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:

1. A calendar year.
2. 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:

1. The calendar year.
2. The fiscal year (including a period of 52 or 53 weeks).
3. A short tax year.
4. An improper tax year.
5. A change in tax year.
6. Restrictions that apply to the accounting period of a partnership, S corporation, or personal service corporation.
7. Special situations that apply to corporations.

Calendar Year

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 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 are required to adopt the calendar year.

1. You do not keep adequate records.
2. You have no annual accounting period.
3. 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.

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:

1. Last occurs in a particular month, or
2. 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 1997 tax year will end on March 31, 1997. If you elect a tax year ending on the Thursday nearest to the end of April, your 1997 tax year will end on May 1, 1997.

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 considered a year of 12 calendar months unless you consistently use another practice.

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:

1. Begin on the first day of the calendar month beginning nearest to the first day of the 52-53 week tax year.
2. 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, 1997. For this purpose, a 52-53 week tax year beginning on June 24, 1997, is treated as beginning on July 1, 1997.

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, as explained earlier under Election, occurs in the same calendar month in which your present tax year ends. You must attach the statement explained in that discussion 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 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, including another 52-53 week 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):

1. Are not in existence for an entire tax year, or
2. 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 short period 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, 1996. It elected the calendar year as its tax year and its first tax return is due March 17, 1997. This short period return will cover the period from July 1, 1996, to December 31, 1996.

Example 2. A calendar year corporation dissolved on July 23, 1997. Its final return is due by October 15, 1997, and it will cover the short period from January 1, 1997, to July 23, 1997.

Example 3. Partnership YZ was formed on September 4, 1996, and elected to use a fiscal year ending November 30. Partnership YZ must file its first tax return by March 17, 1997. It will cover the short period from September 4, 1996, to November 30, 1996.

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, 1997, and her final tax return must be filed by April 15, 1998. It will cover the short period from January 1, 1997, to March 6, 1997.

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 that begins on the first day after the end 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. Then, after one year from the beginning of the short tax year, you may be able to use a relief procedure 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.

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 for 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.

Example. Mike Smith has an adjusted gross income of $28,800 for 1996. His itemized deductions total $6,800 and he can claim exemptions for himself, his wife, and two children. Each exemption is $2,550. Mike's income and itemized deductions are for the 9-month period from January 1 through September 30, 1996. He figures the tax on his joint return for that period as follows.

1. $28,800 - $6,800 = $22,000
2. $2,550 x 4 x 9/12 = $7,650
3. $22,000 - $7,650 = $14,350 (modified taxable income)
4. $14,350 x 12/9 = $19,133 (annualized income)
5. Tax on $19,133 = $2,870 (from 1996 tax rate schedule)
6. $2,870 x 9/12 = $2,152 (tax for short tax year)

Corporations. A corporation figures tax for the short tax year under the general rule described earlier for individuals. 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, 1996. For the short tax year, it had income of $40,000 and no deductions. The corporation's annualized income is $80,000 ($40,000 x 12/6). The tax on $80,000 is $15,450. The tax for the short tax year is $7,725 ($15,450 x 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 less than 359 days. 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.

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 less, it is not a separate tax year. Include it as part of the following year.

Figure the tax for the short tax year as shown previously, except that you prorate items 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 two ways. 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 under the general rule. For more information, see section 443(b)(2).

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(a)(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. For information on the alternative minimum tax for corporations, see Publication 542.

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.

If more than one tax year begins in the same calendar year, the total withheld for the calendar year must be taken as a credit against the tax for the last 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, including a 52-53 week tax year. 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 have adopted an improper tax year. You do not meet the requirements for a calendar or fiscal tax year, including a 52-53 week tax year.

To change to a proper tax year, you must do one of the following.

1. File an amended income tax return based on a calendar 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 both forms with the Internal Revenue Service Center where you filed your original return.

2. Get 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 also include the correct user fee, if any, with Form 1128. User fees are explained at the beginning of the 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 automatic extension. For more information, see the form instructions and Revenue Procedure 99-1, 1991-1 I.R.B. 6 (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.

Net operating loss. If the short period required to effect the change in tax years is a year in which you have a net operating loss (NOL), you must deduct the NOL ratably over a 6-year period starting with the first tax year after the short period unless you meet one of the exceptions discussed later under Corporation. (These exceptions also apply to other taxpayers.) See item 5 in the second list under Automatic approval.

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.

1. 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.
2. 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, 1996. John filed his return for the fiscal year ending June 30, 1996. 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, 1996, for the short period January 1, 1996, through June 30, 1996, 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, 1997.

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, a partnership, S corporation, and personal service corporation must use a "required tax year." It 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 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.

1. 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.
2. 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.
3. 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, the change is considered to be initiated by the partnership with IRS approval. 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.

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 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. Partner A uses the calendar year and Partner 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 x 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 x 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 determined 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. See Section 444 Election and Business Purpose Tax Year, later, for more information about the tax year of an S corporation. For information on S corporations, see the instructions for Form 1120-S.

Personal Service Corporation

A personal service corporation must use a calendar year unless it can establish a business purpose for a different period or it makes a section 444 election, discussed later. For this purpose, a corporation is a personal service corporation if all the following conditions are met.

1. The corporation is a C corporation.
2. The corporation's principal activity during the testing period is the performance of personal services.
3. Employee-owners of the corporation perform a substantial part of the services during the testing period.
4. 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 is 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, 1996, the testing period is A's tax year ending January 31, 1996.

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.

1. The last day of its tax year.
2. The last day of the calendar year in which the tax year begins.

Example. B Corporation's first tax year begins June 1, 1996. 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, 1996, through September 30, 1996. If B wants to use a March 31 fiscal year, the testing period is from June 1, 1996, through December 31, 1996.

Performance of personal services. For this purpose, 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:

1. Is an employee of the corporation on any day of the testing period, and
2. 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 different from 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.

1. It is not a member of a tiered structure (see section 1.444-2T of the regulations).
2. It has not previously had a section 444 election in effect.
3. 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 current 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:

1. Three months, or
2. 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, 1997. 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, 1997, 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 you normally file your return. Form 8716 must be filed by the earlier of:

1. The due date (not including extensions) of the income tax return resulting from the section 444 election, or
2. 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, began operations on September 11, 1996, and is qualified to make a section 444 election to use a September 30 tax year for its tax year beginning September 11, 1996. AB must file Form 8716 by January 15, 1997, which is the due date of the partnership's tax return for the period from September 11, 1996, to September 30, 1996.

Example 2. The facts are the same as Example 1 except that AB began operations on October 21, 1996. AB must file Form 8716 by March 17, 1997, 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, 1996. B qualifies to make a section 444 election to use a September 30 tax year for its tax year beginning September 1, 1996. B must file Form 8716 by December 16, 1996, the due date of the income tax return for the short period from September 1, 1996, to September 30, 1996.

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.

1. Changes its tax year to a required tax year.
2. Liquidates.
3. Willfully fails to comply with the required payments or distributions.
4. Becomes a member of a tiered structure.

The election will also end if:

1. An S corporation's S election is terminated. However, if the S corporation immediately becomes a personal service corporation, it can continue the section 444 election of the S corporation.
2. A personal service corporation ceases to be a personal service corporation. If the personal service corporation elects to be an S corporation, it 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:

1. The section 444 election is in effect.
2. The required payment for that year (or any preceding tax year) is more than $500.

Any tax year a section 444 election is in effect, including the first year, is called an "applicable election year." This payment represents the value of the tax deferral the owners receive by using a tax year different from the required tax year.

Form 8752, Required Payment or Refund Under Section 7519, must be filed each year the section 444 election is in effect, even if no payment is due. If the required payment is more than $500 (or the required payment for any prior year was more than $500), the payment must be made when Form 8752 is filed. If the required payment is $500 or less, and no payment was required in a prior year, Form 8752 must be filed showing a zero amount.

Form 8752 must be filed and the required payment made (or zero amount reported) by May 15 of the calendar year following the calendar year in which the applicable election year begins. For example, if a partnership's applicable election year begins July 1, 1996, Form 8752 must be filed by May 15, 1997.

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.

1. May 15 of the calendar year following the calendar year in which the applicable election year begins.
2. 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. 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 distortion of income.

1. Deferring substantial income or shifting substantial deductions from one year to another to reduce tax liability.
2. Causing a similar deferral or shifting for any other person, such as a partner or shareholder.
3. 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.

1. Using a particular year for regulatory or financial accounting purposes.
2. Using a particular 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.

For examples of situations in which a business purpose is not shown and examples in which a substantial business purpose has been established, see Revenue Ruling 87-57, 1987-2 C.B. 117.

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 as such.

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 deferral of income or another 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, 1987-2 C.B. 396.

25% test. The natural business year is determined by the 25% test using the method of accounting used for the tax returns for each year involved. To figure the 25% test:

1. 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.
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 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 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 normally 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 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. No 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.

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 its tax year.

Change in Tax Year

A corporation (other than an S corporation, a personal service corporation, or an interest-charge domestic international sales corporation (IC-DISC)) 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.

1. 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. However, see Waiver, later, for an exception.
2. Its short tax year must not be a tax year in which it has a net operating loss.
3. 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.
4. 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.
   1. Personal holding company.
   2. Foreign personal holding company.
   3. Exempt organization.
   4. Foreign corporation not engaged in a trade or business within the United States.
5. 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. However, see Waiver, later, for an exception.

Statement. The corporation must file a statement on its behalf 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 be considered a timely application to change the corporation's annual accounting period to the tax year indicated in the statement.

Waiver. The IRS will waive conditions (1) and (5), earlier, and conditions (2) and (3)(c) under Automatic approval, next, for a corporation that:

1. Meets all the other conditions.
2. Elects to be an S corporation for the tax year beginning on January 1, 1997.
3. Completes and timely files Forms 2553 and 1128. It must:
   1. Write "FILED UNDER NOTICE 97-20" at the top of both forms.
   2. Write "Attention: ENTITY CONTROL" on the envelope.
   3. Mail the forms to the Internal Revenue Service Center where it files its return.

A qualified corporation is not required to file the statement discussed earlier.

Automatic approval. Certain corporations can automatically change their tax year. The corporation must meet all the following criteria.

1. It cannot meet the five conditions listed earlier.
2. 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. However, see Waiver, above, for an exception.
3. It is not any of the following:
   1. A member of a partnership.
   2. A beneficiary of a trust or an estate.
   3. An S corporation (and does not attempt to make an S corporation election for the tax year immediately following the short period). However, see Waiver, above, for an exception.
   4. A personal service corporation.
   5. An interest-charge DISC or foreign sales corporation (FSC) or a shareholder in either.
   6. A controlled foreign corporation or foreign personal holding company, or a minority shareholder in either.
   7. A tax-exempt organization, except those exempt under section 521, 526, 527, or 528.
   8. Certain passive foreign investment companies (PFICs) and their shareholders making an election under section 1295.
   9. A cooperative association with a loss in the short period required to effect the tax year change.
   10. A corporation with a section 936 election in effect.

Corporations that qualify and want to change their tax year using this automatic procedure must also comply with the following conditions:

1. 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.
2. The corporation must file a tax return for the short period by the due date, including extensions.
3. 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.
4. 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.
5. 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. It must be deducted ratably over a 6-year period beginning with the first tax year after the short period. However, a short period NOL can be carried back or forward if it:
   1. Is $10,000 or less.
   2. 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.
6. 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 from the short period.
7. If the taxpayer ceases to exist, any remaining short period net operating loss must be taken into account on the final return.

See Revenue Procedure 92-13, 1992-1 C.B. 665, 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. 92-13" at the top of Form 1128.

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 meeting all the conditions, the tax year is considered changed without IRS approval.

If the request is denied, the service center will return Form 1128 with an explanation of the denial. If the request is approved, the service center will return a copy of Form 1128 stamped "Approved." The corporation must attach the approved Form 1128 to its tax return for the short period. It should type or print "FILED UNDER REV. PROC. 92-13" at the top of Form 1128.

Excise Tax Periods

Most federal excise taxes are reported quarterly. The quarters covered, in most cases, are:

Calendar Quarter	Calendar Months
First	January, February, March
Second	April, May, June
Third	July, August, September
Fourth	October, November, December

Information on excise taxes (including due dates for filing and paying the taxes) can be found in Publication 378, Fuel Tax Credits and Refunds, Publication 509, Tax Calendars for 1998, and Publication 510, Excise Taxes for 1998.

Employment Tax Periods

Withheld income tax and social security and Medicare taxes are reported quarterly and federal unemployment taxes are reported yearly. For information on employment taxes, see Publication 15, Circular E, Employer's Tax Guide.

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