It is common for organizations to use a calendar year, as opposed to a fiscal year, as the tax year calendar for their company. The choice is made easy but its intuitiveness and tends to line up with personal returns—this makes things simple and easy. However, many businesses have dominating operating seasons that don’t always fall within a single calendar year, making the choice of fiscal year weigh out as a better option.
Understanding Right from Left
Calendar years cover the entire 12 consecutive month period, starting January 1 and ending on December 31. Flow-through businesses including partnerships, limited liability companies, and S corporations that use a calendar year must file their returns by March 15. April 15 is generally the deadline for C corporations that use a calendar year.
While a fiscal year still consists of 12 consecutive months, the year does not necessarily have to begin on January 1 and end on December 31. An organization’s fiscal year could run September 1 of the current year through August 30 of the next year. Also, a fiscal year period could be between 52 to 53 weeks. It is important to note that these do not have to end on the last day of a month, but may instead end on the same day each year, such as the last Monday in June.
It’s important to note that flow-through entities that use a fiscal year must have their return filed by the 15th day of the third month following the end of their fiscal year. So that means that if their fiscal year ends on July 31, their return would need to be filed by October 15. C corporations that use a fiscal year calendar must file their return by the 15th day of the fourth month following the fiscal year close. When a company adopts a fiscal year, they also must use the same time period when reporting income and expenses and maintaining their books.
Make the Right Choice for Your Business
When filing its first tax return, the business owner must choose the company’s tax year. Unfortunately, a tax year cannot be adopted by simply submitting an application for an employer identification number, paying estimated taxes, or filing for an extension.
Although many businesses have the option to choose between a calendar and fiscal year, the IRS requires some to adopt the calendar year for their taxes. A company must use a calendar year if they do not keep books and have no annual accounting period. It is also required of most sole proprietorships to use a calendar year. In the eyes of the IRS, sole proprietorships lack distinct identities apart from their proprietors, who as individuals generally file their returns using a calendar year.
Unless approved by the IRS, any individual who files their first tax return using a calendar year and then later becomes a partner in a partnership, sole proprietor, or shareholder in an S corporation must continue to use a calendar year. However, it may become necessary to gain approval in instances that involve the majority of partners using a fiscal year.
When Fiscal Years Can be Beneficial
Although following a calendar year is often simpler and more common among businesses, a fiscal year can show a more accurate picture of how a company is performing. Fiscal years tend to be more common for seasonal businesses. For instance, many niche companies make the bulk of their revenue between a short set of seasonal months. If their revenue splits between two different months in order to adhere to a calendar year, it would become difficult to develop a reliable picture of the company’s performance during their peak season.
Companies must also consider the tax year that other businesses in their industry are using. If the majority of companies within an industry use a fiscal year end, a new company may want to consider using the same fiscal year as a means to accurately compare its performance to the performance of its peers.
The Upside to Shortened Tax Years
As you may expect, a shortened tax year is one with fewer than 12 months. Cases like these come about when a business gains approval to switch its tax year or begins its operations midyear.
The business will still need to file a return for the period, regardless of the reason behind the shortened tax year. However, the method varies in which the tax is calculated. Imagine that a business is set to begin its operations on May 1, but have opted to use a calendar year. Their first tax return will only cover the period from their first day of operations, May 1, through the end of the year, December 31.
Now, if the shortened tax year is a result of the company changing the type of tax year that it initially adopted, its income tax will then reflect its annualized income and expenses. The company may be able to reduce its tax bill with have the option to utilize a type of relief procedure found in Section 443(b)(2) of the Internal Revenue Code.
See the Difference
If a company chooses to change their legal structure or their method of operations, it may make sense for them to consider changing its tax year as well. If the decision comes down to changing their tax year, they will need to apply and obtain permission from the IRS by submitting Form 1128, “Application to Adopt, Change or Retain a Tax Year.”
Although the idea of choosing a tax year may seem like an administrative matter, it can have a significant impact on how and when your company pays its taxes. If it’s time to decide a tax year for your business, or you are considered changing your current tax year, your CRI tax advisor is ready to help you build out a plan that makes the most sense for you and your business.