DP Tool Club 12/CD_ASCQ_12_0294.iso/vrac/sba93_4b.zip/F307.SBE

Text File | 1993-10-01 | 14KB | 388 lines

@Q01

 CAN MY BUSINESS ADOPT A FISCAL YEAR FOR INCOME TAX PURPOSES?

Selection of a fiscal tax year (as opposed to the calendar
year) as your business's accounting period can provide consid-
erable tax planning benefits, including increased flexibility.
Not surprisingly, the tax law puts quite a few restrictions
on your ability to adopt, or switch to, a fiscal tax year.
This is particularly true in the case of partnerships, S corp-
orations, and C corporations that are "Personal Service Corp-
orations."  (If you are not sure whether your corporation is
a "Personal Service Corporation," exit now and first go
through the question and answer session on PSC's--Item #3
on the XPERT consulting menu.)

QUESTION: What type legal entity is your business set up as?

 (1) Sole proprietorship  (2) Partnership   (3) S corporation
 (4) C corporation that is a "personal service corporation"
 (5) C corporation (not a "personal service corporation")
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@Q02

CONCLUSION:  As a sole proprietorship, you do not have a
whole lot of leeway in selecting an accounting period for
tax purposes.  Very few sole proprietors (that is, individ-
uals) have fiscal tax years.  Unless you are one of the rare
breed who already have been properly filing your individual
tax returns on a fiscal year basis, you generally will be
required to use the calendar year, ending December 31st, as
your accounting period for income tax purposes.

The rule for individuals is that, no matter how many busi-
nesses a taxpayer conducts, he or she may use only one and
the same taxable year for all of them.  This also means
that a sole proprietor must use the same tax year for bus-
iness income (on a Schedule C, for example) as for personal
income and deductions.

A salaried individual who has been filing on a calendar year
basis, who goes into business for himself, may not change to
a fiscal year without getting IRS approval, which can only
be obtained by showing a very good business reason why a
fiscal year should be allowed.  The IRS will rarely approve
such a change to a fiscal year, so, as a practical matter,
don't expect to be able to use a fiscal year for your sole
proprietorship.  (In any event, the tax planning benefits of
having a fiscal tax year for your business usually come from
having a separate taxable entity, such as a partnership or
corporation, that has a fiscal year that DIFFERS from your
personal calendar year tax period, thus allowing opportuni-
ties for tax planning games and manipulations.  That isn't
possible for a sole proprietorship, which is not a separate
taxable entity, since the only entity is YOU, the individual
taxpayer, so there is seldom any great tax benefit to be de-
rived from your having a fiscal tax year.)

@STOP

@Q03

"NEW" TAXPAYERS:  A "new" taxpayer is a person or entity
that is just becoming subject to any internal revenue tax.
This does not necessarily mean a new business, since an old,
existing business that has just become a partnership or just
been incorporated, for example, will be a "new" taxpayer in
its first year as a new entity.

Ordinarily, a new taxpayer has somewhat more flexibility in
choosing a taxable year than an existing entity.  However,
a partnership, S corporation or personal service corporation
("PSC") is considerably restricted as to its choice of
tax year, except when it applies to the IRS for permission
to select a particular taxable year-end for persuasive busi-
ness purposes. The IRS is not often persuaded, unfortunately.

  QUESTION:  Is your partnership or corporation a "new"
             taxpayer at the present time?

@YN
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@Q04

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@Q05

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@Q06

CONCLUSIONS:  As a newly-formed partnership, your business
is quite limited in its choice of taxable year, unless you
can establish to the IRS's satisfaction that you have good
business reasons for adopting a year-end other than as des-
cribed below.

However, a partnership may make a "Section 444" election,
which will allow it to have a fiscal year (ending only in
September, October, or November, generally), provided that
the partnership agrees to make tax prepayments that negate
any tax deferral benefits the partners would otherwise de-
rive from their having a taxable year different than that
of the partnership.  The required payments, which can be
quite complex to calculate, are due on April 15th each year.

Otherwise, as a general rule, your partnership will have to
adopt as its taxable year a period that coincides with the
taxable year of a majority in interest (over 50%) of its
partners.  If that is not possible, it must select one of
the following as its taxable year, attaching a statement to
the first tax return (Form 1065) justifying the taxable
year used:

  . A year that is the same as that of ALL of its
    "principal partners" (partners who have at least
    a 5% interest in profits or capital of the part-
    nership); or, if they do not all have the same
    taxable year,

  . The calendar year, and a statement showing that
    all the principal partners are not on the same
    taxable year.  (Unless IRS regulations call for
    a different taxable year in your situation.)

In all other cases, you must attach a copy of the IRS's let-
ter approving the partnership's request to use the particu-
lar year-end that is being adopted.

@STOP

@Q07

CONCLUSION:  In general, a partnership that already has adop-
ted a tax year for prior tax returns cannot now change to a
different year without obtaining IRS approval, which usually
requires a showing of some important business purpose.  Such
a change ordinarily WILL NOT be approved if it would result
in any of the following:

  . A deferral of income or a shifting of deductions to ano-
    ther year that will reduce tax liability (for a partner
    or partners); or

  . A net operating loss in the short taxable year that re-
    sults from the change in year-end (except in certain
    circumstances).

@GOTO\Q12

@Q08

CONCLUSIONS:  As a newly-formed S corporation, your business
is quite limited in its choice of taxable year.  In general,
unless you can establish to the IRS's satisfaction that you
have good business reasons for adopting a fiscal year, your
S corporation will have to adopt a December 31st year-end.

However, an S corporation may make a "Section 444" election,
which allows it to have a fiscal year (ending only in
September, October, or November, generally), provided that
the corporation agrees to make tax prepayments that negate
any tax deferral benefits the shareholders would otherwise
receive from its having a taxable year different than theirs.
These required payments, which can be quite complex to cal-
culate, are due on April 15th each year.

@STOP

@Q09

CONCLUSION:  In general, an S corporation that already has
adopted a tax year for prior tax returns cannot now change
to a different year without obtaining IRS approval, which
usually requires a showing of some important business pur-
pose.  Such a change ordinarily WILL NOT be approved if it
would result in any of the following:

  . A deferral of a portion of the corporation's income,
    or a shifting of a portion of its deductions to ano-
    ther taxable year in a way that will reduce its tax
    liability; or

  . A deferral or a shifting of either income or deduc-
    tions of another taxpayer, such as a shareholder, in
    a way that would substantially reduce the sharehol-
    der's tax liability; or

  . A net operating loss in the short taxable year that
    results from the change in year-end (except in cer-
    tain circumstances).

@GOTO\Q12

@Q10

CONCLUSIONS:  As a newly-formed personal service corporation
("PSC"), your business is quite limited in its choice of
taxable year.  Unless you can establish to the IRS's satis-
faction that you have good business reasons for adopting a
fiscal year, your PSC will generally have to adopt a
December 31st year-end.

However, a PSC may make a "Section 444" election, which al-
lows it to have a fiscal year (ending only in September,
October, or November, generally), provided that the corpor-
ation agrees not to claim a full deduction for certain other-
wise deductible payments to its shareholders during each
tax year, unless it meets certain "minimum distribution re-
quirements" for payments of compensation, rent, etc. to its
shareholders during the year.  In effect, if you delay much
of your annual compensation from the corporation until after
January 1, on a disproportionate basis, in order to obtain
a tax deferral, the corporation will not be able to deduct
those payments to you during its current tax year, under a
complex formula.

@STOP

@Q11

CONCLUSION:  In general, a personal service corporation
("PSC") that already has adopted a tax year for prior tax
returns cannot now change to a different year without obtain-
ing IRS approval, which usually requires a showing of some
important business purpose.  Such a change ordinarily WILL
NOT be approved if it would result in any of the following:

  . A deferral of a portion of the corporation's income,
    or a shifting of a portion of its deductions to ano-
    ther taxable year in a way that will reduce its tax
    liability; or

  . A deferral or a shifting of either income or deduc-
    tions of another taxpayer, such as a shareholder, in
    a way that would substantially reduce the sharehol-
    der's tax liability; or

  . A net operating loss in the short taxable year that
    results from the change in year-end (except in cer-
    tain circumstances).

@GOTO\Q12

@Q12
One business reason that may be considered an acceptable
basis for a change in taxable year is a shift to a "natural
business year."  Reasons that usually ARE NOT acceptable to
the IRS include:

   . use of a particular fiscal year for regulatory or
     for financial accounting purposes;

   . the fact that your company usually hires staff at
     a certain time of the year;

   . use of a particular year for internal administrat-
     ive purposes, such as promotions, admitting or
     retiring owners, or setting compensation levels;

   . convenience of the taxpayer (or its accountants);
     or

   . the fact that the business involves use of price
     lists or model years that change on an annual basis
     at a particular time.

@STOP

@Q13

CONCLUSION:  A newly-formed C corporation (which is not a
personal services corporation) is ordinarily free to choose
whatever year-end it desires, without IRS approval.  All
that is necessary is to file a first corporate tax return
(Form 1120) within two months and fifteen days after the
end of the fiscal year you wish to choose, indicating what
taxable year you have selected.

Often, it is useful to select a January 31st fiscal year.
In this way, if the corporation pays substantial bonuses to
you or other of its employees at year-end, these can be de-
layed until the month of January, so that they are deducti-
ble (for example) for the corporation's fiscal year ended
January 31, 1994, which spans the period from February 1,
1993 to January 31, 1994, but won't be included in employ-
ees' taxable income until calendar year 1994, providing an
11-month tax deferral, in effect.

But be careful about paying too much of annual compensation
to owner-employees as bonuses:  The IRS may take the posi-
tion that such payments are really more like dividends than
compensation, and thus not deductible by the corporation!

@STOP

@Q14

CONCLUSION:  An existing C corporation (which isn't a per-
sonal service corporation) may generally change its taxable
year without IRS permission, if it has not changed its year-
end before in the last ten years.  To do so, however, it
must meet certain specific requirements for obtaining auto-
matic approval from the IRS.  To obtain such automatic ap-
proval, it must file certain information with the IRS on a
timely basis, and state that it meets the following require-
ments that are necessary for such automatic approval of the
change:

  . It hasn't changed its taxable year in the last 10
    calendar years.

  . The short taxable year resulting from the change is
    not one in which it has a net operating loss.

  . Its annualized taxable income for the short year is
    80% or more of the income for the preceding year.

  . If it has certain types of "special status" (such as
    being a foreign personal holding company, etc.) for
    either the short period or the preceding tax year,
    it must have such status for both such periods.

  . It must not try to become an S corporation for the
    taxable year that would immediately follow the short
    year that results from the change of year-end.

Remember that this right to automatic approval of a change
in taxable year applies only to certain C corporations, ot-
her than PSCs, and does not apply to S corporations or un-
incorporated taxpayers.

@STOP

@HELP

@H\01

A "C corporation" is  a technical term,
but, fortunately,  is a relatively easy
one to understand.  A C corporation is,
quite  simply,  any corporation  (other
than a  not-for-profit  one) OTHER THAN
an "S corporation" (formerly known as a
Subchapter S corporation). Thus if your
business is incorporated,  unless it is
a corporation that has made an election
to be taxed as an S corporation,  it is
considered to be a "C corporation."

@H\02

The IRS is very unlikely to grant a re-
quest for a change of taxable year to a
fiscal year by  an individual taxpayer,
if it appears that  any tax deferral is
likely  to result  (which would  be the
main reason you would want to change to
a fiscal year).

@H\03

In other words,  is your business entity
one that has not yet filed its first tax
return,  and thus has not yet elected an
accounting period....

@H\14

Corporations that are DISCs, or that are
partners in  a partnership,  or that are
controlled foreign corporations, or that
have made certain  elections relating to
"possessions tax credits" are  not elig-
ible to  change their  accounting period
under the automatic approval procedures.

@END