Choosing Between a Calendar Year and a Fiscal Year
Most business owners use a calendar year as their company’s tax year. It’s intuitive and aligns with most owners’ personal returns, making it about as simple as anything involving taxes can be. But for businesses whose seasonal operations do not fall neatly within a single calendar year, choosing a fiscal year end can make more sense.
The Ins and Outs
A calendar year, as you would expect, covers 12 consecutive months, beginning January 1 and ending December 31. Under tax law changes going into effect with returns due in 2017, flow-through businesses (such as partnerships, limited liability companies and S corporations) using a calendar year must file their tax returns by March 15. (The deadline for calendar-year C corporations is moving to April 15, starting with the 2016 tax year.)
A fiscal year consists of 12 consecutive months that don’t begin on January 1 or end on December 31 — for example, July 1 through June 30 of the following year. A fiscal year also can include periods of 52 to 53 weeks. These might not end on the last day of a month, but instead might end on the same day each year, such as the last Friday in March.
Under the new tax law, flow-through entities using a fiscal year now file their return by the 15th day of the third month following the close of their fiscal year. So, if their fiscal year ends on March 31, they would need to file their return by June 15. (Fiscal-year C corporations now generally must file their return by the 15th day of the fourth month following the fiscal year close.) Companies that adopt a fiscal year must also use the same time period in maintaining their books and reporting income and expenses.
Determining Which Tax Year is Best
A business owner chooses the company’s tax year when filing its initial tax return. Simply paying estimated taxes, filing for an extension or submitting an application for an employer identification number won’t count as having adopted a tax year.
Although just about any business can choose to use a calendar year as its tax year, the IRS requires some businesses to do so. Businesses that don’t keep books and have no annual accounting period must use a calendar year. Most sole proprietorships are also required to use a calendar year. To the IRS, sole proprietorships lack distinct identities apart from their proprietors, who as individuals typically use a calendar year when filing their returns.
Individuals who file their initial tax return using a calendar year and later become sole proprietors, partners in a partnership, or shareholders in an S corporation, generally must continue to use a calendar year, unless they receive authorization from the IRS to change it. Gaining such authorization might be necessary if, for instance, the majority of partners use a fiscal year.
When a Fiscal Year Makes Sense
While a calendar year end is simple and more common, a fiscal year can present a more precise picture of a company’s performance. This often is the case with seasonal businesses. For example, many snowplowing companies make the bulk of their revenue between November and March. Splitting the revenue between December and January to adhere to a calendar year end would make obtaining a solid picture of the company’s performance over a single season difficult.
In addition, if many businesses within an industry use a fiscal year end, a company that wants to compare its performance to its peers probably will achieve a more accurate assessment if it’s also using the same fiscal year.
It Can Make a Difference
Companies that change their legal structure or operations may find it makes sense to also change their tax year. They’ll need to obtain approval from the IRS and submit Form 1128, “Application to Adopt, Change or Retain a Tax Year.”
Although choosing a tax year may seem like a minor administrative matter, it can have an impact on how and when a company pays taxes. Your accounting expert can help you determine whether a calendar or fiscal year makes more sense for your business.
Sidebar: Short Tax Years
A short tax year is, just as its name indicates, a year with fewer than 12 months. A business might end up with a short tax year when it begins operations midyear or changes its tax year.
In either case, the business still needs to file a tax return for this period. But, the way the tax is calculated varies. Suppose a business begins operations on May 1 — in other words, midyear — but is using a calendar year, its initial tax return will cover the period from May 1 through December 31.
If the short tax year is a result of the fact that the company is changing its tax year, its income tax typically will be based on its annualized income and expenses. But, the company might be able to use a relief procedure, described in Section 443(b)(2) of the Internal Revenue Code, to decrease its tax bill.
Join Our Newsletter
Sign up to receive exclusive newsletters with the latest information affecting you and your organization.
SHARE THIS POST