case, the year-end must always fall on the
same day of the week, such as the last Tuesday of December.
A retail business may wish to have its tax years end always on Sundays
so that it can conduct year-end physical inventory counts without
interrupting business operations.
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Short Tax Year
Definition
A short tax year is a period of less than 12 calendar months.
Factors Causing Short Tax Years
Short tax years may arise from one of several factors, including:
1. Initial income tax return
2. Final income tax return
3. Change in tax year
Annualizing Income
Only a change in tax year (#3 above) requires annualizing income.
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Short Tax Year
General Annualization Method
The three-step computations are:
(a) = Annualized short year taxable income:
(a) = (Short year income÷ number of months in the short year) x 12
(b) = Tax on (a)
(c) = Short period tax: (c) = (b) ÷ 12 x number of months in the short year
Example Using the General Annualization Method
FACTS:
1. ABC Corp. changes its accounting period from a calendar year to a fiscal year and
must file a return for the three-month period ending March 31, 20x1 (the “short year”).
2. ABC has $18,750 taxable income during the short year.
QUESTION:
Compute ABC’s short year taxes under the annualization method.
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Short Tax Year
SOLUTION:
(a) = Annualized short year taxable income
(a) = ($18,750 short year income÷ 3 months in the short year) x 12 = $75,000
(b) = Tax on $75,000:
15% x $50,000:
= $ 7,500
25% x($75,000 – $50,000): = 6,250
Tax on annualized income:
$13,750
(c) = Short period tax: $3,437.50 = ($13,750 ÷ 12) x 3 months in short year
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Short Tax Year
Alternative Annualization Method
A taxpayer may enjoy some tax savings by electing an alternative annualization method.
The four-step computations are:
(a) = Taxable income for the short year
(b) = Taxable income for the 12 months beginning on the first day of the short period
(c) = Tax on (b)
(d) = Short period tax: (d) = (c) x (a)÷ (b)
Example Using the Alternative Annualization Method.
FACTS:
1. ABC Corp. changes its accounting period from a calendar year to a fiscal year and must
file a return for the three-month period ending March 31, 20x1 (the “short year”).
2. ABC has $18,750 taxable income during the short year and $81,250 during the next nine
months (i.e., April, 20x1 to December 31, 20x1).
QUESTION: Compute ABC’s short year taxes under the alternative annualization method.
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Short Tax Year
SOLUTION:
(a) = $18,750 (Taxable income for the short year)
(b) = $100,000 ($18,750 + $81,250), taxable income for the period January 1, 20x1 to
December 31, 20x1
(c) = Tax on $100,000:
15% x $50,000:
= $ 7,500
25% x ( $75,000 – $50,000): =
6,250
34% x ($100,000 – $75,000): =
8,500
Tax on annualized income:
$ 22,250
(d) = Short period tax: (d) = $4,171.88 = ($22,250) x [($18,750) ÷ ($100,000)]
NOTE: The Short Period Tax in (d) cannot be less than if computed on short-period taxable income
(without placing it on an annualized basis, i.e., $2,812.50). As previously illustrated, the General
Annualization Method resulted in a tax of $3,437.50. The TP will use the General Annualization
Method since it results in a smaller tax than the Alternative Annualization Method.
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Tax Year
Definition of Calendar Year
The twelve months ended December 31. The calendar tax year is available
to any type of taxpayer.
Definition of Fiscal Year
Any twelve-month period ending on the last day of a month other than
December.
Deferred Income Advantage Under Fiscal Tax Year-End
The fiscal tax year offers an income deferral advantage to the owner of an
entity such as a partnership or S corporation. The income of the entity
earned between the beginning of its fiscal year and December 31 of the
same year is not included in the income of a calendar-year partner or
shareholder until the following calendar year.
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Tax Year
Who Can Adopt a Fiscal Year-End?
Taxpayer Type
Comments on Adopting Fiscal Year-End
Individual
Rarely done because difficult to qualify
Sole Proprietor
(i.e., an individual’s self-employment
income)
A sole proprietor’s tax year follows the tax year on
the personal return. (As noted above, fiscal tax
years are rarely adopted.)
Partnership
Must meet certain conditions to qualify
C Corporation
OK without restrictions
Public Service Corporation
Must meet certain conditions to qualify
S Corporation
Must meet certain conditions to qualify
Estate
OK without restrictions
Trust
Generally OK without restrictions
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Tax Year—Example
FACTS:
Amy, a calendar tax year taxpayer, is considering a fiscal year-end
(“FYE”) for her partnership.
QUESTION:
How much income deferral would she realize if the
partnership’s fiscal year ended on January 31, June 30, or
November 30?
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Tax Year—Example
SOLUTION:
Number of
Deferral
Months
(Assuming ABC’s
FYE is 1/31/x1)
(Assuming ABC’s FYE is
6/30/x1)
(Assuming ABC’s FYE
is 11/30/x1)
11 months
(Feb– Dec. 20x1)
6 months
(Jul. – Dec. 20x1)
1 month
(Dec. 20x1)
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Tax Year—Individuals
Calendar Tax Year-End
The calendar tax year (i.e., 12 months ended December 31) is
used by most individual for reporting taxable income/loss.
Fiscal Tax Year Exception
Individuals are rarely able to adopt a fiscal tax year (any 12month period ending on the last day of a month other than
December). However, an individual filing as a new taxpayer (i.e.,
first time filer) may adopt a fiscal tax year-end, without
obtaining prior approval from the IRS, if the following criteria
have been met.
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Tax Year—Individuals
Criteria That Must Be Met for Adopting Fiscal Year
„ Timely adoption. The first tax year must be adopted by the filing date of the
initial return. (A filing extension does not extend the time for adoption of
the fiscal year.)
„
Formal accounting system. A regular and continuous system of accounting
must be in place during the initial and subsequent years. The IRS standard
for the taxpayer’s system of accounting does not require that the records
be bound. Records which are sufficient to reflect income adequate and
clearly on the basis of a fiscal tax year are normally the acceptable standard
of the IRS. Informal records such as check stubs, rent receipts and
dividend statements are not regarded by the IRS as acceptable books of
accounting. Taxpayers who do not have books (e.g., employees) must use
the calendar year. [Code Sec. 441.]
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Tax Year—Proprietorships
Business Follows Personal
An individual taxpayer conducting a business activity generally
must report the income/loss on Schedule C of the individual
tax return. The tax year for the Schedule C activity must be the
same period as used for personal tax reporting.
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Tax Year—Partnerships
Majority Interest Tax Year
Partnerships are generally required to elect the same tax year
as their partners who represent a majority interest on the first
day of the partnership’s first tax year. [Code Sec. 706(b).]
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Tax Year—Partnerships
Five Percenters’ Common Tax Year
If there is no majority interest tax year, (i.e., the majority interest use
different tax years) the partnership must use the same tax year as
that of the principal partners, i.e., those owning five percent or
more interests in either profits or capital.
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Tax Year—Partnerships
Calendar Tax Year
If there is no majority interest tax year and the principal partners do
not have the same taxable year, the partnership generally must use
the least aggregate deferral method.
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Tax Year—C Corporations
Unrestricted Right to Select Tax Year
Every newly organized corporation has the unrestricted
right to select its annual tax year, regardless of the tax
years employed by its shareholders.
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Tax Year—Personal Service Corporations
Calendar Tax Year
A personal service corporation (PSC) is a C corporation
whose shareholder-employees owning over 10% of the value
of the stock provide personal services (e.g., acting,
entertainment, medical, legal, consulting, or other services
performed through their personal efforts). Generally, a PSC
must use a calendar tax year. [Code Sec. 441(i).] PSCs are
subject to a flat 35% tax rate.
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Tax Year—Personal Service Corporations
Fiscal Tax Year Exception (Sec. 444 Election)
A PSC may elect a fiscal tax year under any of the following conditions:
1. The PSC’s fiscal tax year results in income deferral of not more than
three months, and the shareholder-employee’s salary earned between fiscal
year end and December 31 is both:
(a) Paid during that period; and,
(b) Proportionate to the salary paid during the preceding fiscal
year.
2. A business purpose can be demonstrated.
3.
The PSC retains the same fiscal tax year as was used in 1987, had
it been in existence then.
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Tax Year—Personal Service Corporations
EXAMPLE: Fiscal Tax Year Exception (Sec. 280H(k))
Austin, Inc. is a PSC of CPAs with a fiscal year ending
September 30. For the year ended September 30, 2005, the
Company earned a profit of $480,000 before any salary
payments to the owners. The entire profit, however, was paid
out as salaries to the owners, resulting in a taxable income of
zero. To avoid penalty, Austin must pay salaries to its owners
of no less than $120,000 ($480,000 x 3/12) during the period
October 1, 2005 to December 31, 2005.
-An option allows PSCs to compute the amount of the
minimum distribution by using a three-year average of income
and distributions.
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Tax Year—S Corporations
Calendar Tax Year
Generally, an S Corporation must use a calendar tax year.
Fiscal Tax Year Exception (Sec. 444 Election)
An S Corporation may elect a fiscal tax year if it meets any one of the following
conditions:
1. The S corporation’s fiscal tax year results in income deferral of not more that
three months, and the shareholder-employee’s salary earned between the
beginning of the fiscal year and December 31 is both:
(a) Paid during that period; and,
(b) Proportionate to the salary paid during the preceding fiscal year.
2. A business purpose can be demonstrated.
3. The S corporation retains the same fiscal tax year as was used in 1987,
had it been in existence then.
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Tax Year—S Corporations/Partnerships
Required Payment for S Corporations and Partnerships under Sec. 444
-Purpose: Offset the tax deferral advantage when fiscal years are used.
The “Required Payment” is due May 15 following year-end.
Required Payment:
1. The amount of the required payment is determined by multiplying
the maximum tax rate for individuals plus 1% (i.e., 36% in 2005) times
the previous year’s taxable income times a deferral ratio (Sec. 7519(b)).
2. The deferral ratio is equal to the number of months in the deferral
period divided by the number of months in the taxable year.
3. An adjustment is made for deductible amounts distributed to
owners during the year.
4. If the amount due is $500 or less, no payment is required.
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Tax Year—S Corporations/Partnerships
EXAMPLE: Required Payment for S Corps and Partnerships
-The ABC Partnership begins operations on October 1, 2004 and
elects a September 30 year-end under Section 444. The
Partnership’s net income for the fiscal year ended September 30,
2005 is $100,000. ABC must make a required payment of $9,000
($100,000 x 36% x 3/12) on or before May 15, 2006.
NOTE: The owners of the business are not entitled to claim a credit for payments made by
the entity. Instead, the partnership or S Corporation subtracts the previous year’s required
payment from the current year’s required payment. If the result is negative, then the entity
is entitled to a refund.
-If ABC’s required payment for the year ended September 30, 2006
is $6,000, ABC would be entitled to a refund of $3,000.
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Tax Year—Estates
Unrestricted Right to Select Tax Year
As a “new” taxpayer, an estate has the unrestricted right to
select any annual tax year, without obtaining prior approval.
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Tax Year—Trusts
Calendar Tax Year
Trusts, other than charitable and tax-exempt trusts, must use
the calendar tax year. [Code Sec. 644.]
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Tax Year—IRS Permission to Change
General Rule
The tax year adopted on initial year returns must generally be used in
subsequent years.
Changing Tax Years
However, a taxpayer may change the tax year with prior IRS approval.
An application for permission to change tax years must be made on
Form 1128, Application to Adopt, Change, or Retain a Tax Year.
Filing Deadline
This application must be filed by the fifteenth day of the third
calendar month following the close of the short tax year that results
from the change in tax year.
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Tax Year—IRS Permission to Change
Example
FACTS: Beginning in 20x1, ABC Corporation, a calendar year
taxpayer, wishes to change to a fiscal year ending September 30.
QUESTION: When is the deadline for filing Form 1128?
SOLUTION: The change would result in a short tax year for
the nine months ended September 30, 20x1. Therefore the
filing deadline would be December 15, 20x1 (i.e., end of short
year, September 30, 20x1, + 2-1/2 months).
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Tax Year—No Approval to Change
IRS Approval is not required in limited circumstances:
1.
2.
3.
4.
Newly married persons changing tax years to conform to their
spouse’s tax year in order to file a joint return (Reg. Sec. 1.442-1(e)).
Changing to a 52/53 week year that ends with reference to the same
calendar month in which the former tax year ended (Reg. Sec. 1.441(c)(2)).
Correcting an erroneously filed tax return where the accounting
period does not reflect the accounting period maintained by the
accounting records (Rev. Rul. 58-256) .
For Partnerships where the majority interest partners have the same
tax year to which the partnership changes or if all principal partners
who do not have such a tax year concurrently change to such a tax
year (Reg. Sec. 1.442-1(b)(2)).
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Tax Year—No Approval to Change
IRS Approval is not required in limited circumstances (cont):
5. For Corporations where:
a) there has been no change in its accounting period within the past ten
calendar years;
b) the resulting year does not have a NOL,
c) taxable income for the resulting short tax year when annualized is at
least 90% of the taxable income for the preceding full tax year, and
d) there is no change in status of the corporation (i.e., S-election).
6. However, subsidiaries filing a consolidated tax return are required to adopt
the year of the parent corporation.
.
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Net Operating Losses
„
Purpose of NOL deduction:
„
Individual NOLs are normally created by one of the following:
„
Loss from operating a sole proprietorship
„
Casualty or theft loss or
„
Losses attributable to a Partnership or S-Corp, and LLCs
Note:
‹
The only nonbusiness items that may create NOLs for individuals are casualties and
thefts
‹
A NOL from the above is reported on the individual’s tax return
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NOL Carryback & Carryforward Years
Deduct Over 18 or 22 Year Period
Pre 8/5/97
Post 8/4/97
3 yr. Carryback
15 yr. Carryforward
2 yr. carryback
20 yr. carryforward
TP may elect to forgo carryback period
‹ Election must be made by due date of loss return
(including extensions)
‹ Election is irrevocable once made
Statute of limitations for the carryback year is extended to
coincide with that of the loss year
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NOL Carryback & Carryforward Years
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applicable 2 year carryback period (Sec. 172(j)).
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Corporate Carrybacks & Carryforwards
NOL:
2 yr Carryback / 20 yr Carryforward
CAPITAL LOSSES:
3 yr Carryback / 5 yr Carryforward
(can only offset capital gains)
CHARITABLE CONTRIBUTIONS:
No Carryback / 5 yr Carryforward
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