The business figures its taxable income and files a tax return on the basis of an accounting period called a tax year.
A tax year usually is 12 consecutive months, although in some cases a 52-53 week year or a short tax year may be permitted.
A calendar tax year is 12 consecutive months ending December 31.
A fiscal tax year is either 12 consecutive months ending on the last day of any month other than December, or a 52-53 week year.
To use a fiscal tax year, the business must keep its books on that basis.
Once a tax year is established, the business generally may not change it without Internal Revenue Service approval. The application to change the tax year must show a substantial business purpose for the change, and that no significant tax advantage will result.
Like most individual taxpayers, sole proprietors generally use the calendar year as their federal and Minnesota tax year. The sole proprietor must report income from all sources on the basis of the same tax year.
In general, the partnership must use the same tax year as the partners who own a majority interest in partnership profits and capital. If those partners have different tax years, the partnership must use the same tax year as its principal partners.
Principal partners are defined by the Internal Revenue Service as those having an interest of five percent or more in partnership profits or capital. If the principal partners have different tax years, the partnership generally must use the calendar tax year.
However, a partnership may adopt a fiscal tax year if it can establish to the satisfaction of the Internal Revenue Service that it has a business purpose for using a fiscal tax year.
If a business purpose for using a fiscal tax year cannot be shown, a partnership that would otherwise be required to use a calendar tax year may in some cases elect a fiscal tax year by filing with the IRS Form 8716, Election to Have a Tax Year Other than a Required Tax Year. This election is called a “Section 444 election.”
A partnership that makes the Section 444 election must in some cases make a payment to the government that reflects the value of the tax deferral obtained by the partners as a result of the partnership’s use of a fiscal tax year. A partnership uses the same tax year for both federal and Minnesota income tax purposes.
A C corporation establishes its tax year when it files its first income tax return.
The first tax year must end not more than 12 months after the date of incorporation.
A C corporation that is not a personal service corporation may choose a calendar tax year or a fiscal tax year, so long as the tax year selected does not distort income. This allows the corporation to establish a tax year in conformity with its natural business cycle.
C corporations that are personal service corporations must use a calendar tax year unless the corporation establishes to the satisfaction of the IRS that it has a business purpose for using a fiscal tax year, or makes a Section 444 election.
If the S corporation cannot establish a business purpose for using a fiscal tax year, it may be eligible to make the Section 444 election described above.
The corporation uses the same tax year for both federal and Minnesota tax purposes.
CREDITS: This is an excerpt from A Guide to Starting a Business in Minnesota, provided by the Minnesota Department of Employment and Economic Development, Small Business Assistance Office, Twenty-eighth Edition, January 2010, written by Charles A. Schaffer, Madeline Harris, and Mark Simmer. Copies are available without charge from the Minnesota Department of Employment and Economic Development, Small Business Assistance Office.
This is also part of a series of articles on How to Pick the Right Business Entity Type. These articles help you select the right business type for your circumstances.