A company’s tax year must correspond with its annual accounting period, which is defined as “the period on the basis of which a taxpayer regularly computes its income in keeping its books.” However, taxpayers do have some flexibility in choosing a year-end. Why would a company want to change its year-end? What advantages are there to doing so? When is a company required to change its year-end? How often can it be done? As you might have guessed, the answers to the foregoing questions depend on a company’s specific circumstances. All changes in a company’s year-end must occur for a business purpose; in the discussion which follows, a few of the more common situations are addressed.
Table of Contents
Mandatory Year-Ends
Certain companies are required to adopt a particular year-end. For example, taxpayers who become part of a group which files a consolidated return must adopt the taxable year of the parent corporation. Thus, a company which has been recently acquired by or merged with another may be required to change its year-end.
Companies which elect to be treated under the provisions of subchapter S of the Internal Revenue Code generally must adopt a calendar year end. Personal service corporations are also normally required to utilize a calendar year-end.
8(a) Contractors
An 8(a) contractor (one who is certified as a minority-owned business by the Small Business Administration) may have another important reason for changing its year-end. Based on current regulations governing the calculation of average annual revenue in applying the small business size standards, a contractor may benefit from the inclusion of a “short period” (defined as a period of less than one year) in the computation base. Thus, under certain circumstances, a company may be able to extend its time in the 8(a) program by undertaking a change in year-end which results in a favorable short-period. Obviously, this is a on-time option, and one for which the many peripheral ramifications must be carefully considered.
52-53 Tax-Year
A special type of tax year is the 52-53 week tax year. This is a tax year which ends on the same day of the week within a month instead of the last day of that month (for instance, the last Friday in March instead of March 31). This results in some tax years being 52 weeks long and some being 53 weeks long.
Adoption of a 52-53 week year normally has little effect from a tax standpoint, but can result in substantial business advantages. The most important advantage is that the 52-53 week year gives a solid base for comparative statistical, budgetary, and other business purposes. In a regular year-end calculation, comparison of monthly activity is often misleading because some months will have more weekends than others. However, reporting on the 52-53 week basis breaks the year into four-week blocks which are easily compared with on another. Additionally, if a company’s business is cyclical with much business being conducted on one particular day each week, for instance Friday, comparing regular calendar months may cause skewed data because some months will have four Fridays and some will have five. Using a 52-53 week year stems from a bookkeeping perspective. Using a year-end keyed to a specific day can eliminate many accruals which might otherwise be needed, such as weekly wages.
Finally, for companies with inventory, planning the year-end for a Saturday makes it much easier to conduct the year end inventory count without disrupting normal operations.
Procedures/Approval for Changing Year-End
Once a taxpayer determines that a change in year-end is indicated, it must follow established procedures to effectuate the change. Some changes may be made without prior approval of the IRS, but others must be pre-approved.
For example, changing from a standard to a 52-53 week year does not require prior approval from the Commissioner unless the month in which the taxpayer’s new year will end also changes. For example, changing from March 31 to the last Friday in March does not require prior approval, while changing from March 31 to the last Friday in April does.
A C-Corporation may change its year-end without prior approval if:
- It has not changed its annual accounting period at any time within the preceding 10 calendar years, ending with the calendar year in which the short period which will result from the change begins
- It does not have a net operating loss for the short period
- The taxable income for the short period, if annualized, is at least 80% of the taxable income for the full taxable year immediately preceding the short period
- The corporation files a statement with the District Director of the IRS no later than the time (including extensions) for filing the short period return, indicating that the corporation is changing its annual accounting period and setting forth the information necessary to show that the fist three conditions listed above have been met.
A partnership, S-corporation or personal service corporation which changes from is current year-end to a new required year-end (generally the calendar year) also does not need prior approval.
Most other changes need prior approval from IRS.
Filing a Change in Year-End and Short Periods
The change of year-end is applied for on IRS Form 1128, Application for Change in Accounting Period, which must be filed on or before the 15th day of the second calendar month following the close of the short period resulting from the desired change.
When a taxpayer changes its year-end, it will have to file a separate tax return for the short period resulting from the change in addition to the new year-end period. For instance, if a taxpayer changes from a June year-end to a December year-end, it must file a return for the period July to December in addition to the return it filed for the previous July through June. As a result, a taxpayer will have to file two returns in less than twelve months. Subsequent returns will cover twelve months of activity (or 52-53 weeks, if appropriate).
There are numerous circumstances under which a contractor may wish to change its year-end, and the IRS makes it relatively simple to initiate these changes. However, the IRS does require that whatever year-end a company chooses to adopt be the same as its annual accounting period and that changes needing prior approval have a substantial business purpose. However, within these constraints, companies can use a change in year-end as a powerful planning tool.
Copyright © 1995 Friedman & Fuller, P.C.
