Matter & Substance
  November 13, 2018

Choosing between a calendar year and a fiscal year

Many 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. Not all businesses are able to fit their primary operating seasons neatly into a calendar year, however. For these situations, choosing a fiscal year end may make more sense. 

The ins and outs

As you would expect, a calendar year begins January 1 and ends December 31. Flow-through entities, including S corporations, LLC's, and partnerships, using a calendar year generally are required to file their tax returns by March 15. The deadline for C corporations operating under a calendar year is generally April 15. 

A fiscal year, while still consisting of twelve consecutive months, doesn't necessarily begin on January 1 and end on December 31. For example, July 1 of the current year through June 30 of the following year qualifies under this definition. A fiscal year can also include periods of 52 or 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.

Flow-through entities using a fiscal year 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 generally must file their return by the 15th day of the fourth month following the fiscal year close. Companies that adopt a fiscal year also must use the same time period in maintaining their books and reporting income and expenses.

Determining which tax year is better

A business owner chooses the company's tax year when filing its 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, it is required for some businesses by the IRS. For example, 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 from their proprietors, who as individually typically use a calendar year when filing their returns.

Individuals who file their first 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 approval from the IRS to change it. Gaining such approval might be necessary if, for instance, the majority of the partners use a fiscal year.

When a fiscal year makes sense

While not as simple or as common as a calendar year end, a fiscal year can provide a more accurate picture of a company's performance. This is often the case with seasonable 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 may find benchmarking its performance to the performance of its peers more accurate if it's using the same fiscal year.

Short tax years

A short tax year is, just as its name indicates, a year with fewer than 12 months. This is usually the result of a business either beginning operations midyear or switching 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 (or midyear) but is using a calendar year. It's first tax return will cover the period from May 1 through December 31.

If the short tax year results from a change in the company's 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 reduce its tax bill.

It can make a difference

Companies that change their legal structure or operations may find it makes sense to also change their tax year. When this is the case, they need to obtain permission 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. Let us help you determine whether a calendar or a fiscal year makes more sense for your business.