Cream of the Crop 1/Cream of the Crop 1.iso/BUSINESS/SBA62.ARJ/FSBA.EXE/F307.SBE

Text File | 1992-04-30 | 15KB | 354 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 considerable 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 part-
nerships, S corporations, and C corporations that are "Personal Service
Corporations."  (If you are not sure whether your corporation is a
"Personal Service Corporation," exit now and go thru the question and
answer session on PSC's first--Item #3 on the XPERT consulting menu.)

  QUESTION:  What type of 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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02\Q03
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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, individuals) 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 businesses 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 business income (on a Schedule C, for ex-
ample) 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 opportunities for tax planning games and manipu-
lations.  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 derived 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 necessari-
ly 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 cor-
poration or personal service corporation ("PSC") is considerably res-
tricted 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
business 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

@BR\04

@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 described 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 derive 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 pos-
sible, it must select one of the following as its taxable year, at-
taching 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 part-
    ners" (partners who have at least a 5% interest in profits or
    capital of the partnership); 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 letter
approving the partnership's request to use the particular year-end
that is being adopted.

@STOP

@Q07

CONCLUSION:  In general, a partnership 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 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 another year
    that will reduce tax liability (for a partner or partners); or

  . A net operating loss in the short taxable year that results
    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 calcu-
late, 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 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 shift-
    ing of a portion of its deductions to another taxable year in a
    way that will reduce its tax liability; or

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

  . A net operating loss in the short taxable year that results
    from the change in year-end (except in certain 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 satisfaction that you have good busi-
ness 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 allows it to
have a fiscal year (ending only in September, October, or November,
generally), provided that the corporation agrees not to claim a full
deduction for certain otherwise deductible payments to its shareholders
during each tax year, unless it meets certain "minimum distribution
requirements" for payments of compensation, rent, etc. to its share-
holders during the year.  In effect, if you delay much of your annual
compensation from the corporation until after January 1, on a dispro-
portionate 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 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 a portion of the corporation's income, or a shift-
    ing of a portion of its deductions to another taxable year in a
    way that will reduce its tax liability; or

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

  . A net operating loss in the short taxable year that results
    from the change in year-end (except in certain 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 administrative 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 em-
ployees at year-end, these can be delayed until the month of January,
so that they are deductible (for example) for the corporation's fiscal
year ended January 31, 1993, which spans the period from February 1,
1992 to January 31, 1993, but won't be included in employees' taxable
income until calendar year 1993, 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 position that such payments
are really more like dividends than compensation, and thus not deduct-
ible by the corporation!

@STOP

@Q14

CONCLUSION:  An existing C corporation (which isn't a personal service
corporation) may generally change its taxable year without IRS per-
mission, 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 automatic approval from the IRS.  To obtain such automat-
ic approval, it must file certain information with the IRS on a timely
basis, and state that it meets the following requirements that are ne-
cessary 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, other than PSCs, and does
not apply to S corporations or unincorporated 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