U.S. Income Series
Income Tax Accounting
	 Portfolio 574-1st: Accounting Periods
Accounting Periods
by Anthony P. Polito, Esq. 
Suffolk University Law School
Boston, Massachusetts

Special Consultant to Tax Management
PORTFOLIO DESCRIPTION
Tax Management Portfolio, Accounting Periods, No. 574, discusses the tax considerations involved when a taxpayer seeks to adopt or change to a particular taxable year. The basic framework for selecting and changing taxable years is established by §§441, 442, and 443 of the Internal Revenue Code, and the regulations issued thereunder. Beginning with the Tax Reform Act of 1986 and continuing in subsequent legislation, Congress adopted or substantially rewrote a number of Internal Revenue Code provisions restricting the taxable years available to many taxpayers.
These provisions are designed to stop perceived abusive discrepancies between entity taxable years and their owners' taxable years. Among the entities subject to the restrictions are personal service corporations, S corporations, partnerships, controlled foreign corporations, and, for taxable years of foreign corporations beginning prior to January 1, 2005, foreign personal holding companies. Partnerships, S corporations, and personal service corporations may elect under §444 to have taxable years other than their required taxable years. To obtain this relief, partnerships and S corporations must make required payments under §7519, and personal service corporations must subject themselves to certain minimum distribution requirements under §280H.
This Portfolio discusses the pertinent Code and regulation provisions that set forth the rules regarding the choice and utilization of taxable years, and analyzes the tax effects of: (1) having a taxable year, (2) the first and last taxable years of an entity, (3) the adoption, retention, or change of taxable years, and (4) short period returns.
This Portfolio may be cited as Polito, 574 T.M., Accounting Periods.
Anthony P. Polito (S.B., Economics, Massachusetts Institute of Technology, 1986; J.D., Harvard University, 1989; LL.M., New York University, 1995) is Assistant Professor of Law and Tax Law Concentration Coordinator at Suffolk University Law School.
The author wishes to thank Craig Donais, for his proofreading and cite checking assistance, and Joan Comer, for her word processing assistance.

DETAILED ANALYSIS
I. Introduction
Liability for federal income tax is determinable only with reference to a taxable year. Under §63(a),1 taxable income is an accumulation or aggregation requiring a time element for its determination. Therefore, the Code provides that taxable income must be computed on the basis of the taxpayer's taxable year.2 Determination of the proper taxable year is essential to ascertaining the appropriate tax rates, the applicability of new legislation, and the timing for the payment of tax.
1Unless otherwise indicated, all section references are to the Internal Revenue Code (the Code) and the regulations promulgated thereunder.
2§ 441(a).
The determination of a taxpayer's taxable year and the ability to change taxable years becomes more important as tax laws change. New legislation that results in tax consequences that vary with taxpayers' different taxable years promotes attention to the initial choice of a taxable year or the appropriateness of changing an existing taxable year. In many situations, the desire to change a taxable year may become quite compelling when the potential benefits of such a change are closely examined. Tax planning surrounding the selection of a taxable year can therefore become extremely important.
The basic framework for selecting and changing taxable years is established by §441, §442, §443, and their regulations. Starting with the Tax Reform Act of 1986, however, Congress adopted or substantially rewrote a number of Code provisions restricting the taxable years available to many taxpayers. These provisions were designed to stop perceived abusive discrepancies between entity taxable years and their owners' taxable years. Among the entities subject to these restrictions are personal service corporations, S corporations, partnerships, controlled foreign corporations, and, for taxable years of foreign corporations beginning prior to January 1, 2005, foreign personal holding companies.
Partnerships, S corporations, and personal service corporations may elect under §444 to have taxable years other than their required taxable years. To obtain this relief, partnerships and S corporations must make required payments under §7519, and personal service corporations must subject themselves to certain minimum distribution requirements under §280H. These rules are discussed in further detail in III, below.
This portfolio divides the subject of taxable years into seven general areas:
basic definitions relating to taxable years, restrictions on the taxable years available to numerous taxpayers, 52-53-week taxable years, the selection of an initial taxable year, the procedures for changing an existing taxable year, rules governing short taxable years, and rules governing a taxpayer's final taxable year. Within these areas, this portfolio addresses these topics with respect to individuals, corporations, partnerships, and various other special entities.
II. Taxable Year Defined
The term "taxable year" means the calendar year, the fiscal year, or fractional part of a year upon the basis of which taxable income is computed.3 A cash basis taxpayer generally includes items of gain, profit, or income in gross income in the taxable year in which they are actually or constructively received.4 Such a taxpayer deducts expenditures in the taxable year in which they are actually made.5 An accrual basis taxpayer generally includes items of gross income and deducts items of loss or expense in the taxable year in which they become fixed and determinable.6 There are, however, a number of exceptions to these general rules. These include: (1) depreciation; (2) gain or loss from long-term construction contracts with respect to which taxpayers have adopted the completed-contract method of accounting; (3) income from debt instruments that are subject to the original issue discount and market discount rules; and (4) other items subject to specific accounting methods other than accrual accounting or cash accounting (such as installment sales).
3§ 7701(a)(23).
4Regs. § 1.451-1(a).
5Regs. § 1.446-1(c)(1)(i).
6Regs. § 1.446-1(c)(1)(ii).
A. The Taxable Year May Be Less (But Not More) Than 12 Calendar Months
Taxable income is generally computed for taxable years of 12 full calendar months each. A taxable year may not exceed 12 calendar months except in the case of a 52-53-week taxable year.7 Occasionally, the Code or regulations require or permit a taxpayer to compute its taxable income and file a return for a fractional part of a year.8 Such a fractional period is usually referred to as a short taxable year. (See VII, below.)
7See Regs. §§1.441-1(a)(2),  (b)(1), - 2(a).
8See, e.g., §§708(b) and 1362(d) and  (e).
A taxpayer's first and final taxable periods will be short taxable years unless its formation and termination happen to correspond with the first and last days respectively of full 12 month taxable years.9
9§ 443(a)(2).
Example: A corporation is incorporated on December 15, 1996 and adopts the calendar year as its taxable year. A short taxable year exists from December 15, 1996, to December 31, 1996.
A taxpayer also makes a return for a short taxable year if it changes its annual accounting period.10 Short taxable years may also result from automatic terminations of partnership taxable years,11 or from the entry or exit of a corporation from an affiliated group filing consolidated returns.12 A 52-53-week taxable year is a special case and will often be less than 12 calendar months (see IV, below). In those years, however, the taxable year is not regarded as a short taxable year.
10§ 443(a)(1).
11See §§708(b)(1) and 706(c).
12See Regs. § 1.1502-76(b)(2).
B. The Taxpayer's Annual Accounting Period as the Taxable Year
In general, a taxpayer's taxable year is the annual accounting period (as defined below) that it uses to keep its books, which may be a calendar year or a fiscal year.13 A taxpayer that has no annual accounting period or keeps no books must use the calendar year as its taxable year.14 For this reason, most individual taxpayers must use the calendar year as their taxable year. See III, H, below. Likewise, a taxpayer must use the calendar year as its taxable year if its annual accounting period does not qualify as a fiscal year.15
13§ 441(b)(1), &  (c); Regs. §1.441-1. See Brown v. U.S., 1968-2 USTC Para.9657 (M.D. Fla. 1968) (corporation keeping calendar year basis books could not adopt a fiscal year as its taxable year, and as a consequence its S corporation election was untimely).
14§ 441(g). See, e.g., Calhoun v. U.S., 370 F. Supp 434 (W.D. Va. 1973) (corporation's failure to keep books until almost eleven months after its first taxable year began disqualified it from adopting a fiscal year); MacLean v. Comr., 73 T.C. 1045 (1980) (resident alien's failure to maintain books and records precluded adoption of a fiscal year for tax purposes).
15§ 441(g)(3).
1.	Definition of "Annual Accounting Period"
A taxpayer's annual accounting period is the period on the basis of which the taxpayer regularly computes its income in keeping its books.16 Many corporations and other business entities are obliged to maintain adequate books of account to comply with laws mandating financial disclosure and reporting. The required annual accounting period is usually adopted as a by-law provision, or other express action of stockholders, directors, managers, or others exercising the power to control the business entity. Note that the annual accounting period is the period on the basis of which books are actually kept. A corporation that customarily closed out its books on December 31, to satisfy Interstate Commerce Commission rules, had a calendar year accounting period, even though it adopted a by-law provision calling for both a fiscal year ending November 30 and annual audits on the same basis.17 Nevertheless, the IRS interprets §441(c) to require that a taxpayer's year-end for book purposes be the same as its year-end for financial statements and reports for credit purposes.18
16§ 441(c). The Code and regulations do not address the issue of whether entries reconciling a financial accounting year to a taxable year are included in the definition of "books" that a taxpayer must keep on the basis of its annual accounting period. Compare TAM 8038024 (taxpayer changing its taxable year to a November 30 year-end could continue keeping its books on the prior fiscal year ending October 31, so long as "the taxpayer has reconciled its books and records to the new taxable year. . . .") with TAM 8123011 (Schedule M adjustment reconciling a corporation's annual accounting period to that of its parent does not satisfy the requirement of Regs. § 1.1502-76(a)(1) that a corporation joining a consolidated return adopt the common parent's annual accounting period). But see Regs. §1.441-1(b)(7) (books include taxpayer's regular books and records and data supporting entries on taxpayer's books and tax returns allowing reconciliation of differences between taxpayer's books and tax return).
17Atlas Oil and Refining Corp. v. Comr., 17 T.C. 733 (1951), acq., 1952-1 C.B. 1; see also Dougherty v. Comr., 60 T.C. 917 (1973); Brooklyn City R.R. Co. v. Comr., 27 B.T.A. 77 (1932), acq., 1958-2 C.B. 4, aff'd, 72 F.2d 274 (2d Cir. 1934).
18See, e.g., Rev. Proc. 2002-37, 2002-22 I.R.B. 1030, §6.05; Notice 2002-72, 2002-46 I.R.B. 843.
In general, businesses have no difficulty demonstrating the accounting periods in accord with which they keep their books. Individuals and many closely held businesses, however, are not required to maintain adequate books or records under any applicable law. Therefore, the question becomes what records are sufficient to constitute the keeping of books in accordance with an annual accounting period. In practice, the records that demonstrate the keeping of books will also often establish the taxpayer's annual accounting period.
2.	"Keeping of Books"
Records constitute the keeping of books if they are sufficient to reflect income adequately and clearly on the basis of an annual accounting period.19 Books consisting of a journal and a general ledger, which classify and summarize information obtained from receipts of payment and written memoranda, are adequate for a cash basis taxpayer.20 The former temporary regulations specifically stated that records did not have to be bound to be considered books; this specific reference is not in the current regulations.21 Nevertheless, informal records, such as rent receipts, bank statements, notations on check stubs, or dividend statements, do not constitute the keeping of books,22 even if those records are reorganized after the end of the fiscal year into a formal accounting system covering the fiscal year.23
19Regs. §1.441-1(b)(7).
20Godson v. Comr., 5 T.C.M. 648 (1946). See also Gill v. U.S., 258 F.2d 553 (5th Cir. 1958) (separate folders for each calendar year containing all supporting documents for a taxpayer's returns were sufficient to satisfy the keeping of books requirement).
21Regs. §1.441-1(b)(7) (clarifying the meaning of requirement for fiscal year taxpayers to keep books); Former Regs. §1.441-1T(g).
22Klempner v. Glenn, 82 F. Supp. 626 (W.D. Ky., 1949); Stonegate of Blacksburg, Inc. v. Comr., 33 T.C.M. 956 (1974); Brooks v. Comr., 6 T.C. 504 (1946); Stryker v. Comr., 36 B.T.A. 326 (1937), acq., 1937-2 C.B. 27. See also PLR 7844042.
23Freudmann v. Comr., 10 T.C. 775 (1948), acq., 1948-2 C.B. 2; Brooks v. Comr., 6 T.C. 504 (1946); Stryker v. Comr., 36 B.T.A. 326 (1937), acq., 1937-2 C.B. 27. See also Dougherty v. Comr., 60 T.C. 917 (1973), (taxpayers failed to establish that their controlled foreign corporation had adopted a fiscal year accounting period because the evidence--including balance sheets, income and expense statements, and ledger accounts--indicated otherwise).
3.	Definitions of "Calendar Year" and "Fiscal Year"
The term "calendar year" means a period of 12 months ending on December 31.24 The term "fiscal year" means a period of 12 months ending on the last day of any month other than December.25 It also includes any 52-53-week year adopted by a taxpayer, even if it should happen to end on December 31.26 Because a taxpayer must adopt a calendar year or a fiscal year as its taxable year, 52-53-week years are the only acceptable taxable years that do not necessarily end on the last day of a calendar month.27
24§ 441(d).
25§ 441(e).
26Id.
27See Rev. Rul. 85-22, 1985-1 C.B. 154. For a discussion of 52-53 week taxable years, see IV, below.
III. Required Taxable Years
A. Introduction
Substantial limitations restrict the ability of many individuals and entities to adopt fiscal year accounting periods. These rules are largely designed to prevent taxpayers from manipulating taxable years to create tax deferral advantages. This section outlines the applicable rules.
B. Taxable Year of an Affiliated Group Filing a Consolidated Return
In general, corporations filing consolidated returns must adopt the same taxable year as the common parent corporation.28 Under a special rule, if an affiliated group includes an insurance company required to use the calendar year as its taxable year, the members of the group must adopt the insurance company's calendar year or a 52-53- week taxable year ending within a seven-day period including December 31, beginning with the affiliated group's second year that includes the insurance company.29 In addition, special rules apply to the mechanics of the adoption of the same taxable year by members filing consolidated returns, and special rules apply in the case of a member currently on a 52-53-week year.30
28Regs. § 1.1502-76(a)(1).
29Regs. § 1.1502-76(a)(2).
30For a detailed discussion of these problems, see 754 T.M., Consolidated Returns--Elections and Filing.
C. Required Taxable Year of a Personal Service Corporation
1.	Calendar Year Requirement
In general, for a personal service corporation ("PSC") the calendar year is the required taxable year for all taxable years beginning after December 31, 1986.31 Three relatively narrow exceptions are available. A PSC may adopt a 52-53-week taxable year ending with reference to the month of December.32 The PSC may use a fiscal year accounting period, if it establishes to the satisfaction of the IRS that it has a business purpose for doing so or has a natural business year that differs from the calendar year.33 A PSC may also be entitled to a taxable year beginning in October, November, or December, but in practice it will need to meet certain minimum distribution requirements to do so.34
31§ 441(i), added by P.L. 99-514, §806(c)(1). A PSC in existence at the time of the adoption of §441(i) was compelled to switch to the required taxable year for its first taxable year beginning after 1986. Such a change was treated as initiated by the PSC and approved by the IRS. See P.L. 99-514, §806(e)(2), as amended by P.L. 100-647, §1008(e)(7)-(8).
32Regs. §1.441-3(a)(2). Rev. Proc. 2002-38, 2002-22 I.R.B. 1037, §4.01(4); Notice 2002-72, 2002-46 I.R.B. 843.
33§ 441(i)(1); Regs. §1.441-3(a)(2). See III, C, 3, below.
34§§ 444 and 280H. Rev. Proc. 2002-38, §2.07. See III, C, 4, below.
2.	Definition of a Personal Service Corporation
A PSC is a corporation the principal activity of which is the performance of personal services that are substantially performed by employee-owners.35 Regulations elaborate that an entity will be classified as a personal service corporation only if -- 
(1) The taxpayer is a C corporation as defined in §1361(a)(2) for the taxable year;
(2) The principal activity of the taxpayer during the testing period for the taxable year is the performance of personal services;
(3) During the testing period for the taxable year, the personal services are substantially performed by employee-owners; and
(4) Employee-owners own (using the attribution rules of §318 but substituting "any" for "50 percent" in §318(a)(2)(C)) more than 10% of the fair market value of the outstanding stock of the taxpayer on the last day of the testing period for the taxable year.36
35§§ 441(i)(2) and 269A(b).
36Regs. §1.441-3(c)(1).
The testing period for a taxpayer's first taxable year begins on the first day of the taxable year. It ends on the earlier of: (i) the last day of the taxable year or (ii) the last day of the calendar year in which the taxable year begins.37 The testing period for any period other than the taxpayer's first taxable year is the preceding taxable year.38
37Regs. §1.441-3(c)(2)(ii).
38Regs. §1.441-3(c)(2)(i).
Example: Corporation X's first taxable year begins on June 1, 1997. X wishes to use a taxable year ending September 30. The testing period for its first taxable year begins June 1, 1997, and ends September 30, 1997. If X is a personal service corporation based on that period, it must obtain IRS approval to use a September 30 taxable year.39
39Regs. §1.441-3(c)(3), Ex. 1.
Example: Corporation Y's first taxable year begins June 1, 1997. Y wishes to use a taxable year ending March 31. The testing period for its first taxable year begins June 1, 1997, and ends December 31, 1997. If Y is a personal service corporation based on that period, it must obtain IRS approval to use a March 31 taxable year.40
40Regs. §1.441-3(c)(3), Ex. 2.
a.	Personal Services as Principal Activity
(1)	Performance of Personal Services
During any testing period, services described in §448(d)(2)(A) or the regulations thereunder will be treated as the performance of personal services. Therefore, activities that involve the performance of services in the fields of health, law, engineering, architecture, accounting, actuarial science, performing arts, or consulting are treated as personal service activities.41 The IRS has indicated that the term "qualified personal service corporation" used in §448 should not be interpreted broadly because it would frustrate Congress's intent to establish accrual accounting as the general rule and cash accounting as a narrow exception.42 The IRS's rationale may not directly apply to §441(i), but §441(i) does incorporate the §448 standard by reference. Thus, if an activity is not within the definition of the above fields as described in §448(d)(2)(A) or its regulations, it will not be treated as the performance of personal services.43
41Regs. §1.441-3(d)(1).
42TAM 9529002.
43Regs. §1.441-3(d)(2).
The §448regulations do not define the activities that constitute performing services in law, architecture, accounting, or actuarial science. However, the IRS has ruled that personal services include architecture and "related design services."44 Another ruling indicates that processing of computerized billing does not constitute services within the accounting field.45 The regulations say little about engineering, indicating only that it includes surveying and mapping.46
44PLR 9602013.
45TAM 8927006.
46Regs. § 1.448-1T(e)(4)(i)(C).
According to the regulations, services performed in the field of health include medical services provided by physicians, nurses, dentists, and other similar health care professionals.47 Under this standard, the IRS has ruled that a corporation whose employees spend all their time performing veterinary services is a PSC subject to §441(i).48 Other medical related activities that have been ruled to be personal services include ambulance services,49 and physical therapy.50
47Regs. § 1.448-1T(e)(4)(ii).
48Rev. Rul. 91-30, 1991-1 C.B. 61. Because of the burdens of applying this revenue ruling, the IRS permitted veterinary services corporations to defer any change in taxable year required by Rev. Rul. 91-30 until its first taxable year beginning after 1991. See Rev. Rul. 92-65, 1992-2 C.B. 94.
49TAM 9309004. The National Office concluded that the medical assistance the employees of the corporation provided during ambulance transports were medical services and were thus within the health field.
50TAM 9222004.
On the other hand, services that are not directly related to the medical field are not considered to be in the field of health, even if they arguably relate to the health of the service recipient.51
51Regs. § 1.448-1T(e)(4)(ii). For example, the operation of a health club or a health spa is not the performance of services in the field of health. Id.
Services in the field of performing arts include those provided by actors, actresses, singers, musicians, entertainers, and similar artists.52 The services of those artists are personal services only if performed in their capacity as such.53 Such services do not include the services of managers or promoters, persons who broadcast or otherwise disseminate the performances of artists, or athletes.54 The IRS has ruled that motion picture directing is not within the field of performing arts.55
52Regs. § 1.448-1T(e)(4)(iii).
53Id. See also TAM 9529002 (actor's activities as an actor are personal services under §448(d)(2)(A), but services relating to business meetings and other services that do not involve acting, entertaining, or similar activities are not).
54Regs. § 1.448-1T(e)(4)(iii).
55TAM 9416006.
Performance of services in the field of consulting means providing advice and counsel. It does not include other services, such as sales or brokerage services or similar services. Whether a taxpayer performs services in the field of consulting depends on the facts and circumstances, including the manner in which the taxpayer is compensated for the services.56 Ten examples in the regulations illustrate the evaluation of the facts and circumstances in this regard. Taxpayers are considered to be providing services in the field of consulting in the following four cases: 
-- An economic analyst advises clients on their business activities; after analyzing economic conditions, the analyst makes recommendations to the client regarding entry into, and activities in, a particular industry.57
-- The taxpayer determines a client's electronic data processing needs and makes recommendations regarding the design and implementation of data processing systems for the client; the taxpayer does not provide computer programming services distinct from the recommendations.58
-- The taxpayer determines a client's management and business structure needs by studying the client's organization; based on the study, the taxpayer advises the client on changes in its structure.59
-- The taxpayer provides financial planning services, studying a client's financial situation and assisting the client in making decisions and plans regarding financial activities.60
56Regs. § 1.448-1T(e)(4)(iv)(A).
57Regs. § 1.448-1T(e)(4)(iv)(B), Ex. (1).
58Regs. § 1.448-1T(e)(4)(iv)(B), Ex. (2).
59Regs. § 1.448-1T(e)(4)(iv)(B), Ex. (3).
60Regs. § 1.448-1T(e)(4)(iv)(B), Ex. (4).
As noted above, consulting services do not include sales or brokerage services or other economically similar services. The other six examples in the regulations illustrate this rule as follows: 
-- The taxpayer makes recommendations to clients regarding securities and commodities and executes trades on their behalf, typically being compensated based on the trade orders. The taxpayer is engaged in brokerage services, and is not in the field of consulting.61
-- The taxpayer studies a client's data processing needs and makes recommendations regarding the design and implementation of data processing systems. The client orders equipment through the taxpayer, who is compensated based on the equipment orders. The taxpayer is engaged in sales services, and is not in the field of consulting.62
-- The taxpayer assists businesses in meeting their personnel needs by referring job applicants to them and is compensated based on the job applicants referred. The taxpayer is engaged in services economically similar to brokerage services, and is not in the field of consulting.63
-- The taxpayer assists individuals in obtaining employment positions and is compensated by clients who thereby obtain employment. The taxpayer is engaged in services economically similar to brokerage services, and is not in the field of consulting.64
-- The taxpayer makes recommendations to clients regarding the types of advertisements that they should place in various types of advertising media. Based on those recommendations, the clients purchase advertisements through the taxpayer, who is compensated based on the clients' orders for advertising. The taxpayer is engaged in services economically similar to brokerage services, and is not in the field of consulting.65
-- The taxpayer sells insurance products and is compensated based on purchases made by clients. The taxpayer is engaged in brokerage or sales services, and is not in the field of consulting.66
61Regs. § 1.448-1T(e)(4)(iv)(B), Ex. (5).
62Regs. § 1.448-1T(e)(4)(iv)(B), Ex. (6).
63Regs. § 1.448-1T(e)(4)(iv)(B), Ex. (7).
64Regs. § 1.448-1T(e)(4)(iv)(B), Ex. (8).
65Regs. § 1.448-1T(e)(4)(iv)(B), Ex. (9).
66Regs. § 1.448-1T(e)(4)(iv)(B), Ex. (10).
The IRS has ruled on whether several other activities constitute personal services. Because educational services are not specifically described in Regs. § 1.448-1T(e)(4), they are not personal services.67 The IRS also so treats claim staking,68 commercial photography,69 and legislative lobbying.70
67PLR 8913012.
68TAM 9232009.
69PLR 9009017.
70PLRs 8901023, 8901022, 8901021, 8902005.
(2)	Principal Activity
The principal activity of a corporation for any testing period will be considered to be the performance of personal services if the cost of the corporation's compensation (the "compensation cost") for that testing period attributable to its personal service activities exceeds 50% of the corporation's total compensation cost for the testing period.71 Compensation cost includes amounts allowable as a deduction, allocated to a long-term contract, or otherwise chargeable to a capital account, for wages, salaries, and any other amount attributable to services performed for or on behalf of the corporation by an employee (including employee-owners) during the testing period. Those amounts include: deferred compensation, commissions, bonuses, §83 compensation, compensation for services based on a percentage of profits, and the cost of fringe benefits that are includible in income.72 All of the compensation cost for employees who are involved only in the performance of personal service activities is considered attributable to the corporation's personal service activity.73 None of the compensation cost for employees that do not engage in the performance of personal service activities is so attributable, even if they are involved in supporting the work of personal service employees.74 The compensation cost of mixed activity employees (i.e., not classified as either performing only personal services or not performing any personal services) is allocated to a corporation's personal service activity in proportion to the percentage of total time worked for the corporation that is attributable to personal service activities.75
71Regs. §1.441-3(e)(1). Note that this test is different from the qualified personal service corporation test under §448, which requires that 95% of the activities of the corporation be personal service activities. See Regs. § 1.448-1T(e)(4)(i). The reason for this difference is that a personal service corporation for §441 purposes is defined by reference to §269A(b)(1), which refers to "the principal activity" of the corporation, while §448(d)(2)(A) defines a qualified personal service corporation in terms of "substantially all of the activities" of the corporation.
72Regs. §1.441-3(e)(2)(i)(B). Note that for purposes of this section, compensation cost does not include amounts attributable to a plan qualified under §401(a) or §403(a), or to a simplified employee pension plan defined in §408(k). Id.
73Regs. §1.441-3(e)(3)(i).
74Regs. §1.441-3(e)(3)(ii).
75Regs. §1.441-3(e)(3)(iii). The taxpayer can determine the percentage in any reasonable manner, and need not keep time logs unless they are maintained for other purposes. Id.
b.	Substantial Employee-Owner Services
Services are substantially performed by employee-owners if more than 20% of a corporation's compensation cost attributable to personal service activities for the testing period is attributable to personal services performed by employee-owners.76
76Regs. §1.441-3(f)(1).
Example: Corporation C engages principally in an activity that is the performance of personal services but also participates in an activity that would not be characterized as personal services. For its current testing period, C's total compensation cost (including compensation cost attributable to employee-owners) was $1,500,000 ($1,000,000 attributable to C's personal service activity and $500,000 attributable to C's other activity). The total compensation cost attributable to employee-owners of C for the testing period was $250,000 ($210,000 attributable to C's personal service activity and $40,000 attributable to C'S other activity). The employee-owners of C substantially performed the personal services of C during the testing period because more than 20% of C's $1,000,000 compensation cost during the testing period attributable to its personal service activities was attributable to personal services performed by employee-owners ($210,000).77
77Regs. §1.441-3(f)(3), Ex. 2.
c.	Employee Ownership Requirement
A corporation is a PSC only if employee-owners hold more than 10% of the fair market value of its outstanding stock on the last day of the testing period.78 In determining ownership for these purposes, the §318 attribution rules apply.
78Regs. §1.441-3(c)(1)(iv).
Of those rules, §318(a)(2)(C) is modified to attribute ownership of any stock held by a corporation proportionately to its shareholders, regardless of how little stock they hold in the corporation.79
79Regs. §1.441-3(c)(1)(iv).
A person is an employee-owner of a corporation for a testing period if that person is an employee of the corporation on any day of the testing period and owns outstanding stock of the corporation on any day of the testing period.80 Any person who owns stock of the corporation during any portion of the testing period and performs personal services for the corporation is treated as an employee even if that shareholder is treated as an independent contractor for other purposes.81
80Regs. §1.441-3(g)(1).
81Regs. §1.441-3(g)(2).
d.	Special Rules for Affiliated Groups
For purposes of applying these rules, members of an affiliated group of corporations that file a consolidated return are treated as a single corporation and the employees of the members of the affiliated group are treated as employees of the single corporation. All of the stock of the affiliated group that is not owned by other members of the group is treated as outstanding stock of the single corporation.82
82Regs. §1.441-3(h).
3.	Business Purpose and Natural Business Year
A PSC may use a fiscal year accounting period if it satisfies the IRS that it has a business purpose for doing so.83 The pertinent legislative history indicates that the IRS may prescribe tests to establish the existence of a business purpose.84 The IRS regards the existence of a natural business year as a valid business purpose.85 As a result, the IRS has prescribed four test for PSCs: (a) a 25% gross receipts test for establishing a natural business year; (b) an annual business cycle test; (c) a seasonal business cycle test; and (d) a facts and circumstances test.86
83§441(i)(1).
84H.R. Rep. No. 99-841, II-319 (1986) (1986 Conf. Rep.).
85Rev. Proc. 2002-38, 2002-22 I.R.B. 1037, §5.04 and 5.05.
86Regs. §1.441-3(a)(2); Regs. §1.442-1(b)(2) and  (3). Rev. Proc. 2002-38, 2002-22 I.R.B. 1037, §5.05, provides the 25% gross receipts test for use in establishing a business purpose for a natural tax year in order to obtain automatic approval to adopt, change or retain a fiscal year accounting period. Rev. Proc. 2002-39, 2002-22 I.R.B. 1046, §5.03(1) and §5.03(2), provides the annual business cycle and seasonal business cycle tests for use in establishing a business purpose and obtaining the IRS's approval to adopt, change or retain a fiscal year. Rev. Proc. 2002-39 also provides for use of the 25% gross receipts to establish a business purpose and obtain the IRS's approval to adopt, change or retain a fiscal year; a taxpayer would use the 25% gross receipts test under Rev. Proc. 2002-39, if it is barred, generally because of a prior change in annual accounting period within the most recent 48-month period, from obtaining automatic approval under Rev. Proc. 2002-38. See Rev. Proc. 2002-38, §4.01(5). In addition to the annual business cycle, seasonal business cycle and 25% gross receipts test, Rev. Proc. 2002-39 provides safe harbors, plus examples of the safe harbors, for meeting the tests. Rev. Proc. 2002-39, §5.02(1)(b), provides the facts and circumstances test for establishing a business purpose and obtaining the IRS's approval to adopt, change or retain a fiscal year. The IRS anticipates granting permission under the facts and circumstances test only in rare and unusual circumstances. Rev. Proc. 2002-39, §5.02(1)(b). A PSC that meets one of these four tests in not required to make a §444 election to use its fiscal year. Regs. §1.444-1T(a)(3)(i). For a discussion of the §444 election, see III, C, 4, below.
N.B. Rev. Proc. 87-32, 1987-2 C.B. 396, is generally applicable before May 10, 2002. Rev. Proc. 87-32 provided two tests for PSCs to establish a valid business purpose for a fiscal year accounting period: a 25% gross receipts test, similar to that under Rev. Proc. 2002-38 and Rev. Proc. 2002-39; and a facts and circumstances test, which was illustrated in Rev. Rul. 87-57, 1987-2 C.B. 117. Rev. Proc. 2002-38, §10.02, and Rev. Proc. 2002-39, §10.02, provide transitional rules, under which an entity can use the current procedures for applications pending as of May 10, 2002.
a.	25% Gross Receipts Test
The 25% gross receipts test allows a PSC to use a fiscal year accounting period by establishing that for each of the last three fiscal years at least 25% of gross receipts were in the last two months of that fiscal year.87 A PSC applying for a fiscal year under the 25% gross receipts test computes its gross receipts from sales and services for what would be its most recently completed fiscal year using its proposed annual accounting period. That amount is divided into its gross receipts for the last two months of that accounting period. The same computation is also made for the two fiscal years preceding that one. If these computations yield quotients of 25% or more for each of the three fiscal years, the proposed fiscal year is a natural business year. However, the PSC must determine whether any annual accounting period other than the requested annual accounting period also meets the 25% gross receipts test. If one or more other annual accounting periods produce higher averages than the requested annual accounting period, then the requested annual accounting period will not qualify as the taxpayer's natural business year.87.1
87Rev. Proc. 2002-38, §5.05. See also Rev. Proc. 87-32, §§4 and 6 (generally applicable before May 10, 2002).
87.1Rev. Proc. 2002-38, §5.05(2)(b), and Rev. Proc. 2002-39, §5.03(3)(b)(ii). The comparison of the requested annual accounting period to other periods was not a requirement under Rev. Proc. 87-32, generally applicable before May 10, 2002.
Example: A PSC proposes to adopt a taxable year ending Mar. 31. The corporation's gross receipts for each of the last three 12-month periods ending Mar. 31 amounted to $150,000 and the February and March gross receipts for each of those years was $50,000. Based on these figures, the gross receipts for the last two months of the requested year are greater than 25% of the 12-month amount for each of the last three years. Therefore, Mar. 31 is the end of a natural business year for the PSC.
If the PSC has a predecessor organization and is continuing its business (such as a PSC whose business was previously operated as a sole proprietorship) the gross receipts of the predecessor organization are used to apply the 25% gross receipts test, but the PSC and its predecessor must have at least a 47 month history between them to apply the test. If more than one fiscal year qualifies as a natural business year for the PSC, the natural year approved is the fiscal year producing the highest three-year average of the percentage ratios of final two-month gross receipts to annual gross receipts. If a PSC has a natural business year, approval is automatic.
b.	Annual Business Cycle Test
A taxpayer may demonstrate a business purpose by using the annual business cycle test to demonstrate a natural business year.88 Under the annual business cycle test, a taxpayer's natural business year is deemed to end at, or soon after, the close of the highest peak period of business, if the taxpayer's gross receipts for the short period necessary to effect the change and for the three immediately preceding taxable years indicates that the taxpayer has a peak and a non-peak period of business. A taxpayer that has not been in existence long enough to provide the gross receipts information may provide other information to demonstrate a peak and non-peak period of business, such as a description of its business and/or reasonable estimates of future gross receipts. Under a safe harbor, one month will be deemed to be "soon after" the close of the highest peak period of business.89
88Rev. Proc. 2002-39, §5.03(1)(a).
89Rev. Proc. 2002-39, §5.03(1)(b).
Example: A PSC (P) operates an income tax preparation business for individuals. The highest peak of P's annual business cycle occurs in April of each year. P's natural business year is deemed to end on Apr. 30, or, under the "soon after" safe harbor, on May 31. Accordingly, under Rev. Proc. 2002-39, a request by P for a taxable year ending either on Apr. 30 or on May 31 would be granted, subject to the general terms and conditions set forth by Rev. Proc. 2002-39.
c.	Seasonal Business Cycle Test
A taxpayer may demonstrate a business purpose by using the seasonal business cycle test to demonstrate a natural business year.90 Under the seasonal business cycle test, if the taxpayer's gross receipts from sales and services for the short period necessary to effect the change, and for the three immediately preceding taxable years indicates that the taxpayer's business is operational for only part of the year (e.g., due to weather conditions), and, as a result, the taxpayer has insignificant gross receipts during the period the business in nonoperational, the taxpayer's natural business year is deemed to end at, or soon after, the operations end for the season. Under a safe harbor in Rev. Proc. 2002-39, an amount equal to less than 10% of the taxpayer's total gross receipts for the year will be deemed to be "insignificant," and one month will be deemed to be "soon after" the close of operations.91
90Rev. Proc. 2002-39, §5.03(2)(a).
91Rev. Proc. 2002-39, §5.03(2)(b).
d.	Facts and Circumstances Test
Under Rev. Proc. 2002-39, a taxpayer may establish a business purpose for a requested taxable year base on all the relevant facts and circumstances. The IRS has declined to state examples of what facts and circumstances might be successful in establishing a business purpose, stating that they expect the facts and circumstances test to be used only in rare and unusual circumstances. Deferral of income to owners will not be treated as a business purpose. Additionally, the administrative and convenience business reasons, including those described in Rev. Rul. 87-57, will be insufficient to establish a business purpose.
e.	Filing Requirements
Rev. Proc. 2002-38 sets forth the filing requirements for a PSC using the 25% gross receipts test to request automatic approval to adopt, change or retain a fiscal year. Rev. Proc. 2002-39 provides the filing requirements for a PSC using the annual business cycle test, the seasonal business cycle test or the facts and circumstances test to request IRS approval to adopt, change or retain a fiscal year. The PSC must file Form 1128 after the close of the first effective year and before the due date (including extensions) for filing the federal income tax return for the first effective year.92 The PSC using the 25% gross receipts test must provide information about its gross receipts for the must recent 47 months for itself or any predecessor.93 In addition the PSC must comply with various terms and conditions.94 Most notably the PSC must file, by the due date including extensions, a tax return for the short period required to effect the change; the PSC's taxable income for the short period must annualized in accordance with §443(b) and Regs. §1.443-1(b); and the PSC must keep its books and records on the basis of the approved natural business year.
92Rev. Proc. 2002-38, §7.02(2); Rev. Proc. 2002-39, §6.02(1). Rev. Proc. 2005-27, 2005-20 I.R.B. 1050, provides that the IRS may issue guidance extending the Rev. Proc. 2002-38 and Rev. Proc. 2002-39 filing deadlines for taxpayers who are serving in, or in support of, the Armed Forces in a combat zone, and for taxpayers affected by a Presidentially declared disaster or determined by the IRS to be affected by a terroristic or military action. In accordance with an amendment to §7508(a) by §104 of the Military Family Tax Relief Act of 2003, P.L. 108-121, such an extension would likely include service in a contingency operation, as well as in a combat zone.
93Rev. Proc. 2002-38, §7.02(6); Rev. Proc. 2002-39, §6.02(5).
94Rev. Proc. 2002-38, §6; Rev. Proc. 2002-39, §5.04.
[Footnote 95 reserved.]
4.	Election Under §444 to Use a Fiscal Year Accounting Period
a.	Section 444 Election
Under §444 some PSCs96 may use taxable years that vary from the calendar year by as much as three months.97 This exception, however, is not generally available to tiered entities.98 A PSC taking advantage of this exception must meet the minimum distribution requirements of §280H if it wants to avoid the disallowance of deductions for some amounts paid or incurred to employee-owners.99
96For purposes of §444, the term "personal service corporation" has the same meaning as that set out in §441(i)(2) discussed in III, C, 2, above. §444(f).
97§444(a) and  (b).
98§444(d)(3).
99§444(c)(2); §280H. The requirements of §280H are discussed in III, C, 4, b, below.
(1)	Availability of §444 Election
A PSC may elect a taxable year other than the calendar year if (1) it has not terminated a §444 election previously in effect,100 and (2) it is not a member of a tiered structure.101
100§444(d)(2)(B). An anti-abuse rule prevents the evasion of this rule by asset transfers. Regs. §1.444-1T(b)(5)(iii).
101§444(d)(3); Regs. §1.444-2T(a).
A PSC is a member of a tiered structure if it owns any interest in, or is owned in whole or part by, any deferral entity.102 A deferral entity is any partnership, S corporation, PSC, or trust (other than grantor trusts and certain "qualified trusts").103 In addition, an anti-abuse rule provides that a PSC is a member of a tiered structure if it or related taxpayers have organized or reorganized their ownership structure or operations for the principal purpose of obtaining a significant unintended tax benefit from making or continuing a §444 election.104
102Regs. §1.444-2T(b)(1).
103Regs. §1.444-2T(b)(2). Notice 88-85, 1988-2 C.B. 400, indicates that future regulations will provide that for purposes of Regs. §1.444-2T, a "qualified trust" (i.e., a trust exempt from taxation under §501(a)) is not a deferral entity only if: (A) the qualified trust has no unrelated business taxable income attributable to its investment in the PSC making the §444 election; and (B) the PSC treats any dividend deductible under §404(k)(2)(A) or  (B) and paid or distributed to an employee-owner as an applicable amount under §280H with respect to the taxable year of the PSC in which the dividend is otherwise deductible.
104Regs. §1.444-2T(b)(3). Examples in the temporary regulations indicate that an unintended benefit results if a reorganization would permit deferral of income of an entity that would not be eligible for such a deferral on a stand-alone basis. See Regs. §1.444-2T(f), Ex. (15)-(19).
In each taxable year, whether a PSC is a member of a tiered structure is judged as of the last day of the calendar year. If the taxable year does not include the last day of the calendar year (i.e., a short taxable year), the PSC is not a member of a tiered structure for that taxable year.105
105Regs. §1.444-2T(d)(1).
De minimis rules exempt PSCs (1) that own interests in deferral entities, but only if the deferral entities account in the aggregate for either no more than 5% of the PSC's adjusted taxable income or no more than 2% of the PSC's gross income; and (2) in which deferral entities own aggregate interests of no more than 5% in the PSC.106
106Regs. §1.444-2T(c). A special rule makes §444 elections available to tiered structures consisting only of partnerships or S corporations with the same taxable year, but it does not apply to PSCs. See §444(d)(3)(B); Regs. §1.444-2T(e).
(2)	Limitation on the Taxable Year That May Be Elected
A PSC that makes a §444 election is nevertheless limited to fiscal years with statutorily permitted deferral periods.107 For a PSC, the fiscal year's deferral period is the period between the beginning of the desired fiscal year and the end of the calendar year ending during that fiscal year.108
107§444(b).
108§444(b)(4); Regs. §1.444-1T(b)(4)(ii)(A).
Example: A PSC's required taxable year ends Dec. 31. A taxable year of the PSC that ends Nov. 30 has a deferral period of one month.
A newly formed PSC may not adopt a fiscal year with a deferral period longer than three months. Thus, a newly created PSC that is otherwise required to adopt a calendar year accounting period may adopt a fiscal year ending September 30, October 31, or November 30.109
109§444(b)(1); Regs. §1.444-1T(b)(1).
An existing PSC may change to a fiscal year only if the deferral period of that fiscal year is no longer than the shorter of: (1) three months or (2) the deferral period of the taxable year being changed.110 For this purpose, the phrase "the deferral period of the taxable year being changed" means the deferral period of the taxable year immediately preceding the taxable year for which the taxpayer desires to make a §444 election. Like the deferral period of the proposed fiscal year, the deferral period of the taxable year being changed is determined by reference to the calendar year.111
110§444(b)(2); Regs. §1.444-1T(b)(2)(i). An anti-abuse rule prevents the evasion of this rule by asset transfers. Regs. §1.444-1T(b)(5)(iii).
111Regs. §1.444-1T(b)(2)(iii). A PSC that was already in existence during 1986, the year §444 was adopted, was permitted to retain its prior taxable year for its first taxable year beginning in 1987. §444(b)(3).
Example: A PSC using a fiscal year ending June 30 could change to a fiscal year ending Sept. 30. A PSC using a fiscal year ending Oct. 31, however, could not change to a Sept. 30 fiscal year, because the three-month deferral period of the new fiscal year would exceed the two-month deferral period of the taxable year being changed. The PSC could change to a Nov. 30 fiscal year.112
112See Regs. §1.444-1T(d)(1), Ex. (1).
(3)	Filing for the Election
A §444 election must be made by the PSC rather than its owners.113 The election is made by filing Form 8716 (Election to Have a Tax Year Other Than a Required Tax Year). Form 8716 must be filed by the earlier of: (1) the 15th day of the fifth month following the month that includes the first day of the taxable year for which the election will first be effective or (2) the due date (without regard for extensions) of the income tax return resulting from the §444 election. The Form must also be attached to the tax return for the first taxable year for which the PSC makes a §444 election.114
113§444(d)(1).
114Regs. §1.444-3T(b)(1). Rev. Proc. 2005-27, 2005-20 I.R.B. 1050, provides that the IRS may issue guidance extending the time for filing Form 8716 for taxpayers who are serving in, or in support of, the Armed Forces in a combat zone, and for taxpayers affected by a Presidentially declared disaster or determined by the IRS to be affected by a terroristic or military action. In accordance with an amendment to §7508(a) by §104 of the Military Family Tax Relief Act of 2003, P.L. 108-121, such an extension would likely include service in a contingency operation, as well as in a combat zone.
Example: A PSC that began operations on Sept. 10, 2001 is qualified to make a §444 election to use a Sept. 30 taxable year. The PSC must file Form 8716 by the earlier of: (1) Feb. 15, 2002 (the 15th day of the fifth month following the month that includes the first day of the taxable year for which the election will first be effective) or (2) Dec. 15, 2001 (i.e., the unextended due date of the PSC's return for the period Sept. 10, 1996 to Sept. 30, 1996). Thus, the PSC must file Form 8716 by Dec. 15, 2001.
Note: If a PSC has requested or plans to request a fiscal year based on a business purpose, it may file a "back-up §444 election." If the IRS denies the business purpose request, the PSC can activate the §444 election by filing Form 8716 with the PSC's original or amended income tax return for the taxable year in which the election is first effective.115
115Regs. §1.444-3T(b)(4).
Note: A PSC that liquidates or is sold before making a §444 election may nevertheless make the election, if otherwise qualified.116
116Regs. §1.444-1T(a)(5)(iv).
(4)	Termination of Election
A PSC's §444 election terminates when the PSC: (1) changes to a required taxable year, (2) liquidates, (3) willfully fails to comply with §280H, (4) becomes a member of a tiered structure, or (5) ceases to be a PSC.117 Note that if the PSC ceases to be a PSC because it becomes an S corporation, the S corporation may continue the §444 election.118 Note also that if a PSC ceases to be a PSC but remains a C corporation that is not a member of an affiliated group, it is longer subject to a required taxable year. The termination of a §444 election for any of these reasons requires the PSC to file a short year return.119
117Regs. §1.444-1T(a)(5)(i).
118Id.
119Regs. §1.444-1T(a)(5)(ii).
b.	Limitation on Deduction under §280H
Any PSC that makes a §444 election is subject to §280H.120 Under §280H, in any year in which a PSC has a §444 election in effect ("applicable election year") and does not satisfy the minimum distribution requirements of §280H(c), the deduction otherwise allowable under Chapter 1 of the Code for "applicable amounts"121 cannot exceed the "maximum deductible amount."122 Any amount not allowed as a deduction in an applicable election year is treated as paid or incurred in the next taxable year and may be deductible in that year.123
120§§444(c)(2) and 280H(a); Regs. §1.280H-1T(b)(1). Under §280H(f)(5), the term "personal service corporation" has the same meaning given to that term by §441(i)(2). See the discussion of §441(i)(2) at III, C, 2, above.
121See §280H(f)(1); Regs. §1.280H-1T(b)(4); and III, C, 4, b, (1), below, for a discussion of the term "applicable amount."
122See §280H(d); Regs. §1.280H-1T(d); and III, C, 4, b, (2), below, for the definition of maximum deductible amount.
123§280H(b); Regs. §1.280H-1T(b)(2).
Note: The disallowance of deductions under §280H does not apply for purposes of the accumulated earnings tax, personal holding company rules, or foreign personal holding company rules (as in effect for taxable years of foreign corporations beginning prior to January 1, 2005), nor for determining whether the compensation of employee-owners is reasonable.124 Thus, forexample, in determining whether a PSC is subject to the accumulated earnings tax imposed under §531, deductions disallowed under §280H are treated as allowed in computing accumulated taxable income.
124Regs. §1.280H-1T(b)(3).
(1)	Minimum Distribution Requirement
The minimum distribution requirement for a taxable year is met if the applicable amounts paid or incurred during the deferral period of the taxable year equal or exceed the lesser of: (a) the amount determined under the preceding year test or (b) the amount determined under the 3-year average test.125 A PSC is deemed to satisfy the preceding year test and the 3-year average test for the first year of the corporation's existence.126 Further, if an existing corporation becomes a PSC and makes a §444 election, the determination of whether the corporation satisfies the preceding year test or the 3-year average test is made by treating the corporation as though it had been a PSC for each of the three years preceding the applicable election year.127
125§ 280H(c)(1); Regs. § 1.280H-1T(c)(1).
126Regs. § 1.280H-1T(e)(1).
127Regs. § 1.280H-1T(e)(2).
For purposes of these tests, "applicable amounts" are amounts paid to an employee-owner that would be deductible by the PSC if §280H did not apply and are includible in the gross income of the employee.128 Applicable amounts do not include (1) any gain from the sale or exchange of property between the employee-owner and the corporation; or (2) any dividend paid by the corporation.129 An individual is an employee-owner for a taxable year if: (1) on any day of the taxable year, the individual performs personal services for or on behalf of the corporation as an employee or independent contractor, and (2) on any day of the taxable year, the individual owns any outstanding stock of the corporation.130
128Regs. § 1.280H-1T(b)(4)(i).
129§ 280H(f)(1).
130Regs. § 1.280H-1T(c)(1)(ii).
Example: B is an employee of PSC, a personal service corporation with a §444 election in effect and a taxable year ending September 30. From September 30, 1996 through March 31, 1997, B owns no stock in PSC and receives $40,000 in salary. On April 1, 1997, B purchases 10 of PSC's 200 outstanding shares of stock. From April 1 through September 30, 1997, B receives $60,000 in salary from PSC. The entire $100,000 salary paid to B during PSC's taxable year ending September 30, 1997, is an applicable amount.131
131Regs. § 1.280H-1T(b)(4)(iii), Ex. (1).
Any amount that meets the definition of an applicable amount is an applicable amount regardless of when it is includable in the employee's gross income, whether the recipient remains an employee-owner at the time it is includible in gross income, and whether it is directly or indirectly includible in gross income.132 An amount is indirectly includible in the employee-owner's income if it is includible in the gross income of (1) the spouse of the employee-owner (other than a spouse who is legally separated from the employee-owner under a decree of divorce or separate maintenance) or a child (under age 14) of the employee-owner, or (2) any corporation, partnership, or trust that is more than 50% owned by employee-owners and related individuals described in (1).133 Nevertheless, a payment to such a corporation or partnership is not indirectly includible in the employee-owner's income if the corporation or partnership elects under §444 to use the same taxable year as the paying PSC.134
132Regs. § 1.280H-1T(b)(4)(i).
133Regs. § 1.280H-1T(b)(4)(ii).
134Id.
Example: Individuals X and Y are employee-owners of Corp1, a PSC that has a §444 election in effect and has a September 30 year end. X and Y also own all the stock, and are employees, of Corp2, an calendar year PSC. During its year ending September 30, 1997, Corp1 deducts an $11,000 payment that is included in Corp2's income. Because Corp2 is more than 50% owned by employee-owners of Corp1, the $11,000 payment is an applicable amount. If, however, Corp2 also had a §444 election in effect for a September 30 year end, the payment would not be an applicable amount.135
135See Regs. § 1.280H-1T(b)(4)(iii), Exs. (2) and (3).
Applicable amounts include salary payments, rental payments, and royalty payments. Contributions to any qualified trust described in §401, however, are not treated as applicable amounts.136
136Notice 88-85, 1988-2 C.B. 400.
(a)	Preceding Year Test
The amount determined under the preceding year test is the product of (A) the applicable amounts during the taxable year preceding the §444 election (the "preceding taxable year") divided by the number of months (but not less than one month) in the preceding taxable year, multiplied by (B) the number of months in the deferral period of the applicable election year.137 The PSC passes the preceding year test if the applicable amounts paid to all employee-owners in the aggregate during the deferral period of the election year are equal to or greater than the result of that computation.138
137§ 280H(c)(1)(A); Regs. § 1.280H-1T(c)(2). Under §280H(f)(3)(A), "deferral period" has the same meaning as under §444(b)(4). See III, C, 4, a, (2), above, for an explanation of deferral periods.
138§ 280H(c)(1); Regs. § 1.280H-1T(c)(1).
Note: §280H(c) indicates that amounts "paid or incurred" may satisfy the minimum distribution requirement, and §280H(c)(2)(A) uses that phrase in connection with the 3-year average test. However, since its amendment in 1988, the preceding year test in §280H(c)(1)(A) refers only to amounts paid. Legislative history indicates that the failure to delete the term "incurred" throughout the provision was a technical error.139
139H.R. Rep. No. 795, 100th Cong., 2d Sess. 397 (1988).
(b)	3-Year Average Test
The amount determined under the 3-year average test is the applicable percentage multiplied by the adjusted taxable income for the deferral period of the applicable election year.140 The applicable percentage provides a determination of the percentage of applicable amounts historically paid during the deferral period of each taxable year. The applicable percentage is a percentage (not exceeding 95%) determined by dividing the applicable amounts paid or incurred during the three taxable years immediately preceding the current taxable year by the adjusted taxable income for the PSC for those three taxable years.141 For purposes of the 3-year average test, "adjusted taxable income" means taxable income determined without reduction for: (1) amounts paid to an employee-owner that are includible in the gross income of the employee-owner; and (2) any net operating loss (NOL) carryover to the extent the NOL carryover is attributable to amounts paid to, and includible in the gross income of, employee-owners (i.e., the difference between the NOL carryover computed with the deduction of those amounts and the NOL carryover computed without the deduction of those amounts).142
140§ 280H(c)(1)(B); Regs. § 1.280H-1T(c)(3)(i).
141§ 280H(c)(2); Regs. § 1.280H-1T(c)(3)(ii).
142§ 280H(f)(4).
The adjusted taxable income for the deferral period of an applicable election year is the adjusted taxable income that would result if the PSC filed an income tax return for the deferral period of the applicable election year under its normal method of accounting.143 A PSC may make a reasonable estimate of that amount.144 For purposes of determining adjusted taxable income for the deferral period, an NOL carryover to the applicable election year (reduced as discussed above) is allowed first against the income of the deferral period.145
143Regs. § 1.280H-1T(c)(3)(iii)(B).
144Id.
145Regs. § 1.280H-1T(c)(3)(iii)(C).
(c)	Examples
Example 1: Assume that a PSC elects a September 30 year-end taxable year. In its 1996 taxable year, the entity has $175,000 of adjusted taxable income as of December 31, 1996. It also pays its sole employee-owner a salary of $130,000 ($30,000 before December 31, 1996 and $100,000 thereafter, but before the end of the fiscal year). Last, assume that the taxpayer's salary for the preceding taxable year was $125,000 and that 90% of the PSC's adjusted taxable income was paid out in salary to the taxpayer in each of the preceding three years. To determine if the deductions will be limited, the following calculation must be made: 
(1) Payments made to employee-owner between
12/1/96 - 12/31/96 = $30,000
(2) Minimum Distribution amount -- the lesser of:
                         $125,000 X 3/12 = $31,250                       
                                    or                                   
                         $175,000 X .90 = $157,500                       

Because the $30,000 salary payment before December 31, 1996 was less than the $31,250 minimum distribution requirement for the PSC, applicable amounts are deductible only to the extent of the maximum deductible amount.
Example 2: Assume the same facts as above except that shareholder-employee received $40,000 (instead of $30,000) in salary payments before December 31, 1996. In this case, the minimum distribution requirement is met because the $40,000 payment exceeds the minimum distribution requirement of the personal service corporation.146
146The minimum distribution requirement is the lesser of: [3/12 × $125,000] = $31,250 or [.90 × $175,000] = $157,500.
(2)	Limitation on Deduction
If the applicable amounts paid during the deferral period do not meet the minimum distribution requirements as computed under one of the two tests above, the deductibility of applicable amounts is limited to the maximum deductible amount. This limitation increases the taxable income of the PSC, thereby subjecting the PSC to a higher corporate income tax.147 If the PSC fails to meet the minimum distribution requirement, it may only deduct the amounts paid before December 31 of the current taxable year (i.e., the time between the beginning of the corporation's taxable year and the end of the calendar year) annualized to a 12-month basis.148 If any amount is determined as nondeductible for a taxable year under this section, that amount is treated as paid or incurred in the succeeding taxable year.149 In addition, PSCs are not allowed to carry back net operating losses to or from any taxable year to which an election under §444 applies (an "applicable election year").150
147Note that, under §11(b)(2), a "qualified personal service corporation," as defined in §448(d)(2), does not benefit from the graduated rate structure of §11(b)(1). See TAM 9324001 (the definition of a "personal service corporation" under §441 has no application in determining whether a corporation is a "qualified personal service corporation" under §448(d)(2) for purposes of §11(b)(2)).
148§ 280H(d); Regs. § 1.280H-1T(d).
149§ 280H(b).
150§ 280H(e); Regs. § 1.280H-1T(e)(3).
Example: Assume the same facts as Example 1, above. The maximum deduction allowed for the salary payments is the actual salary payments made before December 31, 1996, annualized to a 12-month basis, or $120,000 ($30,000 X 12/3). The remaining $10,000 ($130,000 - $120,000) is treated as paid or incurred in the succeeding taxable year.
Example: Corporation X is a PSC with a taxable year ending on September 30. X makes a §444 election for its taxable year beginning October 1, 1996, and incurs an NOL for that year. Because an NOL is not allowed to be carried back from an applicable election year, X may not carry back the NOL from its first applicable election year to reduce its 1994, 1995, or 1996 taxable income.151
151See Regs. § 1.280H-1T(e)(5), Ex. (1).
D. Required Taxable Year of an S Corporation.
Substantial restrictions limit the taxable years available to S corporations. In general, an S corporation must adopt a taxable year ending December 31.152 An S corporation may adopt a 52-53-week taxable year ending with reference to the month of December.153 An S corporation may adopt another accounting period if it establishes a business purpose to the satisfaction of the Commissioner.154 An S corporation may also adopt a taxable year beginning in October, November, or December, if it makes the payments required by §7519.155 Some S corporations may retain grandfathered fiscal years.
152§ 1378.
153Regs. §1.441-1(b)(2)(ii)(A) and  (B); Regs. §1.1378-1(a) See IV, below, for a discussion of 52-53-week taxable years.
154§ 1378(b)(2); Regs. §1.1378-1(b).
155§§444 and 7519. See III, D, 5, below.
1.	Must Be a "Permitted Year"
Except pursuant to a §444 election, an S corporation may not adopt a taxable year other than a "permitted year," and no corporation may make an election under Subchapter S unless it adopts a "permitted" taxable year.156 The term "permitted year" means a taxable year that ends on December 31, a 52-53 week taxable year referencing December 31, or any other accounting period for which the corporation establishes a business purpose.157
156§1378(a); Regs. §1.1378-1(a). See PLR 9215042.
157§1378(b); Regs. §1.1378-1(a).
2.	IRS Permission Necessary to Adopt a Fiscal Year
If an S corporation wants to elect a taxable year other than a calendar year, it must secure prior approval from the Commissioner in most instances. At the time it makes an S election, a corporation may, without obtaining IRS approval, adopt a calendar year, a 52-53-week taxable year referencing December 31, or a taxable year elected under §444. However if an electing S corporation wants a fiscal year, it must establish a business purpose and obtain the IRS's approval under §442.158 The Conference Committee Report that accompanies the Technical Corrections Act of 1982,159 indicates that Congress "intend[s] that the IRS, in determining whether a S corporation may have a taxable year other than a calendar year, generally will apply rules similar to the rules applicable to partnerships." Rev. Proc. 2002-38 provides guidance for an S corporation or an electing S corporation to obtain automatic approval to adopt, change or retain an annual accounting period. If automatic approval is not available, an S corporation or electing S corporation may be able to establish a business purpose and to obtain IRS approval using the procedures in Rev. Proc. 2002-39.160
158Regs. §1.1378-1(b).
159H.R. Rep. No. 97-986, at 22 (1982), reprinted in 1983-1 C.B. 498.
160Before May 10, 2002, Rev. Proc. 87-32, 1987-2 C.B. 117, provided expeditious approval procedures for an S corporation or electing S corporation that: (1) desired to adopt, retain or change to a taxable year that coincided with its natural business year; or (2) desired to adopt, retain or change to a taxable year that is the taxable year of a majority of its shareholder. Rev. Proc. 87-32 is reproduced in the Worksheets, below.
3.	Circumstances Allowing Adoption of a Fiscal Year
An S corporation may adopt a fiscal year accounting period if it establishes a business purpose to the satisfaction of the IRS.161 The IRS has prescribed five test that an S corporation may use to establish a business purpose.162 Two, the 25% gross receipts test and the ownership tax year test, can be used to obtain automatic approval under Rev. Proc. 2002-38. An S corporation that cannot obtain automatic approval can also use the 25% gross receipts test under Rev. Proc. 2002-39.163 Rev. Proc. 2002-39 also provides the annual business cycle and the seasonal business cycle tests for requesting IRS approval to adopt, change or retain a fiscal year. Finally, Rev. Proc. 2002-39 provides a facts and circumstances test that can be used to establish a business purpose and to obtain IRS approval. The 25% gross receipts test, the annual business cycle test, the seasonal business cycle test, and the facts and circumstances test are applied in a manner parallel to that applicable to PSCs, described in III, C, 3, above.
161§1378(b).
162The five tests are contained in two revenue procedures, Rev. Proc. 2002-38 and Rev. Proc. 2002-39. Rev. Procs. 2002-38 and 2002-39 are reproduced in the working papers.
Generally before May 10, 2002, the IRS had prescribed three tests for establishing a business purpose: the 25% gross receipts test; the facts and circumstances test; and the ownership tax year test. Rev. Proc. 87-32, 1987-2 C.B. 396.
163Generally, an S corporation will be barred from automatic approval if it made a prior change in annual accounting period within the most recent 48-month period. Rev. Proc. 2002-38, §4.01(5).
An S corporation may satisfy the ownership tax year test if shareholders holding more than 50% of its issued and outstanding stock (measured as of the first day of the taxable year to which the request relates) have the same taxable year or are concurrently changing to the desired fiscal year.164 If, as of the first day of any taxable year, the S corporation no longer meets the ownership tax year test, it must change its taxable year to a permitted year by following the normal procedures for a required change in year end.165 However, the IRS will not apply §5.06 of Rev. Proc. 2002-38, under which less than 100% ownership of an S corporation by a tax-exempt entity is disregarded for purposes of determining the S corporation's ownership taxable year, to require any S corporation to change its annual accounting period in any taxable year beginning before January 1, 2003.165.1
164Rev. Proc. 2002-38, §5.06.
165Rev. Proc. 2002-38, §6.06.
165.1Notice 2002-72, 2002-46 I.R.B. 843, modifying and clarifying Rev. Procs. 2002-37, 2002-22 I.R.B. 1030; 2002-38, 2002-22 I.R.B. 1037; and 2002-39, 2002-22 I.R.B. 1046.
4.	Filing Requirements
Filing requirements for an S corporation generally follow those described for a PSC in III, C, 3, e, above. An S corporation may receive automatic approval under either the 25% gross receipts test or the ownership tax year test.166 The request is make on Form 1128, or Form 2553 in the case of an electing S corporation.167 For requests relying on the 25% gross receipts test, the S corporation must identify its gross receipts for the most recent 47 months.168 The revenue procedures provide general filing instructions.169
166Rev. Proc. 2002-38, §4.01(2) and (3).
167Rev. Proc. 2002-38, §7.02(1); Rev. Proc. 2002-39, §6.01(1).
168Rev. Proc. 2002-38, §7.02(6); Rev. Proc. 2002-39, §6.01(5).
169Rev. Proc. 2002-38, §7; Rev. Proc. 2002-39, §6. See Rev. Proc. 87-32 for filing requirements for before May 10, 2002, noting that Rev. Procs. 2002-38 and 2002-39 provide transitional rules for changes, adoptions and retentions pending on May 10, 2002.
[Footnote 170 reserved.]
[Footnote 171 reserved.]
5.	S Corporation Election to Adopt a Fiscal Year -- §444 Election
a.	In General
The limitation of an S corporation to a permitted taxable year served to eliminate what Congress considered an unwarranted benefit to shareholders of the deferral of income that resulted from the S corporation's taxable year.172 In the Revenue Act of 1987, Congress devised another means of eliminating the benefit of deferral. S corporations may elect fiscal years that result in deferral of three months or less, but an electing S corporation must make required payments that approximate the amount of the deferral benefit.173 Those payments are in addition to any other amounts required to be paid by the S corporation and its shareholders.
172H.R. Rep. No. 100-391, at 1540 (1987).
173§§444 and 7519 (added by the Revenue Act of 1987, §10206). See H.R. Rep. No. 100-495, at 938 (1987).
Note: Some of the rules discussed below relating to a §444 election by an S corporation are the same as those relating to a personal service corporation (discussed at III, C, 4, above). Thus, the discussion of the §444 election as it pertains to S corporations follows the same outline as that used for personal service corporations, but the emphasis is on the different application of the rules.
(1)	Availability of §444 Election
The rules that apply to S corporations are almost identical to those that apply to personal service corporations. See III, C, 4, a, (1), above.
(2)	Limitation on the Taxable Year That May Be Elected
The taxable years that S corporations may elect are subject to the same limitations that apply to PSCs, discussed in III, C, 4, a, (2), above.
(3)	Filing for the Election
An S corporation is subject to the same filing requirements as a personal service corporation (see III, C, 4, a, (3), above), except that a corporation making an S election that also wants to make a §444 election is not required to file a Form 8716 with its Form 2553.174 It must, however, state on Form 2553 its intention to make a §444 election or a back-up §444 election.175 In addition, an S corporation that makes a §444 election must file returns and make required payments under §7519 (discussed at III, D, 5, b, below).176
174Regs. §1.444-3T(b)(3).
175Id.
176See §444(c)(1); Regs. §1.444-1T(a)(2)(i).
(4)	Termination of Election
A §444 election is terminated when an S corporation: (1) changes to a required taxable year, (2) liquidates, (3) willfully fails to comply with §7519, (4) becomes a member of a tiered structure (unless the same taxable year exception of §444(d)(3)(B) applies), or (5) terminates its S corporation election.177 Note, however, that if the S corporation is a PSC immediately after the termination, the PSC may continue the §444 election.178 If it is not a PSC and is not a member of an affiliated group filing a consolidated return after the termination, it is no longer restricted to a permitted taxable year. If a §444 election is terminated for any of these reasons, the S corporation must file a short year return.179
177Regs. §1.444-1T(a)(5)(i).
178Id.
179Regs. §1.444-1T(a)(5)(ii). When filing the short period return, the following should be printed at the top of the first page of the return: "SECTION 444 ELECTION TERMINATED." Id. See Announcement 94-5, 1994-2 I.R.B. 39.
(5)	Re-activating S Elections
Previously revoked S elections can be re-activated in two situations. The first is a corporation that made an S election for its first taxable year beginning in 1987, made a request for a fiscal year based on a business purpose that was denied or withdrawn, and did not agree to use a calendar year.180 The second is a corporation that used a fiscal year as an S corporation and revoked its S election for its first taxable year beginning in 1987.181 Either corporation may re-activate its S election by making a valid §444 election and obtaining the consent of all affected shareholders.182
180Regs. §1.444-1T(a)(6)(i).
181Regs. §1.444-1T(a)(6)(ii).
182Regs. §1.444-1T(a)(6)(iii). For examples illustrating these provisions, see Regs. §1.444-1T(a)(6)(iv).
b.	Required Payment Under §7519
An S corporation that elects a fiscal taxable year under §444 must make "required payments" under §7519 for each year the election is in effect ("applicable election year").183 Section 7519 effectively requires S corporations to pay approximately the same amount in required payments as the shareholders would have paid in actual tax payments for the deferral period (defined in III, D, 5, b, (1), below) had the corporation changed to a calendar year. Because the S corporation is ultimately entitled to a zero-interest refund of the required payments when it terminates its §444 election or liquidates, the required payments serve to deprive the S corporation's shareholders of the time value of money benefit of the discrepancy between the S corporation's taxable year and their own taxable years. Because the required payments are refundable, they are not deductible by the S corporation (or any other person) and no deduction passes through to the shareholders.
183§444(c)(1); Regs. §1.7519-1T(a).
Payments should be made on Form 8752.184 The payments are generally due on or before May 15 of the calendar year following the calendar year in which the applicable election year begins.185 For corporations making a back-up §444 election, the due date for the required payment is the later of: (1) the date determined under the general rule, or (2) 60 days from the date the business purpose request is denied.186 If such a corporation establishes a business purpose for its taxable year, it need not make the required payment under §7519.187
184Form 8752 replaced previously used Form 720. See Announcement 90-112, 1990-40 I.R.B. 37.
185Regs. §1.7519-2T(a)(4)(ii). However, Rev. Proc. 2005-27, 2005-20 I.R.B. 1050, provides that the IRS may issue guidance extending the time for filing Form 8752 and making the required payments for taxpayers who are serving in, or in support of, the Armed Forces in a combat zone, and for taxpayers affected by a Presidentially declared disaster or determined by the IRS to be affected by a terroristic or military action. In accordance with an amendment to §7508(a) by §104 of the Military Family Tax Relief Act of 2003, P.L. 108-121, such an extension would likely include service in a contingency operation, as well as in a combat zone.
186Regs. §1.7519-2T(a)(4)(iii); Regs. §1.444-3T(b)(4)(iii).
187Regs. §1.444-1T(a)(3).
Note: Even if an electing S corporation is not required to make a required payment, it must nevertheless file a return.188
188Regs. §1.7519-2T(a)(2).
(1)	Amount
The amount of the required payment for any applicable election year is equal to the excess of: (1) the applicable percentage of the adjusted highest §1 rate multiplied by the net base year income of the entity, over (2) the net required payment balance.189 For taxable years beginning after 1989, the applicable percentage is 100%.190
189§7519(b); Regs. §1.7519-1T(a)(3).
190§7519(d)(4). The applicable percentage was 25% for taxable years beginning in 1987, 50% for taxable years beginning in 1988, and 75% for taxable years beginning in 1989.
With respect to any applicable election year, the S corporation's "base year" is the corporation's taxable year preceding that applicable election year.191 The "adjusted highest §1 rate" is one percentage point more than the highest §1 rate in effect for the end of the base year.192 The regulations provide that the highest §1 rate is the highest rate during the 12-month period that ends with the required taxable year for the applicable election year and includes the end of the base year. For example, if an S corporation's applicable election year begins on October 1, 1996 and the required taxable year for such applicable election year ends December 31, the period for determining the highest §1 rate is the 12-month period ending December 31, 1996.193
191§7519(e)(2). Special rules apply to short base years. Regs. §1.7519-1T(b)(5)(v).
192§7519(b); Regs. §1.7519-1T(b)(2)(i).
193Regs. §1.7519-1T(b)(2)(ii). Note that for base years before 1990 for which §1(g) required a phaseout of the 15% tax bracket and personal exemptions, the highest §1 rate was computed without regard to the phaseout.
The "net required payment balance" is the excess (if any) of: (1) the aggregate required payments made for all preceding applicable election years, over (2) the aggregate amount of refunds under §7519 made to the entity for all applicable election years.194 Thus, the amount of required payments for all preceding election years, net of any refunds of such payments, is taken into account in determining the amount of payments required for the current election year.195
194§7519(e)(4).
195§7519(b); Regs. §1.7519-1T(a)(3). §7519(b), as enacted by the 1987 Revenue Act, had provided that a current year required payment was reduced only by the required payment of the preceding applicable election year and not by the cumulative total of prior year required payments. Technical and Miscellaneous Revenue Act of 1988, P.L. 100-647, §2004(e)(4), corrected this technical error.
Example: S corporation (S) made required payments of $10,000 and $20,000 for its first and second applicable election years and claimed a refund of required payments for $5,000 in its third applicable election year. Its net required payment balance therefore is $25,000. If, in the fourth applicable election year, the applicable percentage of the adjusted highest §1 rate is 40.6% and S has net base year income of $100,000, the required payment for S's fourth applicable election year is $15,600 ((.406 × $100,000) - $25,000).
If the required payment for any election year is negative, the S corporation is entitled to a refund of that amount.196 An S corporation is also entitled to a refund if it terminates the §444 election or if it liquidates during an election year.197
196§7519(c)(1); Regs. §1.7519-1T(c)(1).
197§7519(c)(2); Regs. §1.7519-1T(c)(2).
Note: For a discussion of when this refund is payable by the IRS, see III, D, 5, b, (2), below.
An S corporation's "net base year income" is equal to the sum of: (a) the "deferral ratio" multiplied by the S corporation's "net income" for the base year, plus (b) the excess (if any) of (i) the "deferral ratio" multiplied by the aggregate amount of "applicable payments" made by the S corporation during the base year over (ii) the aggregate amount of "applicable payments" made between the beginning of the base year and the end of the taxable year ending during the base year that would otherwise be required (the "deferral period" with respect to the base year).198 The "deferral ratio" is a fraction equal to the number of months in the deferral period of the base year divided by the number of months in the S corporation's base year.199
198§7519(d)(1), &  (e)(1); Regs. §1.7519-1T(b)(5)(i).
199§7519(d)(1).
The corporation's "net income" for the base year is the amount (not less than zero) determined by taking into account the total amount of the corporation's items (other than credits and tax-exempt income) that are required to be separately stated under §1366(a).200 Any limitation on any amount described in §1366(a) that may be taken into account for purposes of computing the taxable income of a shareholder is disregarded in computing the net income of the S corporation.201 If the S corporation was a C corporation in its base year, its taxable income for that year is treated as its net income for that year, and, for purposes of determining the amount and timing of applicable payments, the corporation is treated as having been an S corporation during the base year.202
200§7519(d)(2)(B); Regs. §1.7519-1T(b)(5)(iii). See PLR 200129021 (§7519 calculation includes income from sale of significant portion of business).
201§7519(d)(2)(C); Regs. §1.7519-1T(b)(5)(iii)(C).
202§7519(d)(2)(B), &  (d)(3).
The term "applicable payment" means amounts paid by an S corporation that are includible in the income of a shareholder, other than dividends and gain on the sale or exchange of property between the corporation and a shareholder.203 Two special rules apply for determining an S corporation's applicable payments. First, if the corporation was a C corporation for the base year, the amount of applicable payments is determined as if it had been an S corporation for that year.204 In addition, under attribution rules, payments to a person or entity related to a shareholder are considered to have been made directly to the shareholder in computing applicable payments.205 The IRS has stated that for any year for which a §444 election is in effect, any contribution to a qualified trust described in §401 is not treated as an applicable payment under §7519.206
203§7519(d)(3).
204Regs. §1.7519-1T(b)(5)(iv)(C).
205Regs. §1.7519-1T(b)(5)(iv)(D)(1).
206Notice 88-85, 1988-2 C.B. 400.
The following example assumes that no applicable payments were made.
Example 1: A corporation (S) converts from a C corporation to an S corporation and elects under §444 to retain its Sept. 30 year, rather than convert to a calendar year. S had net income of $1,000,000 for the year ending Sept. 30, 1995 (its last year as a C corporation) and $1,800,000 for the year ending Sept. 30, 1996.
For the taxable year ending Sept. 30, 1996, the required payment is computed as follows: 
                                                                        
  (1)         Net income during base year                     $1,000,000
  (2)         Deferral ratio ( 3/12)                                 25%
  (3)         Net base year income (1 × 2)                       250,000
  (4)         Adjusted highest §1 rate                             40.6%
  (5)         Applicable percentage                                 100%
  (6)         Aggregate required payment (3 × 4 ×                       
              5)                                                 101,500
  (7)         Net required payment balance                    - 0 -     
  (8)         Required payment (6 - 7)                         $ 101,500

For the taxable year ending Sept. 30, 1997, the calculation is:
                                                                        
  (1)         Net income during base year                     $1,800,000
  (2)         Deferral ratio ( 3/12)                                 25%
  (3)         Net base year income (1 × 2)                       450,000
  (4)         Adjusted highest §1 rate                             40.6%
  (5)         Applicable percentage                                 100%
  (6)         Aggregate required payment (3 × 4 ×                       
              5)                                                 182,700
  (7)         Net required payment balance                       101,500
  (8)         Required payment (6 - 7)                          $ 81,200

If, however, the S corporation makes "applicable payments", the calculation of the required payment changes. The following example assumes that applicable payments were made.
Example 2: Assume the same facts as Example 1 above, except that the corporation paid $120,000 in salary to a shareholder in 12 equal installments during the period. For the taxable year ending Sept. 30, 1996, the required payment is: 
                                                                       
  (1)         Net income during base year                    $1,000,000
  (2)         Deferral ratio ( 3/12)                                25%
  (3)         Deferred net income (1 × 2)                       250,000
  (4)         Applicable payments during base year              120,000
  (5)         Deferral ratio applicable payments (4 ×                  
              2)                                                 30,000
  (6)         Applicable payments during base year's                   
              deferral period                                    30,000
  (7)         Deferred applicable payments (5 - 6)             - 0 -   
  (8)         Net base year income (3 + 7)                      250,000
  (9)         Adjusted highest §1 rate                            40.6%
  (10)        Applicable percentage                                100%
  (11)        Aggregate required payments (8 × 9 × 10)          101,500
  (12)        Net required payment balance                     - 0 -   
  (13)        Required payment (11 - 12)                      $ 101,500

Example 3: Assume the same facts as Example 2, except that on Jan. 1, 1995, a $30,000 bonus payment was paid to a stockholder. The required payment calculation would be: 
                                                                       
     (1)      Net income during base year                    $1,000,000
     (2)      Deferral ratio ( 3/12)                                25%
     (3)      Deferred net income (1 × 2)                       250,000
     (4)      Applicable payments during base year              150,000
     (5)      Deferral ratio applicable payments (4 ×            37,500
              2)                                                       
     (6)      Applicable payments during base year's             30,000
              deferral period                                          
     (7)      Deferred applicable payments (5 - 6)                7,500
     (8)      Net base year income (3 + 7)                      257,500
     (9)      Adjusted highest §1 rate                            40.6%
    (10)      Applicable percentage                                100%
    (11)      Aggregate required payments (8 × 9 × 10)          104,545
    (12)      Net required payment balance                     - 0 -   
    (13)      Required payment (11 - 12)                      $ 104,545

The $7,500 deferred applicable payment represents the excess of the $37,500 applicable payment that would have been paid before Jan. 1, 1995, if the bonus were paid pro rata during the taxable year.
No payment is required to be made if the total of the required payments for the current year and all preceding election years does not exceed $500.207 If a required payment is less than $500 in the first election year and if, in the following election year, the aggregate required payments exceed $500, the entire amount of any required payments is due.208 Once a required payment is due in year, such payments must be made in subsequent years even if those payments are less than $500.209
207§7519(a)(2).
208H.R. Rep. No. 100-495, at 942 (1987).
209Regs. §1.7519-1T(a)(2).
Example: An S corporation (S) has a required payment of $400 in its first election year and $400 in its second. S is not required to make a required payment after the first election year, but it is required to make an $800 payment after the second election year. The required payment for S's third year is $300. S must make a required payment in that amount.210
210Regs. §1.7519-1T(a)(4), Exs. (2) and (3).
The required payments are assessed and collected in the same manner as if they were an employment tax imposed by subtitle C.211 Each S corporation that makes a §444 election is required to include on its return or statement such information as the IRS may deem necessary to carry out the purpose of §7519.212
211§7519(f)(1); Regs. §1.7519-2T(b).
212§7519(e)(3).
(2)	Refunds
As indicated above, an S corporation may receive a refund of required payments if it: (1) has a negative required payment; (2) terminates its §444 election; or (3) liquidates.213 No interest is due or allowable on the refund of a required payment.214
213§7519(c)(1) and  (2); Regs. §1.7519-1T(c).
214§7519(f)(3); Regs. §1.7519-2T(a)(6)(iii). See  Semmes, Bowen, & Semmes v. U.S., 30 Fed. Cl. 134 (1993), (§7519(f)(3) prohibits the payment of interest with respect to any refund of a required payment irrespective of whether the refund is overdue); see also TAM 9430001(§7519(f)(3) specifically prohibits the IRS from paying interest on refunds of required payments, regardless of whether refund is timely).
In those cases in which an S corporation (or partnership) is entitled to receive a refund, the IRS must make such a refund according to statutorily defined deadlines. A refund that is due for any applicable election year because the required payment is negative is payable on the later of: (1) April 15 of the calendar year following the calendar year in which the applicable election year began; or (2) 90 days after the day a refund claim is filed.215 A refund that is due for any applicable election year because the S corporation (or partnership) terminates its §444 election or liquidates is payable on the later of: (1) April 15 of the calendar year following the calendar year in which the applicable election year ends; or (2) 90 days after it files its refund claim.216 If such refund is not applied for in a timely manner (within three years of the filing of the return or within two years of the tax payment, whichever period expires later), no refund will be issued.216.1
215§7519(c)(3)(A)(i) and  (B).
216§7519(c)(3)(A)(ii) and  (B).
216.1Voss Indus., Inc. v. U.S., 2003-1 USTC ¶50,248 (N.D. Ohio 2003) (claim for refund of §7519 payment is a claim for refund of tax and is subject to §6511(a) limitation period).
Treasury regulations governing the procedure for claiming refunds have been reserved,217 and the IRS has indicated that "[f]orthcoming regulations or other form of guidance will provide procedural rules for taxable years beginning after 1988."218 Temporary regulations provide that: 
[I]n no event shall a refund be made prior to April 15 of the second calendar year that follows the calendar year in which an applicable election year begins. For example, assume a partnership made a section 444 election to retain its taxable year for its taxable year beginning October 1, 1987, and as a result made a required payment for such year. Further assume that the partnership terminates its election for its taxable year beginning October 1, 1988. Based on these facts, the partnership will be entitled to a refund, but no earlier than April 15, 1989.219
217Regs. §1.7519-2T(a)(6)(ii).
218Notice 89-41, 1989-1 C.B. 681. Notice 89-41 also sets forth procedures for claiming refunds for taxable years begun in 1988.
219Regs. §1.7519-2T(a)(6)(i).
(3)	Interest and Penalties
The required payment is treated as a subtitle C tax for purposes of interest on underpayments, penalties and collection.220 Therefore, interest is imposed at the underpayment rate under §6621 on any required payment that is not paid by the due date. In addition to any other penalties, the S corporation is subject to a penalty of 10% of any such underpayment (i.e., the excess of the amount of the payment required over any amount of such payment paid on or before April 15th).221 Any required payment is treated as a tax for purposes of the negligence and fraud penalties.222
220§7519(f); Regs. §1.7519-2T(b).
221§7519(f)(4)(A); Regs. §1.7519-2T(a)(5). A taxpayer defense to the 10% penalty was added by §1281(d) of the Taxpayer Relief Act of 1997 (P.L. 105-34). As amended, §7519(f)(4)(A) provides that no penalty shall be imposed for any failure to pay the prescribed amount which is shown to be due to reasonable cause and not willful neglect.
222§7519(f)(4)(B); Regs. §1.7519-2T(d).
Example: The required payment for the election year is $10,000 but the S corporation pays only $6,000 on Apr. 15. The rest is paid six months later.
Assuming the late payment is not due to negligence or fraud, the S corporation would owe an additional $400 (10% × ($10,000 - $6,000)) plus interest on the $4,000 underpayment for six months.
If the S corporation willfully fails to comply with the requirements of §7519, its election under §444 terminates, effective from the year in which the willful failure occurred.223 The automatic conversion to the required taxable year will result in a bunching of income for the shareholders, although the S corporation will be entitled to a refund of required payments that it made pursuant to §7519.
223§7519(f)(4)(C); Regs. §1.7519-2T(c); Regs. §1.444-1T(a)(5)(i)(C).
The IRS National Office has advised that willful failure to comply with the requirements of §7519 is not a permissible method of termination available for taxpayer use. The taxpayer cannot terminate its §444 election retroactively by triggering a cancellation of the election under §7519(f)(4) for willful failure to comply with the requirements of §7519. Termination under this provision is a penalty, the National Office reasoned, and therefore the determination of "willful failure" under the statute is made by the appropriate district director, not the taxpayer. To allow the taxpayer to apply willful failure as a method of termination would negate the monetary penalties that the statute imposes, the National Office stated.224
224TAM 9419002.
Note: For a discussion of the tax effects of an S corporation retaining a fiscal year or converting to a required taxable year, see 730 T.M., S Corporations--Formation and Termination.
6.	Grandfathered Fiscal Year
Some S corporations may retain grandfathered fiscal years.225 A "grandfathered fiscal year" is a fiscal year the S corporation received permission to use on or after July 1, 1974, and that permitted deferral of more than three months' income for its owners (i.e., a fiscal year for which a business purpose was established under pre-1986 law).226 A fiscal year accounting period may be grandfathered only if the corporation received IRS permission for that fiscal year.227
225See 1986 Conf. Rep., at II-319. See the Working Papers, below.
226Rev. Proc. 2002-38, §5.07.
227See TAM 9505003.
E. Permissible Taxable Years of Partnerships
Substantial limitations apply to the taxable years available to a partnership. In general, a partnership's taxable year must conform to that of its partners.228 A partnership may adopt a 52- 53-week taxable year ending with reference to the month in which its taxable year is required to end.229 It may adopt another accounting period if it establishes a business purpose to the satisfaction of the Commissioner.230 If a partnership makes the payments required by §7519, it may also adopt a taxable year beginning up to three months earlier than the required taxable year would begin.231 Some partnerships may retain grandfathered fiscal years. If the partnership fails clearly to specify its taxable year, the taxable year will be determined under §706(b).232
228§706(b). See 1986 Conf. Rep., at II-318 (reprinted in the Working Papers, below); H.R. Rep. No. 100-495, at 938.
229Regs. §1.706-1(b)(2)(ii). See IV, below, for a discussion of 52-53 week taxable years.
230§706(b)(1)(C); Regs. §1.706-1(b)(2)(ii).
231§444, §7519. See III, E, 3, below.
232See C.H. Leavell & Co. v. Comr., 53 T.C. 426 (1969).
1.	Required Tax Year
In general, a partnership must adopt a "required tax year,"233 defined as: 
(1) the "majority interest taxable year"234 or,
(2) if a taxable year cannot be established under (1), the same taxable year as that of all of its principal partners235 or
(3) if a taxable year cannot be established under (1) or (2), a taxable year that will result in the least aggregate deferral of income to partners.236
233§706(b)(1). See Rev. Proc. 2002-38, §5.03 (defining "required tax year").
234§706(b)(1)(B)(i); Regs. §1.706-1(b)(2)(i)(A).
235§706(b)(1)(B)(ii); Regs. §1.706-1(b)(2)(i)(B).
236§706(b)(1)(B)(iii) and Regs. §1.706-1(b)(2)(i)(C) prescribes "the calendar year unless the Secretary by regulations prescribes another period." The Secretary has used that authority to prescribe the taxable year that minimizes aggregate deferral. Regs. §1.706-1(b)(3). These rules apply not only to the selection of a taxable year by a newly formed partnership but also are imposed on all partnerships.
In CCA 200411043, the Chief Counsel's Office advised that, in order for a taxpayer to receive a refund of excess required payments, all delinquent Forms 8752 must be filed, even in taxable years where a required payment was zero. The Chief Counsel's Office stated that this ensures that a taxpayer's liability for underpayment interest and penalties for the year in question is established.
A "majority interest taxable year" is the taxable year (if any) that, on the testing day, constitutes the taxable year of one or more partners having (on the testing day) an aggregate interest in partnership profits and capital of more than 50%.237 The testing day is the first day of the partnership taxable year, or of a representative period as may be prescribed by the Secretary if that period is more representative of the ownership of the partnership.238 If a partnership is required to change its taxable year to the majority interest taxable year, it is not required to change to another taxable year for either of the two taxable years following the year of change.239
237§706(b)(4)(A)(i).
238§706(b)(4)(A)(ii).
239§706(b)(4)(B).
A principal partner is defined as any partner with at least a 5% interest in partnership profits or capital.240
240§706(b)(3).
Note: In determining the taxable year of a partnership under §706(b) and the regulations thereunder, any §444 election by a partner must be taken into account in determining the taxable year of the partnership.241 In addition, a partner that is tax exempt under §501(a) is disregarded if, in the partnership's taxable year immediately preceding the current year, the partner did not have any unrelated business taxable income attributable to its investment in the partnership (or, in the case of a new tax-exempt partner, if the partnership reasonably believes that the partner will not have any unrelated business taxable income attributable to its investment in the current year).242
241Regs. §1.706-1(b)(11). See T.D. 9009, 67 Fed. Reg. 48017 (7/23/02), effective Jul. 23, 2002, replacing Regs. §1.706-3T(b).
242Regs. §1.706-1(b)(5). See T.D. 9009, 67 Fed. Reg. 48017 (7/23/02), effective Jul. 23, 2002, replacing Regs. §1.706-3T(a).
If a partnership has a foreign partner then such partner is a disregarded partner unless such partner is allocated any gross income of the partnership that was effectively connected (or treated as effectively connected) with the conduct of a trade or business within the United States during the partnership's taxable year immediately preceding the current year and taxation of the income is not otherwise precluded under any U.S. income tax treaty.242.1 If the foreign partner was not a partner during the immediately preceding taxable year, and the partnership reasonably believes that the foreign partner will be allocated income treated as effectively connected with the conduct of a trade or business within the United States, then the foreign partner will not be disregarded.242.2 The regulations contain a minority interest rule which provides that if a partner is not a disregarded foreign partner and holds less than a 10% interest, and in the aggregate all such partners hold less than a 20% interest in the capital and profits of the partnership, then the rules for disregarding a foreign partner do not apply and, in addition, each regarded partner is treated as owning any interest in the partnership owned by a related partner.242.3 Partners will be deemed related if they are related within the meaning of §267(b) or §707(b), substituting the language "10 percent" in the place of "50 percent."242.4
242.1Regs. §1.706-1(b)(6)(i), T.D. 9009, 67 Fed. Reg. 48017 (7/23/02), effective Jul. 23, 2002.
242.2Id.
242.3Regs. §1.706-1(b)(6)(iii).
242.4Id.
Note: A partnership subject to Rev. Proc. 2002-38 must comply with the revenue procedure if the partnership is changing its annual accounting period because a related entity must change its accounting period, even if there are conflicting provisions under §706 or §898 or the regulations under §921.242.5
242.5Notice 2002-72, 2002-46 I.R.B. 843, modifying and clarifying Rev. Procs. 2002-37, 2002-22 I.R.B. 1030; 2002-38, 2002-22 I.R.B. 1037; and 2002-39, 2002-22 I.R.B. 1046.
a.	Least Aggregate Deferral
The aggregate deferral for a particular year is computed with respect to the taxable year of each partner. The amount of aggregate deferral for the year is determined by multiplying, for each partner, the months of deferral generated by that year times that partner's interest in partnership profits for that year and adding the amount thus derived for all the partners. The partner's taxable year that produces the lowest sum when compared to the other partners' taxable years is the taxable year that results in the least aggregate deferral of income to partners.243
243Regs. §1.706-1(b)(3)(i).
Example: A and B each have a 50% interest in a partnership. A and B report income on fiscal years ending June 30 and July 31, respectively. Aggregate deferral must therefore be determined for those two year ends. For a year end of June 30, A would have no deferral, and B would have one month of deferral. If the year end were July 31, A would have 11 months of deferral, and B would have no deferral. Therefore, the aggregate deferral for the period ending June 30 is 0.5 months (zero months × 50% + one month× 50%), and for the test period ending July 31 the aggregate deferral is 5.5 months (11 months × 50% + zero months × 50%). Therefore, because the aggregate deferral for the June 30 ending test period is less than that of the July 30 ending test period, the partnership must use a taxable year ending June 30.244
244Regs. §1.706-1(b)(3)(iv), Ex. 1.
If two or more taxable years result in the same aggregate deferral, the partnership may select any one of them as its taxable year, unless one of the taxable years is also the partnership's existing taxable year. In that case, the partnership must maintain its existing taxable year.245
245Regs. §1.706-1(b)(3)(i) and  (iv), Ex. 3.
The determination of the taxable year that results in the least aggregate deferral of income is generally made as of the beginning of the partnership's current taxable year. The appropriate director of the IRS, however, may determine that the beginning of the taxable year is not an appropriate time to determine the ownership of the partnership. The director may require the use of some other day or period that will more accurately reflect the ownership of the partnership, if the partners have engaged in a transaction the principal purpose of which is to avoid the principles of §706.246 A de minimis rule provides that if the taxable year that results in the least aggregate deferral of income produces a deferral of less than 0.5 months when compared to the aggregate deferral of the current taxable year, the partnership's current taxable year will be treated as the taxable year with the least aggregate deferral.247
246Regs. §1.706-1(b)(3)(i). The IRS indicated that a partnership is expected to be aware of any proposed voluntary changes in a partner's taxable year and to react accordingly if a partner effects such a change. Thus, the IRS concluded that a voluntary change in a partner's taxable year is to be considered in computing the least aggregate deferral if it affects the partner's deferral period. See PLR 8907042.
247Regs. §1.706-1(b)(3)(iii) and  -1(b)(3)(iv), Exs. 5 and 6.
b.	Business Purpose
In general, a partnership can establish a business purpose for adopting a fiscal year by satisfying the 25% gross receipts test, the annual business cycle test, or the seasonal business cycle test.248 A partnership may in rare circumstances be able to demonstrate a business purpose for a fiscal year by using the facts and circumstances test. The tests are discussed at III, C, 3, above.
248Rev. Procs. 2002-38 and 2002-39. Bearing in mind that Rev. Procs. 2002-38 and 2002-39 provide transitional rules, see Rev. Proc. 87-32 for changes, adoptions or retentions before May 10, 2002.
[Footnote 249 reserved.]
2.	Filing Requirements
The filing requirements for a partnership generally follow those described for a PSC in III, C, 3, e, above. The general partner must sign the Form 1128 on behalf of the partnership.250 The partnership should file the Form 1128 no earlier than the day following the end of the first effective year and no later than the due date, including extensions, of the federal return for the first effective year.251
250Rev. Proc. 2002-38, §7.02(4); Rev. Proc. 2002-39, §6.01(2). See Rev. Proc. 87-32 for filing requirements for before May 10, 2002, noting that Rev. Procs. 2002-38 and 2002-39 provide transitional rules for changes, adoptions and retentions pending on May 10, 2002.
251Rev. Proc. 2002-38, §7.02(2); Rev. Proc. 2002-39, §6.02(1). Rev. Proc. 2005-27, 2005-20 I.R.B. 1050, provides that the IRS may issue guidance extending the Rev. Proc. 2002-38 and Rev. Proc. 2002-39 filing deadlines for taxpayers who are serving in, or in support of, the Armed Forces in a combat zone, and for taxpayers affected by a Presidentially declared disaster or determined by the IRS to be affected by a terroristic or military action. In accordance with an amendment to §7508(a) by §104 of the Military Family Tax Relief Act of 2003, P.L. 108-121, such an extension would likely include service in a contingency operation, as well as in a combat zone.
3.	Partnership Election to Adopt Non-Required Year -- § 444 Election
Like an S corporation, a partnership may elect under §444 to use a taxable year with a deferral period of not more than three months.252 The deferral period is the number of months from the beginning of the desired taxable year until the close of the first taxable year determined under §706(b)(1)(B) ending during the desired taxable year.253 Partnerships (like S corporations) making this election must make "required payments" under §7519. For a discussion of these rules, see III, D, 5, above.
252§444(b).
253§444(b)(4) and  (e).
In addition to the rules described above, certain special rules apply to partnerships under §7519. First, partnership net income is the amount (not below zero) determined by taking into account the aggregate amount of the partnership's items described in §702(a), except for: (1) credits; (2) tax-exempt income; and (3) guaranteed payments under §707(c).254 Second, for purposes of determining the aggregate amount of partnership items, deductions and losses are treated as negative income.255 Last, any limitation on the amount of a partnership item described in §702(a) that may be taken into account for purposes of computing the taxable income of a partner must be disregarded in computing the net income of the partnership.256 In addition, a guaranteed payment (as defined by §707(c)) by a partnership is not treated as an applicable payment for purposes of computing the partnership's required payment.257
254§7519(d)(5); Regs. §1.7519-1T(b)(5)(ii)(A).
255§7519(d)(2)(A); Regs. §1.7519-1T(b)(5)(ii)(B).
256Regs. §1.7519-1T(b)(5)(ii)(C).
257§7519(d)(5).
4.	Grandfathered Fiscal Year
A partnership may also be able to retain a grandfathered fiscal year.258 A grandfathered fiscal year is defined as a fiscal year the partnership received permission to use on or after July 1, 1974, and that permitted deferral of more than three months' income for its owners (i.e., a fiscal year for which a business purpose was established under pre-1986 law).259
258See 1986 Conf. Rep. at II-319.
259Rev. Proc. 2002-38, §5.07.
5.	Temporary Changes in Ownership
Under Rev. Proc. 2002-38, where there is a minor, temporary percentage change in ownership, a partnership may retain its current taxable year for one year.259.1 However, if such change is not reversed at the end of the year, then the partnership must apply to retain its current year or to change to a taxable year for which it has a business purpose.259.2
259.1Rev. Proc. 2002-38, §4.01(5).
259.2Notice 2002-72, 2002-46 I.R.B. 843, modifying and clarifying Rev. Proc. 2002-38.
F. Certain Foreign Corporations
Section 898 restricts the taxable year available to many contolled foreign corporations (CFCs), as well as to foreign personal holding companies (FPHCs) before 2005.260 In general, a corporation subject to §898 ("Specified Foreign Corporation") must adopt the taxable year of its majority U.S. shareholder.261 The application of §898, as well as a number of exceptions thereto, are outlined in this section.
260§898(a) and  (b). The foreign personal holding company provisions (§§551-558) were repealed effective for taxable years of foreign corporations beginning after 2004 by the 2004 American Jobs Creation Act, P.L. 108-357, §413(a)(1).
261§898(c)(1)(A).
1.	Specified Foreign Corporations
In general, any foreign corporation that is a CFC for any purpose of Subpart F (§§951-964) is a Specified Foreign Corporation if it meets the ownership requirements of §898(b)(2).262 Such a corporation meets those ownership requirements if a U.S. shareholder 263 owns, on each testing day, more than fifty percent of either (1) the total voting power of all classes of stock of the corporation entitled to vote, or (2) the total value of all classes of stock of the corporation.264
262§898(b)(1). Before 2005, the definition of a Specified Foreign Corporation also include an FPHC (as defined by former §552).
263In general, for purposes of §898 a U.S. shareholder means a U.S. person who owns, actually or constructively, 10% or more of the total combined voting power of all classes of stock entitled to vote of the corporation. §898(b)(3); §951(b). In the case of any former FPHC that was not also a CFC, a U.S. shareholder was any person who was treated under former §551 as a U.S. shareholder for purposes of the former FPHC rules. Former §898(b)(3)(B).
264§898(b)(2)(A). For purposes of applying the ownership requirements, a CFC applies the constructive ownership rules of §958. §898(b)(2)(B). A former FPHC applied the constructive ownership rules of former §§551(f) and 554. Former §898(b)(2)(B).
Testing days are (1) the first day of the corporation's taxable year (determined without regard to §898) and (2) the days during such representative period as the Secretary may prescribe.265 Proposed regulations provide that any day after the first day of a taxable year (determined without regard to §898) is a testing day if a substantial change in the U.S. ownership of its stock occurs on that day. A substantial change in the U.S. ownership of the stock of a specified foreign corporation is a change that results in a new more-than-50% U.S. shareholder of the corporation.266 An anti-abuse rule would permit the appropriate district director to require the use of a testing day that will reflect, more accurately than those described above, the ownership of the corporation and thereby the aggregate deferral of income to its U.S. shareholders if the U.S. shareholders engage in a transaction (or transactions) with the principle purpose of avoiding the purpose of §898.267
265§898(c)(3)(B)(ii).
266Prop. Regs. §1.898-3(a)(5)(iii).
267Prop. Regs. §1.898-3(a)(5)(v). See also Prop. Regs. §1.898-4(b)(3).
Proposed regulations would exempt foreign corporations from the §898 rules in three circumstances: (1) if a corporation's U.S. shareholders have never had any amount includible in gross income pursuant to §951(a) and did not receive any actual or deemed distributions attributable to amounts described in former §553 (foreign personal holding company income);268 (2) if a corporation is a foreign insurance company and elects to be treated as a domestic corporation pursuant to §953(d); and (3) if a corporation organized under the laws of a contiguous foreign country elects, under provisions of §1504(d), to be treated as a domestic corporation.269 Under the proposed regulations, a foreign corporation that is not a CFC for 30 days or more during the current taxable year will be required to determine whether it is a Specified Foreign Corporation on any testing day during the current year only if the foreign corporation (1) met the FPHC ownership requirements of former §552(a)(2) for the current taxable year, and (2) was an FPHC for its taxable year immediately preceding the current taxable year.270
268Many specified foreign corporations that would have been eligible for this exception changed taxable years under §898 before the proposed regulations were issued. Notice 95-13, 1995-1 C.B. 296, provides that many such corporations that remain eligible for that exception will be permitted to revert to their prior taxable years. To do so, such a corporation had to file Form 5471 (and, if applicable, Form 1120-F) no later than Mar. 14, 1997. If such a corporation missed that deadline, it may request the consent of the Commissioner for the reversion under §442 and its regulations. Such a reversion would create a short year. The reversion is not available if it would create a short year for which the filing of a Form 1120-F would be past due (including extensions).
269Prop. Regs. §1.898-1(c).
270Prop. Regs. §1.898-2(c).
2.	Required Taxable Year
In general, a Specified Foreign Corporation must adopt the taxable year of its majority U.S. shareholder.271 A Specified Foreign Corporation may adopt a taxable year that begins one month earlier than the majority U.S. shareholder year.272
271§898(c)(1)(A).
272§898(c)(2); Prop. Regs. §1.898-3(a)(2).
A corporation that elects such a one month deferral may revoke that election. If it does so, the proposed regulations would not permit it to re-elect that deferral for five years. Prop. Regs. §1.898-4(b)(2)(iv). Rev. Proc. 2002-37, 2002-22 I.R.B. 1030, while not applying generally to CFCs, establishes the procedural requirements for a CFC to revoke its one-month deferral election under §898(c)(1)(B) and to change its taxable year to the majority U.S. shareholder year. Rev. Proc. 2002-37, §4.01(4). These procedures differ from, and presumably take precedence over, earlier proposed regulations, which the IRS has not yet withdrawn. See Prop. Regs. §1.898-4(b)(2)(v).
In general, the majority U.S. shareholder taxable year of a Specified Foreign Corporation means the taxable year (if any) that, on each testing day, constituted the taxable year of either (1) the U.S. shareholder that owns more than fifty percent of the voting power of all classes of stock of the Specified Foreign Corporation entitled to vote or more than fifty percent of the total value of all classes of stock of the Specified Foreign Corporation, after the application of the attribution rules described in §898(b)(2)(B), (the "more than fifty percent U.S. shareholder"), or (2) each U.S. shareholder that is not a more than fifty percent U.S. shareholder and whose stock was treated under the attribution rules described in §898(b)(2)(B) as owned by the more than fifty percent U.S. shareholder.273
273§898(c)(3)(A). See also Prop. Regs. §1.898-3(b)(1); Prop. Regs. §1.898-3(a)(3)(i). With respect to U.S. shareholders that are passthrough entities, the proposed regulations would determine the majority U.S. shareholder year based on the taxable year of the passthrough entity rather than the taxable years of the passthrough entity's shareholders, partners, or beneficiaries. Prop. Regs. §1.898-3(a)(3)(ii).
This rule may produce inconsistent taxable years. Proposed regulations provide that if it does, the specified foreign corporation must adopt the taxable year that results in the least aggregate deferral of income to all U.S. shareholders of the specified foreign corporation, even if that taxable year is not a majority U.S. shareholder year.274
274Prop. Regs. §1.898-3(a)(4)(i). If the required year is determined under this provision, the one-month deferral election is unavailable. Id.
The aggregate deferral of income for a particular year is equal to the sum of the products determined by multiplying, on each testing day, the number of months of deferral for each U.S. shareholder (that is a shareholder on the testing day) that would be generated by that year end by that U.S. shareholder's percentage interest in deemed distributions from the specified foreign corporation. The number of months of deferral for a U.S. shareholder of a specified foreign corporation is measured by the number of whole or partial months from the end of the taxable year of the specified foreign corporation to the end of the taxable year of the U.S. shareholder. If the calculation results in more than one taxable year with the least aggregate deferral, the specified foreign corporation may select any one of those years as its taxable year. If one of those years is also its existing year, however, it must maintain its existing year.275
275Prop. Regs. §1.898-3(a)(4)(ii).
Example: FX is a foreign corporation with two classes of stock, only one of which is voting stock. Each class of stock shares equally in distributions. FX has a June 30 taxable year. FX's shareholders, A, B, and C are U.S. citizens and each acquired the stock in FX on July 1. A owns 45% of each class of stock, B owns 35% of each class of stock, and C owns the remaining 20% of each class of stock. A is B's grandfather and C is unrelated to A and B. A and C are calendar year taxpayers. B's taxable year ends on June 30. Under §§958(b)(1) and 318(a)(1)(A), A is considered to own the stock owned by B. Under §898(c)(3)(A)(i), A is a more than 50% U.S. shareholder and under §898(c)(3)(A)(ii), B is a U.S. shareholder whose stock is considered to be owned by a more than 50% U.S. shareholder. Accordingly, FX has two majority U.S. shareholder years, the calendar year and the fiscal year ending June 30. These majority U.S. shareholder years are inconsistent.
FX must conform its taxable year to the required year by adopting the taxable year that results in the least aggregate deferral of income, taking into consideration the taxable year of each U.S. shareholder, including C. The taxable year ending Dec. 31 produces .35 × 6 (B's percentage share of distributions from FX multiplied by the number of months of deferral if Dec. 31 is the required year), or a product of 2.1. The taxable year ending June 30 produces [.45 × 6] plus [.20 × 6] (A and C's percentage shares of distributions from FX multiplied by the number of months of deferral if June 30 is the required year), or a product of 3.9. Accordingly, the taxable year ending Dec. 31 is the required year. However, if C's year end were also June 30, or if only the nonvoting stock shared in distributions and B owned all of the nonvoting stock, then the taxable year ending June 30 would produce the least aggregate deferral of income, and would be the required year.
Example: LX is a calendar year foreign corporation with one class of stock. LX's shareholders, A, B and C are U.S. citizens and each acquired the stock in FX on January 1. A is B's grandfather and C is unrelated to A and B. A owns 10% of LX's stock and has a taxable year ending June 30. B owns 45% of LX's stock and has a taxable year ending March 31. C owns the remaining 45% of LX and has a September 30 taxable year. Under §§958(b)(1) and 318(a)(1)(A), A is considered to own the stock owned by B. Under §898(c)(1)(C)(i)(I), A is a more than 50% U.S. shareholder and under §898(c)(1)(C)(i)(II), B is a U.S. shareholder whose stock is considered to be owned by a more than 50% U.S. shareholder. Accordingly, LX has two inconsistent majority U.S. shareholder years, the fiscal year ending June 30 and the fiscal year ending March 31.
LX must conform its taxable year to the required year by adopting the taxable year that results in the least aggregate deferral of income, taking into consideration the taxable year of each U.S. shareholder. The taxable year ending June 30 produces [.45 X 3] plus [.45 X 9] (B and C's, respective percentage shares of distributions multiplied by the number of months of deferral), or a product of 5.4. The taxable year ending March 31 produces [.1 X 9] plus [.45 X 6] (A and C's percentage shares of distributions multiplied by the number of months of deferral), or a product of 3.6. The taxable year ending September 30 produces [.1 X 3] plus [.45 X 6] (A and B's percentage shares of distributions multiplied by the number of months of deferral), or a product of 3.0. Accordingly, September 30 is the required year, even though it is not the taxable year of a majority U.S. shareholder.276
276Prop. Regs. § 1.898-3(a)(4)(iii).
Rather than conforming the taxable year of a specified foreign corporation to that of its majority U.S. shareholder, the requirements of §898 may be satisfied by conforming the shareholder's taxable year to that of the specified foreign corporation. Such a change, however, requires the approval of the Commissioner and must be made in accordance with §442 and the regulations issued thereunder.277
277Prop. Regs. § 1.898-4(b)(4).
If a majority U.S. shareholder has a 52-53-week taxable year and the specified foreign corporation chooses not to adopt such a year, then the required year of the specified foreign corporation must end on the last day of the same month used in determining the 52-53-week taxable year of its majority U.S. shareholder.278 If a specified foreign corporation elects to follow a 52-53-week taxable year and the majority U.S. shareholder chooses not to do so, then the required year of the specified foreign corporation shall be a 52-53-week taxable year that must end within a seven-day period from the last day of the taxable year of its majority U.S. shareholder.279 In either case, the availability of a one-month deferral remains unchanged.280
278Prop. Regs. § 1.898-4(c)(3)(i).
279Prop. Regs. § 1.898-4(c)(3)(ii).
280Prop. Regs. § 1.898-4(c)(3)(i), and (ii).
Example: X is a U.S. corporation created on January 1, 1996, that elected to follow a 52-53-week taxable year which ends on the Friday nearest the end of December. Thus, X's first U.S. taxable year began on Monday, January 1, 1996, and ended on Friday, January 3, 1997. Its next taxable year began on Saturday, January 4, 1997, and ended on Friday, January 2, 1998. X owns 100% of FY, a specified foreign corporation that is a controlled foreign corporation which follows a 12-month taxable year ending on November 30. In these circumstances, X's taxable year may end either earlier or later than one month after the end of FY's taxable year. Nonetheless, an election under §898(c)(2), which would permit FY to retain its current taxable year, will be effective because FY's taxable year ends on the last day of the month which immediately precedes the same month used in determining the 52-53-week taxable year of X, its majority U.S. shareholder.
Example: Y is a U.S. person with a taxable year ending September 30. Y also is the majority U.S. shareholder of FX, a specified foreign corporation which is a controlled foreign corporation that wishes to make the one-month deferral election under §898(c)(2). FX follows a 52-53-week taxable year that ends on the Monday closest to the last day of August. In 1996, the last day of August fell on a Saturday. Thus, FX's taxable year ended on Monday, September 2, 1996, a date within a seven-day period from the last day of the month which immediately precedes the 12-month taxable year of its majority United States shareholder, Y. In 1999, FX's taxable year will end on Monday, August 30, and its next taxable year will begin on August 31, 1999. Thus, in 1999, FX's taxable year will begin more than one month before the beginning of Y's United States taxable year. Nevertheless, the election made under §898(c)(2) will be effective because FX's taxable year will end within a seven-day period from the last day of the month which immediately precedes the 12-month taxable year of its majority United States shareholder.281
281Prop. Regs. § 1.898-4(c)(3)(iii).
If a captive insurance company elects under §953(c)(3)(C) to treat its related person insurance income as income effectively connected with the conduct of a trade or business in the U.S., it must use the calendar year as its annual accounting period for U.S. tax purposes, regardless of the taxable year of its majority U.S. shareholder.282
282Prop. Regs. § 1.898-4(c)(4).
3.	Procedural Rules
A specified foreign corporation must conform its taxable year to a different required year should circumstances arise in which the required year changes, such as when a substantial change in ownership of a specified foreign corporation results in a new more than fifty percent U.S. shareholder with a different majority U.S. shareholder year.283 Such a change in taxable year is treated as initiated by the taxpayer and as having been made with the consent of the Commissioner.284 In general, if a specified foreign corporation is required to conform to a different required year, the words "Change in Taxable Year" must be placed in the upper left hand corner of the first page of Form 5471, and, if applicable, on Form 1120-F, with respect to the taxable year for which the change is made.285 A specified foreign corporation electing a one-month deferral must place the words "Section 898(c)(1)(B) Election -- Change in Taxable Year" in the upper left hand corner of the first page of Form 5471 and, if applicable, on Form 1120-F, with respect to the taxable year for which the change is made.286
283Prop. Regs. § 1.898-4(b)(1). Special rules are proposed for specified foreign corporations' first taxable years begun after July 10, 1989. See Prop. Regs. § 1.898-4(a); Prop. Regs. § 1.898-4(d). See also Rev. Proc. 90-26, 1990-1 C.B. 512.
284Prop. Regs. § 1.898-4(b)(1).
285Prop. Regs. § 1.898-4(b)(2)(i). Special rules apply to specified foreign corporations that conformed their taxable years to those required by §898 but did not follow the procedures of Prop. Regs. § 1.898-4(b)(2). See Prop. Regs. § 1.898-4(b)(2)(iii).
286Prop. Regs. § 1.898-4(b)(2)(ii). For taxable years beginning after 2004, the election should presumably read "Section 898(c)(2) Election--Change in Taxable Year" to reflect the redesignation of the relevant Code section by the 2004 American Jobs Creation Act, P.L. 108-357, §413.
Any short period required for a specified foreign corporation to conform its taxable year to that required by §898 will begin on the first day of the specified foreign corporation's current taxable year and will end on the last day of the new required year within which the change in ownership of the specified foreign corporation (or other event that necessitates a change in taxable year) occurs.287 If, however, the last day of the current year occurs before the last day of the new required year within which the change in ownership (or other event resulting in a new required year) occurs, then the short period will begin the day after the last day of the current year and will end on the last day of the new required year after the required year within which the change in ownership (or other event resulting in a new required year) occurs.288 In no case shall the taxable year of the specified foreign corporation be in excess of one year.289
287Prop. Regs. § 1.898-4(b)(3)(i).
288Id.
289Id.
Example: FX is a foreign corporation that is a specified foreign corporation within the meaning of §898(b). FX had been a calendar year taxpayer. On July 1, 1997, FX was purchased by a U.S. shareholder with a September 30 fiscal year. Accordingly, the short period required to change the taxable year of FX to the required year began on January 1, 1997, the first day of FX's current taxable year, and ended on September 30, 1997, the last day of the new required year within which the change in ownership of FX occurred.
Example: The facts are the same as in the above Example except that on July 1, 1997, FX was purchased by a U.S. shareholder with a June 30 fiscal year. Accordingly, the short period required to change the taxable year of FX to the required year does not begin until January 1, 1998, the day following the last day of FX's current taxable year because the last day of FX's current taxable year occurs before the last day of the new required year within which the change in ownership occurred. The short period will begin January 1, 1998, and will end June 30, 1998.290
290Prop. Regs. § 1.898-4(b)(3)(ii).
4.	Nonconforming Taxable Years
If a specified foreign corporation's foreign taxable year (for purposes of computing income tax liabilities due a foreign country) does not conform to the required year under §898, two methods are available for its U.S. shareholders to compute any income inclusion relating to the specified foreign corporation including, but not limited to, Subpart F income, increase in earnings invested in U.S. property, (before 2005) FPHC income, and §864(d) income.291 First, the specified foreign corporation could maintain separate books of account based upon the required year.292
291Prop. Regs. § 1.898-4(c)(1). The foreign personal holding company (FPHC) provisions (§§551-558) were repealed effective for taxable years of foreign corporations beginning after 2004 by the 2004 American Jobs Creation Act, P.L. 108-357, §413(a)(1).
292Prop. Regs. § 1.898-4(c)(2)(i).
In the alternative, income and earnings and profits can be allocated in a two step process. First, for the foreign annual accounting period of the specified foreign corporation that ends within its required year, the income (and earnings and profits) of the specified foreign corporation is the entire income (or earnings and profits) of the foreign annual accounting period, less the income (or earnings and profits), if any, of that foreign annual accounting period properly allocable to the preceding taxable year, determined under a consistent application of the principles of §964 and its regulations. Second, for the foreign annual accounting period of the specified foreign corporation that ends after its required year, the income (and earnings and profits) of the specified foreign corporation is the income (and earnings and profits) of each month (or quarter) that has ended within the required year determined on the basis of interim actual book closings and computed by a consistent application of the principles of §964 and its regulations. If the amount of income properly includible in the gross income of U.S. shareholders in the preceding taxable year, is different from the amount of income actually included by U.S. shareholders in the preceding taxable year, then an adjustment must be made by each U.S. person affected by means of an amended return for that preceding taxable year.293
293Prop. Regs. § 1.898-4(c)(2)(ii).
Example: FX is a specified foreign corporation organized in foreign country, FC. FX's annual accounting period and taxable year, for FC purposes, end March 31. FX's required year is the calendar year. FX did not conform its FC taxable year to the required year. Separate books for United States tax purposes are not maintained. Accordingly, FX's required year, Calendar Year 1, will include portions of two FC annual accounting periods and FC taxable years.
For the FC period ending March 31, during Calendar Year 1, FX's income (in U.S. dollars) was $1,000, all of which was FPHC income. This amount was determined on the basis of FX's annual March 31, FC financial reports, adjusted in accordance with §964 and the regulations under that section. Of the $1,000, it was determined from the annual financial reports that $350 was earned during the months ending in Calendar Year 1. For the period April 1, during Calendar Year 1, to the end of Calendar Year 1, FX's income was $1,200, determined on the basis of FX's monthly interim FC books of account. Accordingly, the income of FX subject to inclusion in the gross income of U.S. shareholders for Calendar Year 1, is $1,550. However, based on FX's annual March 31, Year 2, financial reports (adjusted in accordance with §964 and the regulations under that section), FX's income for the period April 1, during Calendar Year 1, to the end of Calendar Year 1 was $1,300, not $1,200. Accordingly, each U.S. shareholder of FX must file an amended return for Calendar Year 1 showing its portion of the additional $100 of income.294
294Prop. Regs. §1.898-4(c)(2)(iii).
G. Required Taxable Years of Special Entities
Special rules apply to the adoption of the taxable years of real estate investment trusts, insurance companies, employee benefit plans, trusts, and estates, and bank common trust funds.
1.	Real Estate Investment Trusts ("REITs")
REITs may not change to an accounting period other than a calendar year. In addition, a corporation, trust, or association may not elect to be a REIT for any taxable year beginning after October 4, 1976, unless its accounting period is the calendar year. Therefore, unless the REIT was in existence for a taxable year beginning on or before October 4, 1976, a calendar year-end is required.295
295§859(a)(1).
2.	Insurance Companies
An insurance company subject to tax under Subchapter L is required to adopt a calendar year accounting period, except in the first year in which it joins in the filing of a consolidated return of an affiliated group the common parent of which does not have a calendar year.296 If an insurance company is included in a consolidated return using a fiscal year, it must be able to reconcile its fiscal year returns with its calendar year regulatory filings.297
296§843; Regs. §1.1502-76(a)(2).
297PLR 8239100.
Note: An insurance company subject to tax under Subchapter L can file consolidated tax returns with its parent corporation only after the insurance company has been a member of the affiliated group for the five years immediately preceding the taxable year for which the consolidated return is filed. The election to include an insurance company in the consolidated returns must be made by the parent corporation.298
298§1504(c)(2)(A).
3.	Employee Benefit Plans, Trusts, and Estates
Employee benefit plans are generally subject to the rules of §441 for adopting a year-end. In addition, employee benefit plans are subject to the rules and restrictions placed on them by the Employee Retirement Income Security Act, which may require the use of specified year-ends. Like other entities, the time at which an employee benefit plan must adopt a taxable year is when a return is first required.299 In general, the restrictions applicable to employee benefit plans depend upon the legal form of the entity (typically a tax-exempt trust).
299See §6033 for rules regarding the filing of returns for tax-exempt organizations.
The adoption of a fiscal year by an estate is similarly governed by the general rules of §441. All trusts, other than charitable and tax-exempt trusts, must adopt or change to a calendar taxable year.300
300§644, as redesignated by §507(b)(1) of the Taxpayer Relief Act of 1997 (P.L. 105-34). For pre-1987 taxable years, see Rev. Rul. 57-71, 1957-1 C.B. 171.
4.	Bank Common Trust Funds
The taxable year of any common trust fund shall be the calendar year.301 A common trust fund is a fund maintained by a bank (1) exclusively for the collective investment and reinvestment of moneys contributed thereto by the bank in its capacity as a trustee, executor, administrator, guardian, or custodian of accounts under state laws substantially similar to the Uniform Gifts to Minors Act with respect to which the bank has duties and responsibilities similar to those of a trustee or guardian; and (2) in conformity with rules and regulations of the Board of Governors of the Federal Reserve System or the Comptroller of the Currency pertaining to the collective investment of trust funds by national banks.302 For these purposes, two or more banks that are members of the same affiliated group are treated as one bank with respect to any fund of which any of the banks is trustee or two or more of the member banks are co-trustees.303
301§584(i).
302§584(a).
303Id.
H. Adoption of Fiscal Year by an Individual
In general, a calendar year is mandatory if an individual keeps no books, does not have an annual accounting period, or has an annual accounting period but the period does not qualify as a fiscal year.304 There are, however, a variety of situations in which certain individuals may be allowed to adopt a fiscal year.
304§441(g). See also Regs. §1.441-1(b)(1)(iv).
1.	New Taxpayer
Subject to the basic requirements of §441 (see II, above) an individual who is considered a new taxpayer may adopt in his or her first return a fiscal year without obtaining prior approval.305 The term "new taxpayer" means a taxpayer subject to U.S. taxation for the first time. For example, a U.S. citizen or resident whose taxable income rises above the threshold for filing a return for the first time, or a nonresident alien who becomes engaged in a U.S. business for the first time, is considered a new taxpayer. Every individual who is a citizen, resident, or alien bona fide resident of Puerto Rico must make and file a tax return if he or she has gross income for the taxable year in excess of the statutory threshold for filing.306 Once a taxable year has been adopted, the individual must use it for all subsequent taxable years unless he or she obtains prior approval to change from the Commissioner.307
305Regs. §1.441-1(c)(1). A taxpayer's newly formed sole proprietorship is not a new taxpayer. Therefore, the taxpayer may not adopt a taxable year for the proprietorship that differs from his own. Vance v. Comr.,56 T.C.M. 1408 (1989).
306§6012(a)(1); Regs. §1.6012-1(a).
307Regs. §1.441-1(e). For a discussion of the procedures by which an individual may obtain automatic consent to change the individual's annual accounting period from a fiscal to a calendar year, see VI, B, 3, below (C&A pages).
2.	Resident and Nonresident Aliens Engaged in U.S. Business
Similar to the treatment of citizens and residents of the U.S. discussed supra, a resident or nonresident alien engaged in a U.S. trade or business may elect a fiscal year if that individual meets the general requirements of §441 (i.e., adequate books and records are kept on the basis of the desired fiscal year and the taxable year ends on, or with reference to, the last day of a calendar month).308 Although the taxpayer has or had an annual accounting period in another country, a different year is available for U.S. tax purposes when the nonresident alien first becomes a U.S. taxpayer.
308See §441(e),  (g). See also II, above.
Therefore, when the alien receives enough income effectively connected with a U.S. trade or business, the taxpayer must adopt a taxable year.309 That year may be a fiscal year, if the taxpayer meets the general requirements of §441.
309Rev. Rul. 80-352, 1980-2 C.B. 160. See §864 and the regulations thereunder for the rules regarding the determination of effectively connected income.
IV. The 52-53-Week Taxable Year
The 52-53-week taxable year is a year that ends on the same day of the week with reference to the end of a specific calendar month, instead of on the last day of the calendar month itself.310
310§ 441(f)(1).
Example: A taxpayer utilizing a 52-53-week year could choose Saturday as the year-end day and November as the year-end month. Depending upon the taxpayer's initial selection, the taxable year will end either on the last Saturday in November or on the Saturday nearest Nov. 30, which in some years will be the first Saturday in December.
The taxpayer's initial choice is binding absent approval to change from the Commissioner.311 Formerly, partnerships, S corporations, and personal service corporations were greatly restricted in their ability to adopt and change to and from a particular taxable year, including 52-53-week years. However, a newly-formed partnership, S corporation or PSC may adopt a 52-53-week year without IRS approval if such tax year ends with reference to the taxpayer's required taxable year or to the taxable year elected under §444. Additionaly, the IRS has provided guidance on allowing partnerships, S corporations, electing S corporations and PSCs to adopt, change to or retain a 52-53-week taxable year.312
311Regs. §1.441-2(b)(2).
312Regs. §1.441-2(b)(1)(i); Rev. Proc. 2002-38; Rev. Proc. 2002-39. See IV, B, 1, below. Rev. Procs. 2002-38 and 2002-39 are reproduced in the working papers.
A 52-53-week taxable year is always a fiscal year for federal income tax purposes, even if the last day of the calendar month of reference is December 31.313 A 52-53-week year will occasionally exceed 12 calendar months.
313§ 441(e).
A. Advantages and Tax Effect of a 52-53-Week Taxable Year
Adoption of a 52-53-week year normally has little effect from a tax standpoint, but it can result in substantial business advantages. A four-week period is a uniform, fixed period that affords a solid basis for comparative statistical, budgetary and other business purposes. Calendar months, with their varied lengths and varying numbers of Sundays, Saturdays, and other days of the week, do not supply the same consistency. Using a 52-53-week year allows for comparison of operating results of one four-week period with another without complicated adjustments for extra days that may be necessary in calendar-month comparisons. Similarly, if one day of the week is customarily a heavy business day, such as Friday in the case of retail supermarkets, use of a 52-53-week year avoids having four Fridays in one period and five in another, as would often happen with calendar-month comparisons.
In businesses, such as the amusement business or the resort hotel and catering businesses, that depend on weekend trade for the bulk of their business, a mid-week day could be selected for the end of the business week, rather than a Friday or a Saturday. This type of selection would provide that each week will include the business of a full weekend.
Apart from comparative uses, a 52-53-week year enables simplification or elimination of adjustments for accruals such as weekly wages or other expenses normally accrued on a weekly basis. Also, if business activity typically ends on Friday or Saturday, choosing a weekend day for year-end makes possible the physical taking of inventories during the weekend with minimal interruptions.
B. Adoption of or Change to a 52-53-Week Taxable Year
Many taxpayers are subject to rules limiting the taxable years available to them (see III, above). Subject to those restrictions, a new taxpayer may adopt the 52-53-week taxable year for its first taxable year without obtaining the prior approval of the Commissioner.314 A taxpayer is not allowed to adopt a 52-53-week year (or any fiscal year) if the taxpayer keeps no books, has no annual accounting period, or has an annual accounting period that does not qualify as a fiscal year.315 Taxpayers can generally receive automatic consent to change from a 52-53-week taxable year that references a particular month to a non-52-53-week taxable year that ends on the last day of that month, and vice versa.316
314Regs. §1.441-2(b)(1)(i), referencing Regs. §1.441-1(c). In addition, Regs. §1.441-2(b)(1)(i) allows a newly-formed partnership, S corporation or PSC to adopt a 52-53-week year without IRS approval if such tax year ends with reference to the taxpayer's required taxable year or to the taxable year elected under §444.
315§441(g).
316Rev. Proc. 2002-37, §4.01(2); Rev. Proc. 2002-38, §4.01(4). A taxpayer will not be granted automatic approval to change from one 52-53-week taxable year to another 52-53-week year, even if both years reference the same calendar month. Regs. §1.441-2(b)(2); Preamble to T.D. 8996, 67 Fed. Reg. 35009 (5/17/02). The Preamble to T.D. 8996 is reproduced in the working papers.
[Footnote 317 reserved.]
Example: A C corporation can receive automatic consent to change from a calendar year to a taxable year ending on the Thursday falling nearest to Jan. 31.
1.	Partnerships, S Corporations, and Personal Service Corporations
Special rules apply to partnerships, S corporations, personal service corporations and their owners.318 If the taxable year of an entity and an owner end with reference to the same calendar month, items that are passed through to the owner, as well as items that are deductible by the entity and includible in the owner's income, are taken into account by the owner as though the owner's taxable year ended on the last day of the entity's taxable year.319 This rule prevents deferral of income to the owners if the taxable years of the owners end with reference to the same calendar month as the entity's.
318See Regs. §1.441-2(e). These special rules also apply to other pass-through entities, including trusts, estates, closely-held REITs, common trust funds, CFCs, FPHCs (for taxable years of foreign corporations beginning prior to Jan. 1, 2005), and PFICs. Regs. §1.441-2(e)(3)(i).
319Regs. §1.441-2(e)(1).
Example: Assume a partnership adopts a 52-53-week taxable year ending with reference to Dec. 31 and that the partners are all calendar year taxpayers. Further assume that for the partnership's taxable year ending Jan. 3, 2003, each partner's distributive share is $10,000. The partners must take the $10,000 into income in their 2002 taxable years. This is true even if the partners have 52-53-week taxable years that end a few days before Jan. 3, 2003. Similarly, if the partnership makes a guaranteed payment to Partner D on Jan. 3, 2003, D must include the payment in her 2002 taxable year.
2.	Changes Requiring Approval
An existing taxpayer's change to or from a 52-53-week taxable year is treated as a change requiring IRS approval.320 However, in certain circumstances, a taxpayer can receive automatic approval.320.1 Taxpayers can generally receive automatic consent to change from a 52-53-week taxable year that references a particular month to a non-52-53-week taxable year that ends on the last day of that month, and vice versa.321 Further, a C corporation, other than certain specified types, can receive automatic consent to change to or from a 52-53-week taxable year.321.1 These automatic consent provisions are subject to various scope limitations.321.2 If the Commissioner's approval is required but not properly obtained, the Commissioner may either: (1) disapprove the change and require a return to the old taxable year, or (2) accept the new taxable year-end.322
320Regs. §1.441-2(b)(2)(i).
320.1Id.; Rev. Proc. 2002-37, §4.01(2); Rev. Proc. 2002-38, §4.01(4).
321Rev. Proc. 2002-37, §4.01(2); Rev. Proc. 2002-38, §4.01(4). A taxpayer will not be granted automatic approval to change from one 52-53-week taxable year to another 52-53-week year, even if both years reference the same calendar month. Regs. §1.441-2(b)(2); Preamble to T.D. 8996, 67 Fed. Reg. 35009 (5/17/02).
321.1Rev. Proc. 2002-37, §4.01(2).
321.2Rev. Proc. 2002-37, §4.02; Rev. Proc. 2002-38, §4.02. Notice 2002-72, 2002-46 I.R.B. 843, modifying and clarifying Rev. Procs. 2002-37, 2002-22 I.R.B. 1030; 2002-38, 2002-22 I.R.B. 1037; and 2002-39, 2002-22 I.R.B. 1046, provides that certain passthrough interests that have existed for three years may be disregarded under the de minimis test under Rev. Proc. 2002-37, §4.02(2)(d), even though the interest does not qualify for the exceptions under §4.02(2)(c).
322Williamson v. Comr., 22 T.C. 684 (1954).
3.	Requirements for Adoption of or Change to a 52-53-Week Taxable Year Without Approval
Like other taxable years, the Commissioner's approval is not required for adoption or change in all circumstances. There are, however, requirements that must be met as conditions for adopting or changing to a 52-53-week taxable year, even if the Commissioner's approval is unnecessary.323
323See Regs. §1.441-2(b); Rev. Procs. 2002-37 and 2002-38.
A corporation or partnership subject to either Rev. Proc. 2002-37 or Rev. Proc. 2002-38 must comply with the revenue procedure if it is changing its annual accounting period because a related entity must change its accounting period, even if there are conflicting provisions under §706 or §898 or the regulations under §921.323.1
323.1Notice 2002-72, 2002-46 I.R.B. 843, modifying and clarifying Rev. Procs. 2002-37, 2002-22 I.R.B. 1030 and 2002-38, 2002-22 I.R.B. 1037.
a.	Books and Records Must Reflect Adoption or Change
A taxpayer that adopts or changes to a 52-53-week year in reporting taxable income must keep its books on the same basis.324 For the year of adoption or change the taxpayer must conform its books to the changed year.325 If the taxpayer keeps its books on another basis, the IRS must calculate taxable income using the year-end of the taxpayer's books. The IRS does not have the discretion selectively to choose the taxable year that would provide it with the most advantageous result.326
324Regs. §1.441-1(b)(5) (a fiscal year, including by definition a 52-53-week taxable year, will only be recognized if the taxpayer's books are kept in accordance with the same fiscal year). Exceptions under Rev. Procs. 2002-37, 2002-22 I.R.B. 1030; 2002-38, 2002-22 I.R.B. 1037; or 2002-39, 2002-22 I.R.B. 1046, apply to books and records kept for financial accounting purposes, but not for tax accounting purposes.
325Id.
326Brooklyn City R.R. Co. v. Comr., 27 B.T.A. 77 (1932), acq., 1958-2 C.B. 4, aff'd, 72 F.2d 274 (2d Cir. 1934).
b.	The 52-53-Week Taxable Year Elected by the Taxpayer Must Conform to Statutory Specifications
The 52-53-week year that the taxpayer adopts or elects is a fiscal year that always ends on the same day of the week and always ends on: 
(1) Whatever date this day last occurs in a calendar month, or
(2) Whatever date this day falls that is nearest to the last day of the calendar month.327
327Regs. §1.441-2(a)(1).
Example: If a taxpayer elected a taxable year always ending on the last Friday in October, for the year 2002 its taxable year would end on Oct. 25, 2002. On the other hand, if the taxpayer elected a taxable year always ending on the Friday nearest to the end of October, its taxable year would end on Nov. 1, 2002. Note that in the first situation, the year may end with the month or as many as six days before the end of the month. In the second situation, the year may end on the last day of the month, or as many as three days before or after the last day of the month.
If any member of a group filing a consolidated return is on a 52-53-week taxable year, the requirement that a subsidiary adopt its common parent's taxable year is, with the advance consent of the Commissioner, deemed satisfied if the taxable years of all group members end within the same seven-day period.328
328Regs. §1.1502-76(a); Rev. Ruls. 72-184, 1972-1 C.B. 289, 78-322, 1978-2 C.B. 228.
c.	Statement to Be Attached to the Return for Year of Adoption or Change
Every taxpayer that adopts or changes to a 52-53-week taxable year must file a statement with its return for the year of adoption or change that contains the following information: 
(1) The calendar month with reference to which the new 52-53-week taxable year ends;
(2) The day of the week on which the 52-53-week taxable year will always end; and
(3) Whether the 52-53-week taxable year will always end on:
(i) The date on which that day of the week last falls within the calendar month, or
(ii) The date on which that day of the week occurs nearest to the last day of the applicable calendar month.329
329Regs. §1.441-2(b)(1)(ii).
[Footnote 330 reserved.]
4.	Treatment of Short Period Required to Effect Change
If a change to or from a 52-53-week taxable year results in a short-period of less than seven days or greater than 358 days, the taxpayer does not need to comply with the short period return requirements of Regs. §1.443-1.331 In such a case, a short period of 359 days or more is treated as a full taxable year; a short period of six days or less is not treated as a separate taxable year, but is instead added to and deemed a part of the following taxable year.332 In these cases, annualization of the short period income will not be required. A taxpayer will always fall within these rules if it changes to or from a 52-53-week taxable year that ends with reference to the same month.
331Regs. §1.441-2(b)(2)(ii).
332Regs. §1.441-2(b)(2)(ii).
Example 1: A taxpayer on a calendar year elects, for taxable years beginning after 2001, a 52-53-week taxable year ending on the last Friday in December. This election involves a short period of 361 days from Jan. 1 to Dec. 27, 2002, inclusive. Because the short period is longer than 358 days, it is not required to be annualized and is treated as a full taxable year.
Example 2: Assume the same facts as above, except that the taxpayer elects a taxable year ending on the Friday nearest to Dec. 31. The Friday nearest to Dec. 31, 2002 is Jan. 3, 2003. This election involves a short period of three days, Jan. 1 through Jan. 3, inclusive. Because this short period is less than seven days, it is not treated as a separate taxable year. This short period is added to and deemed part of the following 52-53-week taxable year, which begins on Jan. 4, 2003.
Taxable income for a short period that is more than six days and less than 359 days is annualized for purposed of Regs. §1.443-1(b) by multiplying the short period income by 365 and dividing the results by the number of days in the short period.333 The tax for the short period is the same part of the tax computed on this annualized income as the number of days in number of days in the short period is to 365 days.334
333Regs. §1.441-2(b)(2)(ii).
334Regs. §1.441-2(b)(2)(ii).
C. Computation of Taxable Income for 52-53-Week Taxable Year
The computation of taxable income for 52-53-week taxable years is generally determined by the same rules applicable to regular taxable years.
Example: The IRS concluded that an accrual method taxpayer that elected to use a 52-53-week taxable year and did not treat that taxable year as consisting of 12-calendar months could deduct two years' property taxes, because the 52-53-week taxable year contained two assessment dates (lien dates).335
335Rev. Rul. 76-482, 1976-2 C.B. 127.
Generally, all items of income and deduction are determined on the basis of a 52-53-week taxable year.336 A taxpayer may determine particular items as though the 52-53-week year were 12 calendar months, provided that the practice clearly reflects income and is consistently followed by the taxpayer.337 For example, a taxpayer using a 52-53-week year may calculate depreciation or amortization as if over 12 calendar months, provided that the taxpayer consistently follow that practice with respect to all depreciable or amortizable items.337.1
336Regs. §1.441-2(d).
337Regs. §1.441-2(d).
337.1Regs. §1.441-2(d).
D. Application of Effective Dates Under the Code to Taxable Years
For purposes of determining the effective date of provisions of the Code that refer to the first or last day of a specified calendar month, a 52-53-week taxable year is deemed to begin on the first day of the calendar month beginning nearest to the first day of the 52-53-week taxable year.338 The taxable year is deemed to end on the last day of the calendar month ending nearest the last day of the 52-53-week taxable year.339
338Regs. §1.441-2(c)(1).
339Id.
Example 1: Assume that a Code provision is applicable to taxable years beginning on or after Jan. 1, 2001. For that purpose, a 52-53-week taxable year beginning on any day within the period Dec. 26, 2000, to Jan. 4, 2001, inclusive, is treated as beginning on Jan. 1, 2002.
Example 2: Assume that a Code provision requires that a return must be filed on or before the 15th day of the third month following the close of the taxable year. In this situation, a 52-53-week taxable year ending on any day during the period May 25 to June 3, inclusive, is treated as ending on May 31 (the last day of the month ending nearest to the last day of the taxable year). Therefore, the return is due August 15 (without regard to extensions).
When applying these rules in a taxable year in which the rate of tax changes, the apportionment rules of §15 apply.340 Under this provision, the tax is computed at the old and new rates on the taxable income for the full year. The portion of the liability associated with the old rates is then computed by multiplying the total tax for the year (based on the old rates) by the ratio of the number of days in the taxable year before the rate change to the total days in the taxable year. The portion of the liability associated with the new rates is computed by multiplying the total tax for the year (based on the new rates) by the ratio of the number of days under the new rates to the total days in the taxable year. The sum of these two components results in the tax liability for the year.
340Regs. §1.441-2(c)(3). N.B. §15 does not apply to rate reductions enacted by the 2001 Tax Relief Act, §101(c). §15(f).
Example: Assume a taxpayer, on a 52-53-week year beginning on Thursday, Sept. 25, 1996, and ending on Wednesday, Sept. 30, 1997, has taxable income for the year of $100,000. Assume further the applicable effective tax rate changed on July 1, 1997, from 24.5% to 22.25%. Applying the old tax rates, the tax on the entire year's taxable income would be $24,500. Applying the new rates, the tax would be $22,250. Under §15, the tax would be computed as follows: [Tax associated with old rate × (the number of days in the taxable year before the date of the rate change ÷ the total number of days in the taxable year)] + [tax associated with the new rate × (the number of days in the taxable year on or after the date of the rate change ÷ the total number of days in the taxable year)] = [$24,500 × (279 ÷ 371)] + [$22,250 × (92 ÷ 371)] = $23,942.
V. Initial Taxable Years
In general a taxpayer must adopt a taxable year when it is first required to file a return.341 A domestic corporation must file its first return for the year of its incorporation, unless it can satisfy the appropriate IRS district director that it has not perfected its organization, has transacted no business, and has no income from any source.342 Estates, trusts, and individuals must first file returns when their incomes first meet certain threshold levels.343 A partnership must file its first return for the first accounting period it receives income or incurs any expense that is deductible for federal income tax purposes.344
341Regs. §1.441-1(c).
342Regs. §1.6012-2(a)(2).
343Regs. §1.6012-1(a)(1); Regs. §1.6012-3(a)(1).
344Regs. §1.6031-1(a)(1). Opening a bank account was not enough, by itself, to begin a partnership's first accounting period. Sutow v. Comr., 64 T.C.M. 537 (1992).
Substantial limitations restrict the permissible taxable years available to many taxpayers (see III, above). Newly-organized corporations that are not subject to those restrictions, however, have a largely unrestricted right to adopt annual accounting periods.345 There is authority supporting a position that this flexibility is available even if a new corporation is the successor to other corporate or unincorporated taxpayers or entities, and the predecessors had different taxable years.346 If the annual accounting period of the new corporation qualifies as a taxable year, that period becomes its taxable year and the approval of the Commissioner is not required.347 A complete change in a corporation's capital stock ownership, however, is not deemed to result in a new corporation entitled to select a different annual accounting period and taxable year.348
345Regs. §1.441-1(c)(1).
346See Hash v. Comr., 4 T.C. 878 (1945), acq., 1945 C.B. 3, aff'd, 152 F.2d 722 (4th Cir. 1945) (IRS approval was unnecessary for a new accounting period when an old company was ended and a new company was created simultaneously).
347Regs. §1.441-1(c)(1).
348East Coast Motors, Inc. v. Comr., 35 B.T.A. 212 (1936).
An individual's initial taxable year is restricted only by the requirement that for a taxable year other than a calendar year the taxpayer must maintain books and records (see III, H, above). Most individuals utilize the calendar-year taxable year primarily as a result of the requirements for information reporting by employers, financial institutions, brokers, etc., which are generally based on calendar year information. Therefore, a calendar year provides individuals with the ability more easily to gather the requisite information.
A. Qualifying Conditions Governing Taxpayer's Choice of Initial Taxable Year
Subject to any applicable limitations discussed in III, above, an individual or corporate taxpayer may, without obtaining the Commissioner's approval, adopt for its first return any taxable year that meets the requirements of §441 and the regulations thereunder.349 The requirements for adoption of a taxable year under those provisions include: 
(1) The taxable year must be the same as the taxpayer's annual accounting period, regardless of whether that period is a calendar year or a fiscal year.
(2) The taxable year must not exceed 12 calendar months, unless it qualifies as a 52-53-week year.
(3) The taxpayer must keep and maintain books of account based upon the annual accounting period. Note: Although corporations elect a 52-53-week taxable year more often than other entities, individuals, partnerships, S corporations, and certain other entities may also elect such taxable years if they satisfy all of the requirements of §441. 
(4) The taxpayer must adopt the taxable year within the prescribed period of time (see V, A, 1, below).
349Regs. §1.441-1(c).
Failure to satisfy any of the foregoing requirements will generally result in the required use of the calendar year. For example, the IRS ruled that, if a taxpayer begins business on a date other than the first day of a calendar month and it adopts an accounting period of exactly 12 months beginning with that date and ending on a date other than the last day of a calendar month, it fails to establish an annual accounting period within the meaning of §441.350
350Rev. Rul. 54-273, 1954-2 C.B. 110.
A taxpayer should exercise care when it adopts a taxable year, because once it adopts a taxable year it generally must obtain prior approval from the Commissioner to change to a different taxable period.351
351Regs. §1.441-1(e).
[Footnote 352 reserved.]
1.	Time Limit for Adopting Taxable Year
A taxpayer adopts its first taxable year by filing its first federal income tax return using that year.353 The filing of an extension of time to file, the filing a request for taxpayer identification number, or the payment of estimated taxes do not constitute an adoption of a taxable year.354
353Regs. §1.441-1(c)(1). For taxable years ending before May 17, 2002, a taxpayer was required to adopt its first taxable year no later than the time prescribed by law (not including extensions) for the filing of the return for the taxable year. Former Regs. §1.441-1T(b)(2).
354Id. For taxable years ending before May 17, 2002, a taxpayer could adopt a taxable year by the filing of other forms. See, e.g., Rev. Rul. 69-563, 1969-2 C.B. 104 (estate adopted taxable year by filing extension request), superseded by T.D. 8996, 67 Fed. Reg. 35009 (5/17/02).
The regulations under §441 may create some tax planning opportunities for certain corporations.
Example: The management of a corporation organized on Apr. 10, 2002, in a fit of over optimism about the new corporation's earnings, originally anticipate earnings of about $50,000 by June 30, 2002. A fiscal year-end of June 30 is tentatively considered to maximize the benefit of the graduated tax rates under §11(b) on the first $50,000 of taxable income. Near the end of July, however, taxable income figures for the period ended June 30 appear to be no more than $10,000, and further investigation indicates that July will contribute no more than an additional $8,000. While following Regs. §1.441-1, the management can push the fiscal year-end forward to Mar. 31, thereby providing the possibility of the full benefit of the lower tax rates on the first $50,000 of taxable income.355
355The book conformity rules for adopting a taxable year are more lenient than the rules for changing to a new taxable year. Compare Regs. §1.441-1 with Rev. Proc. 2002-37, §6.04.
In Wilson v. U.S.,356 a district court held that a timely amended return that changed the taxable year of a newly-formed corporation to a later date was effective to adopt the altered taxable year. The holding assumed that the selection of the later date would have been permissible if chosen in the original return. In this case the corporation had selected a March 31 year-end. It submitted an amended return on June 14 with an amended taxable year ending May 31. Specifically noting that the corporation had valid business reasons for adopting a May 31 year-end, the court concluded that an amended return may substitute for an earlier "first return" if the taxpayer files the amended return within "the statutory period for filing the original return."
356267 F. Supp. 89 (E.D. Mo. 1967). The IRS continues to follow the decision in Wilson. Preamble to REG-106917-99, 66 Fed. Reg. 31850 (6/12/2001).
[Footnote 357 reserved.]
[Footnote 358 reserved.]
[Footnote 359 reserved.]
[Footnote 360 reserved.]
[Footnote 361 reserved.]
[Footnote 362 reserved.]
2.	Time Limit for Establishing the "Keeping of Books"
A taxpayer must establish and maintain adequate books of account no later than the end of the first fiscal year.363 Informal records are not necessarily sufficient, even if the taxpayer intends to set up a formal system of accounting after the close of the fiscal year.364 All taxpayers that wish to adopt fiscal year accounting periods, including individuals, corporations, partnerships, estates, and trusts, are subject to the same "keeping of books" requirements. If adequate books do not exist, the choice of a fiscal year is not available, and calendar-year reporting is required.365
363Freudmann v. Comr., 10 T.C. 775 (1948), acq., 1948-2 C.B. 2; Brooks v. Comr., 6 T.C. 504 (1946).
364Id.
365§441(g).
Observation: This does not necessarily mean that the books must be completely closed immediately at the end of the fiscal year. Normally, an accrual-basis taxpayer leaves its books open until it resolves depreciation charges, income and liability accruals, and various valuations and adjustments affecting the period. For example, it is customary practice to keep the books open until outside auditors have completed the annual audit.
B. Corporation Issues
A corporation in existence during any portion of a taxable year must file a return.366 If a corporation is not in existence throughout an annual accounting period (either calendar year or fiscal year of 12 months), the corporation must make a return for that fractional part of a year during which it was in existence.367 In general, a new corporation comes into existence on the date of its incorporation.368
366Regs. § 1.6012-2(a)(2).
367Id.
368Id.
The first taxable year generally ends either on the following December 31 (as a calendar taxable year) or on the last day of any other month chosen and established by the new corporation as the last month of its annual accounting period. It may be a full 12-month year if a corporation happens to be incorporated on the first day of the month, but it is usually a short taxable year. For different rules applicable to a new corporation adopting a 52-53-week taxable year, see IV, above.
1.	Dormant Initial Period Following Incorporation During Which Corporation Keeps No Books of Account
Many new corporations have a period of dormancy before becoming active. Some corporations remain dormant for many years before engaging in any activities. This situation typically occurs when a corporation is incorporated in anticipation of a subsequent transfer of property or an acquisition of a going business at an indefinite future time.
In general, every corporation must file a return for its first taxable year, despite the lack of any business, or taxable income or loss during the initial period.369 If a corporation, despite its incorporation, has never perfected its organization, entered into any business transactions, nor had any income, it may be relieved from the necessity of filing a return. The appropriate IRS district director may grant such relief upon review of the facts presented by the corporation.370
369Id.
370Id.
Comment: This type of request is somewhat pointless, however, as it would normally be simpler to file an inactive return and thereby ensure the corporation's ability to elect the desired taxable year.
2.	Dormant Corporation Reactivated May Be Treated as a New Corporation
A corporation goes out of existence when it ceases business and dissolves, retaining no assets, even if under state law it continues as a corporation for limited purposes connected with winding up its affairs.371 If a corporation ceases business operations, disposes of all its assets, and liquidates all of its outstanding stock, it ceases to exist for federal income tax purposes. This is true even if no corporate officer or state official takes the action necessary formally to dissolve the corporation. If such a corporation is reactivated, it is a new corporation for federal income tax purposes, entitled to file a first return and to elect the fiscal year of its choice without seeking the Commissioner's approval. It is immaterial that before the dormant period it filed returns, paid taxes, and kept its books based on a different accounting period.372
371Id.
372Rev. Rul. 60-51, 1960-1 C.B. 169.
A reactivated corporation is ineligible for treatment as a new corporation, even under the foregoing circumstances, if there is evidence of an ongoing intention to continue the corporation's existence. For example, the payment of franchise or other state taxes required to prevent forfeiture of the corporation's charter is evidence of such an intention.373
373American Coast Line, Inc. v. Comr., 159 F.2d 665 (2d Cir. 1947); Rev. Rul. 56-483, 1956-2 C.B. 933.
3.	Effect of Dormant Initial Period on a New Corporation's Choice of Fiscal Year
A corporation may be subject to penalties for the failure to file returns for its initial inactive period.374 More important, however, the corporation may be deprived of its choice of a fiscal year by its failure timely to take the necessary actions to establish an annual accounting period.375 The failure properly to elect a fiscal year would give the corporation a calendar-year accounting period by default.376
374See §6651(a)(1); Regs. § 301.6651-1(a)(1).
375See §441(g). See also V, A, 1, above.
376§ 441(g); Regs. §1.441-1(b)(1)(iv).
Example: Assume that Corporation X is incorporated on November 7, 1996, but remains dormant until February 1, 1997. The corporation files its initial return on the basis of a fiscal year ending November 30, 1997 overlooking the fact that its first taxable year began on November 7, 1996, instead of February 1, 1997.
Because the return covers a period in excess of 12 calendar months (November 7, 1996, to November 30, 1997), both the return and the elected fiscal year are invalid, and X must report its taxable income on the basis of the calendar year. The error may not be discovered until a revenue agent examines the first return. By that time, X may have filed returns and paid tax for additional invalid fiscal years.
A new corporation that has an initial dormant period during which it keeps no books of account may be precluded from adopting a fiscal year that covers only the inactive period.377 To avoid this result, it may be wise to have the corporation conduct some business activity, not necessarily income-producing but requiring the keeping of books of account, before the close of its desired fiscal taxable year. For example, the corporation might hold cash or other property before the end of the desired fiscal year, accompanied by proper recording of those assets in the corporation's books.
377See Calhoun v. U.S., 370 F. Supp. 434 (W.D. Va. 1973).
Serious complications are likely to arise from a misstep. For example, if December is a high income-producing month, the time for payment of the tax relating to the December income each year would be accelerated eleven months by the loss of the November 30 taxable year.
Note: Even if fiscal year returns are invalid for purposes of electing a taxable year, they are returns for purposes of beginning the running of the statutory period for assessment of deficiencies.378 Although the limitation period under those circumstances technically applies to the calendar year it does not begin to run until the taxpayer files the fiscal-year return that completes the information for the entire calendar year.379
378American Hide & Leather Co. v. U.S., 284 U.S. 343 (1932); Paso Robles Mercantile Co. v. Comr., 33 F.2d 653 (9th Cir. 1929).
379Id.
4.	First Taxable Year of a Corporation Emerging from a Reorganization, or Entering or Leaving a Consolidated Group
If a corporation is acquired in an A, C, D, or G reorganization, its taxable year ends under §381(b) on the date it transfers its assets to the acquiring corporation. §381(b) does not apply to an F reorganization, which is a "mere change in identity, form or place of organization."380 The taxable year of a corporation that engages in an F reorganization is unaffected. The taxable year does not close, and the corporation files a single return for the full taxable year including the periods before and after the reorganizations.381 Neither a B reorganization nor an E reorganization has any effect on accounting periods, unless it causes a corporation to become a member of an affiliated group. See III, B, above.
380§ 368(a)(1)(F).
381Regs. § 1.381(b)-1(a)(2). See also Rev. Rul. 57-276, 1957-1 C.B. 126.
A corporation involved in a reorganization generally determines its taxable year by the taxable year of the acquirer (transferee) corporation.382 For example, in merger transactions, the year-end of the company that remains in existence continues. In transactions resulting in a new entity, the resulting entity may adopt a new taxable year under the general rules of §441.
382Regs. § 1.381(b)-1.
Example: A corporation purchases the stock of another corporation and elects to treat the stock purchase as a purchase of assets under §338. The acquired corporation is treated as a new entity.383 If a consolidated return is not filed (or required), the acquired corporation may elect a new taxable year. If the acquiring corporation was newly-formed to effect the acquisition (and is not a member of an existing group filing consolidated returns), it and its new subsidiary may elect a new taxable year.
383§ 338(a)(2).
A corporation leaving a group filing consolidated returns may encounter some difficulty adopting its desired fiscal year. For example, a subsidiary corporation leaving a group filing consolidated returns must retain the taxable year of the group unless it obtains IRS permission to change its year. Therefore, if the departing subsidiary does not request and receive approval to change its year-end, it will have two short taxable years. The first will end on the day the corporation leaves the group, and the second will end on the last day of the group's year-end.384
384Regs. § 1.442-1.
Example: The stock of a subsidiary of a group filing consolidated returns with a June 30 year-end is sold on June 10, 1997, to a partnership. The subsidiary first has a short-period return (included in the June 30, 1997, year-end consolidated return of its former parent) from July 1, 1996, through June 10, 1997. The subsidiary then has a short-period return from June 11, 1997, through June 30, 1997. The subsidiary would not need to annualize its short year income under §443. See VII, E, below for a discussion of the annualization of short periods.385
385See Regs. § 1.1502-76(b).
In Rev. Rul. 74-585,386 a subsidiary was allowed to change its taxable year to a taxable year ending on the day it left the affiliated group. It is not clear whether the IRS would have permitted the subsidiary to select a new year-end other than that ending 12 months from the date it left the affiliated group. A broad reading of the ruling would allow a change to a taxable year ending after the date on which its year would have otherwise ended absent a change (and provided the first return does not cover a period longer than 12 months). For example, if on July 11 a corporation leaves an affiliated group that files tax returns based on the calendar year, that corporation may be able to change its taxable year to any taxable year ending after December 31. A narrow reading of the ruling, however, would permit only a change to a July 31 year-end taxable year.
3861974-2 C.B. 143.
A corporation entering an affiliated group filing consolidated returns, or a subsidiary formed by a corporation that is a member of an affiliated group filing consolidated returns, must adopt the year-end of the consolidated group.387 This rule is satisfied if a member is on a 52-53-week year, so long as the year-end of all group members end within the same seven-day period and they receive advance consent from the Commissioner.388
387Regs. § 1.1502-76(a).
388Id.
5.	First Taxable Year of a Foreign Corporation
In general, when a foreign corporation is first required to file a United State tax return, it determines its taxable year under §441 as though it were a U.S. taxpayer.389 Any such year determined or established may not be changed except with the prior approval of the Commissioner.390 The application for prior approval must be filed by one or more U.S. shareholders. In general, the IRS will approve requests for changes in taxable years if made for bona fide business reasons or to conform to the requirements of foreign law, provided the other requirements of Regs. § 1.442-1(b) are met.391 The permitted taxable years are severely restricted for certain controlled foreign corporations and (before 2005) foreign personal holding companies in which U.S. shareholders own or owned more than fifty percent of the total voting power of all classes of stock of the corporation or more than fifty percent of the total value of all classes of stock of the corporation.392
389See Rev. Proc. 63-7, 1963-1 C.B. 485.
390See Rev. Proc. 75-54, 1975-2 C.B. 594, clarifying Rev. Proc. 63-7, 1963-1 C.B. 485. For corporations subject to §898, Rev. Proc. 90-26, 1990-1 C.B. 512, modifies Rev. Proc. 75-54.
391Rev. Proc. 75-54, 1975-2 C.B. 594.
392§ 898. For a discussion of these restrictions see III, F, above. The foreign personal holding company provisions (§§551-558) were repealed effective for taxable years of foreign corporations beginning after 2004 by the 2004 American Jobs Creation Act, P.L. 108-357, §413(a)(1).
6.	Effect of Preliminary Business Activities by Others on Behalf of a New Corporation
Often, a new corporation is formed to take over the activities or purchase the assets of a partnership, an individual, another corporation, or other entity. The purchase agreement may provide that the transfer will be considered to be made earlier than the date the purchase agreement is formally executed. For example, the transfer may be made as of January 1, but the purchase agreement may be executed on January 15. A delay is often necessary to provide time to record all transactions and accruals before the nominal transfer date, to close books, and to determine the values to be transferred. In the interim, business goes on as usual, and profits and losses accrue to the purchasing corporation during the intervening period.
If the new corporation is in existence on the earlier date, the transferor should be treated as operating the business as an agent of the purchasing corporation, and any resulting profit or loss should accrue to the purchasing corporation. If the corporation is not in existence on the date the transfer is deemed to take place, the acquiring corporation can neither do business nor have taxable income or loss. The profit or loss resulting during the intervening period will accrue to the transferor. A nonexistent corporation cannot acquire or own property, nor can any person acquire or hold property for the corporation as an agent or otherwise, before the time that it comes into existence.393
393Younger Bros., Inc. v. Comr., 8 B.T.A. 333 (1927), acq., VII-2 C.B. 44.
Similarly, if a corporation is incorporated during the period between the nominal date of transfer and the date the purchase agreement is executed, no legal basis would exist for arbitrarily treating the transfer as taking place as of the date of incorporation. In this situation, any profit or loss accruing through the date of execution of the purchase agreement may not be attributable to the new corporation.394
394See Rouss v. Bowers, 4 B.T.A. 516 (1926), aff'd, 30 F.2d 628 (2d Cir. 1929); Stern v. Comr., 11 B.T.A. 1309 (1928); Coddington v. Comr., 10 B.T.A. 712 (1928); Florida Grocery Co. v. Comr., 1 B.T.A. 412, (1925), acq., IV-1 C.B. 2 (1925); cf. Waldron Co. v. Comr., 2 B.T.A. 715 (1925).
a.	Method of Determining Taxable Income or Loss for the Intervening Period
If the taxable income or loss for the intervening (pre-incorporation) period cannot be accurately ascertained, the courts have held that a portion of the taxable income of the purchasing corporation's first taxable year is allocated to the intervening period based on the number of days in the intervening period.395
395See Rouss, Stern, and Coddington, above.
Example: X corporation, incorporated on Feb. 28, 2002, conducts business of an enterprise in existence from Jan. 1, 2002. The total income of the enterprise for the calendar year ended Dec. 31, 2002 is $12,000. For a various reasons, X cannot accurately allocate the enterprise's income between the pre-incorporation and post-incorporation periods. X adopts a calendar year as its taxable period.
The portion of the enterprise's income that is allocated to X for the year ended Dec. 31, 2002 is $10,060 (306 days divided by 365 days × $12,000 = $10,060). The remaining amount, $1,940 (59 days divided by 365 days × $12,000 = $1,940) should not be allocated to X corporation.
b.	Isolated Pre-Incorporation Expenditures -- Due Date of Elections
A corporation is permitted to elect to deduct a limited amount of organizational expenditures for the taxable year in which the corporation begins business.396 The amount allowable as a deduction is the lesser of: (1) the amount of organizational expenditures with respect to the taxpayer, or (2) $5,000, reduced, but not below zero, by the amount by which such organizational expenditures exceed $50,000.397 Any organizational expenditure beyond the deduction limit may be amortized ratably over a 180-month period beginning in the month in which the corporation begins business.398 All organizational expenditures related to a particular corporation, whether incurred before or after October 22, 2004, would be considered in determining whether the cumulative cost of organizational expenditures exceeds $50,000.399
396§248(a), as amended by the 2004 American Jobs Creation Act, P.L. 108-357, §902, effective for amounts paid or incurred after October 22, 2004.
397§248(a)(1).
398§248(a)(2).
399See H.R. Conf. Rep. No. 755, 108th Cong., 2d Sess. 763 (2004).
Organization expenditures are deductible if: (1) incident to the creation of the corporation; (2) chargeable to capital account; and (3) of a character that, if expended incident to the creation of a corporation having a limited life, would be amortizable over that life.400 Such expenditures include an incorporation fee and related expenses, legal and accounting fees incurred in connection with the organization, and expenses of temporary directors and organization meetings.401 Organizational expenditures, do not, however, include costs associated with issuing stock or connected with the transfer of assets to the corporation.402
400§248(b).
401Regs. §1.248-1(b)(2).
402Regs. §1.248-1(b)(3).
The election to deduct organization expenditures must be made no later than the due date (including extensions) for the return for the taxable year in which the corporation begins business.403
403§248(c).
Organizational expenditures incurred before October 23, 2004 may amortized and deducted over a 60-month period commencing with the month in which the corporation begins business.403.1
403.1Former §248(a).
Similarly, a taxpayer is allowed a deduction for a limited amount of start-up expenditures of a trade or business.403.2 The amount allowable as a deduction is the lesser of: (1) the amount of start-up expenditures with respect to the active trade or business or (2) $5,000, reduced, but not below zero, by the amount by which such start-up expenditures exceed $50,000.403.3 Any start-up expenditures not deducted may be amortizable ratably over a 180-month period beginning in the month in which the trade or business begins.403.4 All start-up expenditures related to a particular trade or business, whether incurred before or after October 22, 2004, would be considered in determining whether the cumulative cost of start-up expenditures exceeds $50,000.403.5
403.2§195(b)(1), as amended by the 2004 American Jobs Creation Act, P.L. 108-357, §902(a), effective for amounts paid or incurred after October 22, 2004.
403.3§195(b)(1)(A).
403.4§195(b)(1)(B).
403.5See H.R. Conf. Rep. No. 755, 108th Cong., 2d Sess. 763 (2004).
Start-up expenditures are amounts paid or incurred in connection with investigating the creation or acquisition of an active trade or business, creating an active trade or business, or in a for-profit activity in anticipation of becoming a trade or business, but only if these expenditures would have been deductible (in the year paid or incurred) had they been incurred in connection with the operation of an existing active trade or business.403.6 For example, typical expenses -- such as utilities, rent, and salaries -- incurred by a new enterprise before it opens its doors for business are expenses to which §195 applies.
403.6§195(c).
The taxpayer must make an election to amortize these expenditures no later than the due date of the taxpayer's first return (including extensions).404 If the taxpayer does not make the required election, it forfeits the ability to amortize the expenditures. Start-up expenditures incurred before October 23, 2004 continue to be eligible to be amortized over a period not to exceed 60 months.404.1
404§195(d)(1).
404.1Former §195(b)(1).
VI. Change of Taxable Year
A change in a taxpayer's "annual accounting period" cannot become the taxpayer's taxable year without the Commissioner's approval.405 This seemingly absolute rule is modified, however, by various administrative pronouncements, principally regulations and revenue procedures permitting certain changes to be made pursuant to automatic approval procedures. This section discusses the requirements for obtaining approval of a change in taxable year, circumstances under which automatic approval is available, and general procedural requirements. Note that many taxpayers are subject to rules that substantially limit the taxable years available to them.406
405§442.
406See III, above.
A. Effecting a Change
As noted above, the Code provides that if a taxpayer changes its annual accounting period, the new period will become the taxpayer's taxable year only if the Commissioner approves of the change.407 Some taxpayers are eligible for automatic consent to a change in annual accounting period.408 Such a taxpayer must comply with the particular requirements of the applicable regulations and IRS guidance. If automatic consent is not available, the taxpayer must use the prior approval procedures, which entail demonstrating a business purpose for the change and receiving IRS consent.409
407§442.
408See Rev. Proc. 2002-37 (automatic consent for certain corporations, primarily C corporations) and Rev. Proc. 2002-38 (automatic approval for certain partnerships, S corporations and PSCs) and Rev. Proc. 2003-62, 2003-32 I.R.B. 299 (automatic approval for certain individuals to change from fiscal to calendar year).
409See Rev. Proc. 2002-39 (guidance on establishing a business purpose and obtaining IRS consent to change, adopt or retain accounting period, if automatic consent is not available).
Whether using the automatic approval procedures or using the prior approval procedures, a taxpayer obtains IRS consent by filing Form 1128, Application for Change in Accounting Period.410 Generally, a taxpayer must file the application on or before the due date (including extensions) for filing the federal income tax return for the short period required to effect the change.411
410Regs. §1.442-1(b)(1). But see Rev. Proc. 2002-39, §6.01(1) (an electing S corporation requesting to adopt, change or retain an annual accounting period makes the request on Form 2553, Election by a Small Business Corporation).
411Rev. Proc. 2002-37, §7.02(2); Rev. Proc. 2002-38, §7.02(2); Rev. Proc. 2002-39, §6.02(1); Rev. Proc. 2003-62, 2003-32 I.R.B. 299, §7.02(2). However, Rev. Proc. 2005-27, 2005-20 I.R.B. 1050, provides that the IRS may issue guidance extending the Form 1128 filing deadlines in Rev. Procs. 2002-37,  2002-38, and 2002-39 for taxpayers who are serving in, or in support of, the Armed Forces in a combat zone, and for taxpayers affected by a Presidentially declared disaster or determined by the IRS to be affected by a terroristic or military action. In accordance with an amendment to §7508(a) by §104 of the Military Family Tax Relief Act of 2003, P.L. 108-121, such an extension would likely include service in a contingency operation, as well as in a combat zone. In addition, change requests under Rev. Procs. 2002-38 and 2002-39 must be made no earlier than the day following the end of the first effective year.
In order to obtain approval for a change in annual accounting period, the taxpayer must agree to the Commissioner's prescribed terms, conditions and adjustments for effecting the change.412 These terms and conditions are set forth in the various revenue procedures that provide guidance on changes in annual accounting periods.413
412Regs. §1.442-1(b)(2). Formerly, IRS approval would not be granted "unless the taxpayer and the Commissioner agree[d] to terms, conditions, and adjustments under which the change [would be] effected. Former Regs. §1.442-1(b)(1), effective for changes prior to May 17, 2002.
413Rev. Proc. 2002-37, §6 (providing terms and conditions for non-pass-through corporations to obtain automatic approval to change accounting periods); Rev. Proc. 2002-38, §6 (providing terms and conditions for pass-through entities to obtain automatic approval to change accounting periods); and Rev. Proc. 2002-39, §5.04 and 5.05 (providing terms and conditions for nonautomatic changes in accounting periods) and Rev. Proc. 2003-62, §6 (providing terms and conditions for certain individuals to obtain automatic approval to change from fiscal to calendar year).
 Comment: Although the taxpayer may receive an affirmative response from the IRS to its request, it is not required to make the change. The approval merely gives the taxpayer the option to change. Form 1128 does request, however, that the taxpayer notify the IRS within 30 days of approval if it does not desire the approved taxable year. Lack of response by the taxpayer within 30 days arguably does not cause the taxpayer to lose this option. The final decision is probably made when the taxpayer files a return for either the requested year or ignores the request and files on the basis of the old year.
B. Automatic Consent Changes
1.	C Corporations
a.	Changes After May 9, 2002
Generally, a C corporation can request automatic approval to change its annual accounting period using the guidance provided in Rev. Proc. 2002-37. Under the scope limitations of Rev. Proc. 2002-37, the automatic consent mechanism is unavailable to corporations that have changed their annual accounting period in the most recent 48-month period;414 to corporations that have certain types of interests in pass-through entities;415 and to various specified corporations.416 If a corporation is unable to use the automatic consent procedures of Rev. Proc. 2002-37, it may still be able to use the prior approval procedures of Rev. Proc. 2002-39, discussed below.
414Rev. Proc. 2002-37, §4.02(1). A corporation that made any of the following changes would still be eligible to use Rev. Proc. 2002-37's automatic consent procedure: a prior change in accounting period in order to comply with the common taxable year requirement of either Regs. §§1.1502-75(d)(3)(v) or - 76(a)(1); a prior change in accounting period by a corporation either acquired in the last 12 months, or whose majority shareholder changed its taxable year in the last 12 months, if that corporation currently wants to change to the taxable year of its majority (more than 50%) shareholder with which it does not file consolidated tax returns in order to file consolidated financial statements; a prior change from a 52-53-week taxable year that reference a particular month to a non-52-53-week taxable year that ends on the last day of that month, and vice versa; or a prior change in accounting method to a required taxable year or an ownership taxable year. Notwithstanding these prohibitions, Rev. Proc. 2002-37 is available to a corporation that wants to change from a 52-53-week taxable year that references a particular month to a non-52-53-week taxable year that ends on the last day of that month, and vice versa, even if that corporation has made prior changes.
415Rev. Proc. 2002-37, §4.02(2). The interest in a pass-through entity will be disregarded if any of the following conditions are met: the pass-through entity would be required to change its taxable year to the new taxable year of the corporation; the pass-through entity is a partnership, which is owned 50/50 by two partners, and the corporation and the partnership both want to change to the taxable year of the other 50% partner; the new taxable year of the corporation would result in no change in, or in less deferral from, the pass-through entity than the present taxable year of the corporation; the corporation has a de minimis interest in a pass-through entity which has been in existence for at least three taxable years. Notwithstanding these prohibitions, Rev. Proc.  2002-37 is available to a corporation that wants to change from a 52-53-week taxable year that references a particular month to a non-52-53-week taxable year that ends on the last day of that month, and vice versa, even if that corporation holds an interest in a pass-through entity.
416Rev. Proc. 2002-37, §4.02(3)-(12). Among the listed corporations are: FSCs or IC-DISCs and shareholders of certain FSCs or IC-DISCs; S corporations and electing S corporations; PSCs; CFCs or FPHCs (for taxable years of foreign corporations beginning prior to Jan. 1, 2005); tax-exempt organizations; possessions corporations electing under §936; cooperative associations with a loss in the short period required to effect the change of annual accounting period, unless the members of the cooperative are substantially the same (more than 90% continuity) in the year before the change, the necessary short period and the year after the change; and corporations with a required taxable year (unless changing to that required taxable year). Notwithstanding these prohibitions, Rev. Proc. 2002-37 is available to a corporation that wants to change from a 52-53-week taxable year that references a particular month to a non-52-53-week taxable year that ends on the last day of that month, and vice versa, even if that corporation is an FSC shareholder, an electing S corporation, a CFC or FPHC (for taxable years of foreign corporations beginning prior to Jan. 1, 2005), or a cooperative association.
In order to receive automatic approval to change its annual accounting period under Rev. Proc. 2002-37, a corporation must comply with specified terms and conditions.417 The corporation must file a federal income tax return for the short period required to effect the change in annual accounting period. The return for the short period must be filed by the due date of that return, including extensions. Additionally, the corporation's taxable income for the short period must be annualized and the tax computed in accordance with §443(b) and Regs. §1.443-1(b).418 Returns for subsequent taxable years must be made on the basis of a full 12 months (or 52-53-week taxable year) ending on the last day of the requested taxable year.419 The corporation must close its books on the last day of the first effective year, and thereafter keep its books on the basis of the requested taxable year.420 If applicable, the corporation must comply with Regs. §1.441-2(e), which relates to the timing of taking items into account in those cases where the taxable year of a pass-through entity ends with reference to the same calendar month as one or more of its owners.421 Any net operating loss (NOL) or capital loss (CL) generated in the required short period must be carried forward, beginning with the first taxable year after the short period.422 If there is an unused general business credit or any other unused credit generated in the short period, the corporation must carry that unused credit forward.423 Finally, if the corporation's interest in a pass-through entity, FSC or IC-DISC is disregarded because that entity is required to change its taxable year to the corporation's new taxable year, the related entity must change its taxable year concurrently with the corporation's change in taxable year.424
417Rev. Proc. 2002-37, §6.01.
418Rev. Proc. 2002-37, §6.02. However, for changes to or from a 52-53-week taxable year referencing the same month as the current or requested taxable year, see special rules in Regs. §1.441-2.
419Rev. Proc. 2002-37, §6.03.
420Rev. Proc. 2002-37, §6.04. This requirement does not apply to books and records maintained solely for foreign law purposes or if the requested taxable year is the corporation's required taxable year.
421Rev. Proc. 2002-37, §6.07.
422Rev. Proc. 2002-37, §6.08. However, for taxpayers requesting to change accounting periods prior to Apr. 8, 2003, the short period NOL or CL may be carried back if it is either: $50,000 or less, or results from a short period of 9 months or longer and is less than the NOL or CL for a full 12-month period beginning with the first day of the short period. For taxpayers requesting to change annual accounting periods on or after Apr. 8, 2003, and certain qualifying taxpayers that previously changed annual accounting periods, the 9-month requirement is removed, thus taxpayers that generate NOLs or CLs in the short period may carryback those losses if the losses are less than the NOL or CL generated for the 12-month period beginning with the first day of the short period. Rev. Proc. 2003-34, 2003-18 I.R.B. 856.
423Rev. Proc. 2002-37, §6.09.
424Rev. Proc. 2002-37, §6.10.
A corporation that wants to change its annual accounting period using the automatic consent provisions of Rev. Proc. 2002-37 must comply with the general application procedures set out in Rev. Proc. 2002-37, §7. The corporation should file a Form 1128 with the Director, Internal Revenue Service, Attention: Entity Control, where the corporation files its federal income tax return. The corporation must also attach a copy of the Form 1128 to its return for the required short period. The Form 1128 must be filed on or before the due date (including extensions) for filing the federal income tax return for the required short period. At the top of the Form 1128, the corporation should either type or print "FILED UNDER REV. PROC. 2002-37." The Form 1128 must be signed by an individual with authority to bind the corporation in such matters. Rev. Proc. 2002-37, §7, outlines additional procedures for a CFC revoking a post-2004 ACJA §898(c)(2)424.1 election, for a corporation changing to a natural business year that satisfies the 25% gross receipts test, and for an application on behalf of a consolidated group of corporations.
424.1For taxable years of foreign corporations beginning after Dec. 31, 2004 and for taxable years of U.S. shareholders with or within which such taxable years of foreign corporations end, the one-month deferral election can be found in post-2004 §898(c)(2). See 2004 American Jobs Creation Act, P.L. 108-357, §413(c)(13) (amending §898). For taxable years beginning before Jan. 1, 2005, the one-month deferral election was located in pre-2004 ACJA §898(c)(1)(B).
For corporations within its scope, Rev. Proc. 2002-37 is effective for all changes in annual accounting period for which the first effective year ends on or after May 10, 2002. Special transitions rules are provided for corporations with applications pending on May 10, 2002.425
425Rev. Proc. 2002-37, §9. Note also that Rev. Proc. 2005-27, 2005-20 I.R.B. 1050, provides that the IRS may issue guidance extending the Form 1128 filing deadlines in Rev. Proc. 2002-37 for taxpayers who are serving in, or in support of, the Armed Forces in a combat zone, and for taxpayers affected by a Presidentially declared disaster or determined by the IRS to be affected by a terroristic or military action. In accordance with an amendment to §7508(a) by §104 of the Military Family Tax Relief Act of 2003, P.L. 108-121, such an extension would likely include service in a contingency operation, as well as in a combat zone.
b.	Changes Before May 10, 2002
(1)	Former Regs. §1.442-1(c)
In general, a C corporation could change its taxable year under former Regs. §1.442-1(c) without the prior approval of the Commissioner if it met all of the following conditions.426 
(1) It had not changed its annual accounting period at any time within the 10 calendar years ending with the calendar year that included the beginning of the short period required to effect the change of annual accounting period.
(2) It did not have a net operating loss for the short period.  Note: The Commissioner would approve a change in annual accounting period under certain circumstances even though a net operating loss occurred in the short taxable year resulting from the change.427
(3) The taxable income for the short period, if annualized, was at least 80% of the taxable income for the full taxable year immediately preceding the short period. Note: In calculating the 80% test, net operating loss carrybacks from years subsequent to the short taxable year were not considered.428 If the rule were otherwise, taxpayers would have had to wait at least three years to determine the taxable income of the short period and at least two years for the taxable year preceding it.
(4) If the corporation was a personal holding company, an exempt organization, a foreign corporation not engaged in trade or business in the U.S., a Western Hemisphere Trade corporation, or a China Trade Act corporation during either the short period or the taxable year immediately preceding the short period, the corporation had to have the same status for both the short period and the preceding taxable year.
(5) The corporation did not attempt to make an S corporation election that purported to become initially effective with respect to a taxable year that would immediately follow the short period required to effect the change of annual accounting period.
(6) The corporation filed a statement with the appropriate district director, no later than the time (including extensions) for filing the short period return, indicating that the corporation was changing its annual accounting period under former Regs. §1.442-1(c) and setting forth the information necessary to show that all the foregoing conditions had been met.
426Former Regs. §1.442-1(c). See, e.g., FSA 200011002. This procedure did not apply to S corporations, DISCs, CFCs, FPHCs, and REITs. Former Regs. §1.442-1(c). See also Rev. Procs. 77-26, 1977-2 C.B. 536, 66-13, 1966-1 C.B. 626; and Rev. Rul. 65-316, 1965-2 C.B. 149, obsoleted by T.D. 8996, 67 Fed. Reg. 35009.
In Notice 97-20, 1997-10 I.R.B. 52, the IRS waived certain of these conditions for C corporations that were electing to be S corporations as of Jan. 1, 1997 (with a short period ending Dec. 31, 1996). In order to take advantage of the more liberal provisions of Notice 97-20, a corporation had to file Form 2553, Election by a Small Business Corporation, before Mar. 16, 1997. For a discussion of Notice 97-20 and the requirements to elect S corporation status, see 730 T.M., S Corporations: Formation and Termination.
427Rev. Proc. 85-16, 1985-1 C.B. 517.
428See Rev. Rul. 65-163, 1965-1 C.B. 205.
After the taxpayer filed the required statement and the short-period return with the appropriate district director, subsequent developments could invalidate the filed statement and establish a failure to meet all the prescribed conditions.
Example: Taxable income for the taxable year preceding the change might have increased as a result of a revenue agent's examination so that the taxable income for the short period, annualized, was less than the required 80%. Alternatively, the taxable income for the short period might have decreased, with similar effect, or even converted into a net operating loss, through proper adjustments made either by a revenue agent or by the taxpayer. Furthermore, it might have transpired that the corporation had a special status, such as PHC, in the preceding taxable year, but not in the short period, or vice versa.
Under Regs. §1.442-1(c)(3), if the taxpayer did not meet all of the conditions, the filed statement was considered a timely application for permission to change the corporation's annual accounting period to the taxable year indicated in the statement. Acceptance of the filed statement as a timely application for the change, however, did not imply that approval would be given. The filed statement had the status of any other application for prior approval by the Commissioner of a change in taxable year, and accordingly, was subject to the tests set forth in former Regs. §1.442-1(b).
(2)	Rev. Proc. 2000-11
Rev. Proc. 2000-11 429 provided a procedure whereby certain corporations could obtain automatic approval of a change of annual accounting period. This procedure was generally effective for all changes in annual accounting periods for which the short period ended after January 17, 2000, and before May 10, 2002. Rev. Proc. 2000-11 applied to any corporation or to any consolidated group, if every member of the group met all the requirements, that: 
(1) could not satisfy all the conditions of former Regs. §1.442-1(c) regarding a change of an annual accounting period without the prior approval of the IRS;
(2) with stated exceptions, had not changed its annual accounting period at any time within the previous six calendar years (or within any of the calendar years the taxpayer had been in existence if less than six years) ending with the calendar year that included the beginning of the short period required to effect the change of annual accounting period;430
(3) was not, as of the end of the short period:
(a) a member of a partnership, a beneficiary of a trust or an estate, however, interests in these pass-throughs were disregarded if the corporation was a more than 50% owner and the partnership would be required to change its taxable year pursuant to §706(b) to the new taxable year of the corporation, the new taxable year of the corporation would result in no change in or less deferral from the pass-through entity than the present taxable year of the corporation, or where a pass-through entity did not qualify under the two preceding conditions but the corporation only held a de minimis interest in the pass-through entity which has been in existence for at least three years;430.1 or
(b) a shareholder of an interest in an IC-DISC or a FSC, however an interest in an FSC or an IC-DISC was disregarded if the corporation was the principal shareholder and the FSC or the IC-DISC would have been required to change its taxable year pursuant to Regs. §1.921-1T(b)(4)  and  (b)(6) to the new taxable year of the corporation or the new taxable year of the corporation would have resulted in no change or less deferral from the FSC or the IC-DISC than the present taxable of the corporation;430.2
(4) was not an IC-DISC or a FSC;430.3
(5) was not an S corporation and did not attempt to make an S corporation election effective for the taxable year immediately following the short period, unless the change was to a permitted S corporation year;430.4
(6) was not a personal service corporation;430.5
(7) was not a CFC or FPHC;430.6
(8) was not a minority shareholder of a CFC or FPHC;430.7
(9) was not a tax-exempt organization, other than an organization exempt from income tax under §§521, 526, 527 or 528;430.8
(10) was not a direct or indirect shareholder of a passive foreign investment company that is a qualified electing fund, within the meaning of §1295, with respect to the shareholder;431
(11) was not a passive foreign investment company that U.S. persons (who own directly or indirectly, in the aggregate, 10% or more of the company) elected under §1295 to treat as a qualified electing fund;431.1
(12) was not a corporation with a §936 election in effect;431.2 and
(13) was not a cooperative association (as defined in §1381(a)) with a loss in the short period required to effect the change of annual accounting period, unless all the patrons of the cooperative associaton were substantially the same in the year before the change of annual accounting period, in the short period required to effect the change, and in the year following the change.431.3
4292000-3 I.R.B. 309, reprinted in the Worksheets, below.
430Rev. Proc. 2000-11, §4.02(1).
430.1Rev. Proc. 2000-11, §4.02(2).
430.2Rev. Proc. 2000-11, §4.02(3). The FSC Repeal and Extraterritorial Income Exclusion Act of 2000, P.L. 106-519, terminated inactive FSCs and eliminated the election to be taxed as a FSC. Existing active FSCs continue to receive the tax benefits of the provisions under certain conditions. Further, the Act created an extraterritorial tax regime, found in §§114 and 941-943, exempting "qualifying foreign trade income" from current inclusion in gross income. Further, the Act created an extraterritorial tax regime, found in pre-2004 ACJA §114 and pre-2004 ACJA §§941-943, exempting "qualifying foreign trade income" from current inclusion in gross income. The 2004 American Jobs Creation Act, P.L. 108-357, §101, eliminated this extraterritorial tax regime, effective for taxable years of foreign corporations beginning after Dec. 31, 2004 and for taxable years of U.S. shareholders with or within which such taxable years of foreign corporations end. Given the similarity of the former extraterritorial tax regime to the FSC provisions, shareholders of corporations with qualifying foreign trade income were potentially excluded from obtaining an automatic approval under Rev. Proc. 2000-11.
430.3Rev. Proc. 2000-11, §4.02(4).
430.4Rev. Proc. 2000-11, §4.02(5), (6).
430.5Rev. Proc. 2000-11, §4.02(7).
430.6Rev. Proc. 2000-11, §4.02(8).
430.7Rev. Proc. 2000-11, §4.02(9).
430.8Rev. Proc. 2000-11, §4.02(10).
431Rev. Proc. 2000-11, §4.02(11).
431.1Rev. Proc. 2000-11, §4.02(12).
431.2Rev. Proc. 2000-11, §4.02(13). §1601 of the Small Business Job Protection Act of 1996, P.L. 104-188, added §936(j), which repeals the §936 credit for taxable years beginning after Dec. 31, 1995, subject to grandfather rules permitting existing credit claimants to claim credits for a 10-year transition period.
431.3Rev. Proc. 2000-11, §4.02(14).
A corporation described above was required to complete Form 1128 and type or print legibly at the top of page one of the form, "FILED UNDER REV. PROC. 2000-11." 431.4 Form 1128 was considered timely filed if it is filed on or before the time (including extensions) for filing the return for the short period required by the change.431.5
431.4Rev. Proc. 2000-11, §6.02(3).
431.5Rev. Proc. 2000-11, §6.02(2).
To obtain automatic approval under Rev. Proc.2000-11, the corporation also had to comply with the following conditions:
(1) The short period required to effect the change of annual accounting period had to begin with the day following the close of the old taxable year and end with the day preceding the first day of the new taxable year.431.6
(2) The corporation or consolidated group had to file a federal income tax return for the short period by the due date of the return, including extensions, pursuant to Regs. §1.443-1(a).431.7
(3) Taxable income for the short period had to be annualized (except in the case of REITs and RICs) and the tax computed in accordance with the provisions of §443(b) and Regs. §1.443-1(b).431.8
(4)  Returns for subsequent taxable years had to be made on the basis of a full 12 months (or on a 52-53-week basis) ending on the last day of the new taxable year, unless the corporation or consolidated group secured the approval of the Commissioner to change its new taxable year.431.9
(5) The books of the corporation or consolidated group had to be closed as of the last day of the new taxable year. The corporation or consolidated group had to compute its income and keep its books and records (including financial reports and statements for credit purposes) on the basis of the new taxable year.431.10
(6) Except for the exceptions below, if the corporation (or consolidated group) had an NOL (or consolidated NOL) in the short period required to effect the change, the NOL could not be carried back, but had to be carried over, in accordance with the provisions of §172, beginning with the first taxable year after the short period. However, the short period NOL (or consolidated NOL) was carried back or carried over in accordance with §172(b), if it was either, (a) $50,000 or less, or (b) resulted from a short period of nine months or longer and was less than the NOL for a full 12-month period beginning with the first day of the short period.431.11
(7) If there was an unused general business credit or any other unused credit for the short period, the corporation had to carry that unused credit forward. An unused credit from the short period could not be carried back.431.12
(8) If a corporation's interest in a pass-through entity, FSC, IC-DISC, CFC, or FPHC was disregarded, pursuant to Rev. Proc. 2000-11, §§4.02(2)(a), 4.02(3)(a), or 4.02(8) because the entity was required to change its taxable year to the corporation's new taxable year, the entity had to change its taxable year concurrently with the corporation's change in taxable year, notwithstanding the testing date provisions in §§706(b)(4)(A)(ii) and former 898(c)(1)(C)(ii).431.13
431.6Rev. Proc. 2000-11, §5.02.
431.7Rev. Proc. 2000-11, §5.03. In addition, Rev. Proc. 2000-11, §6.02(6) provides that the common parent of a consolidated group may file one Form 1128 for its consolidated group to obtain automatic approval of a change of an annual accounting period.
431.8Rev. Proc. 2000-11, §5.03.
431.9Rev. Proc. 2000-11, §5.04.
431.10Rev. Proc. 2000-11, §5.05.
431.11Rev. Proc. 2000-11, §5.06. Compare to provisions in Rev. Procs. 2002-37 and 2003-34, which allow the carryback of short-period NOLs under certain circumstances.
431.12Rev. Proc. 2000-11, §5.07.
431.13Rev. Proc. 2000-11, §5.08.
The only basis for denial of the change of annual accounting period under Rev. Proc. 2000-11 were that: 
(1) the Form 1128 was untimely filed,431.14 or
(2) the corporation failed to meet the scope, terms, or conditions of Rev. Proc. 2000-11.431.15 If the change was denied, the IRS returned the Form 1128 to the taxpayer, with an explanation for the denial.431.16
431.14Rev. Proc. 2000-11, §7.01(a).
431.15Rev. Proc. 2000-11, §7.01(b).
431.16Rev. Proc. 2000-11, §7.01(b).
Corporations changing their annual accounting periods pursuant to this revenue procedure without complying with or satisfying all the conditions of this revenue procedure were deemed to have initiated the change in annual accounting period without the consent of the IRS.431.17
431.17Rev. Proc. 2000-11, §7.02.
c.	Certain Subsidiary Corporations
A subsidiary corporation that is required to change its annual accounting period under Regs. §1.1502-76, regarding the taxable year of members of an affiliated group filing a consolidated return, need not file a Form 1128 to make the change.431.18
431.18Regs. §1.442-1(c).
d.	Foreign Corporations
Under §898, the taxable year of any specified foreign corporation is the required year, which is generally the majority U.S. shareholder year. A specified foreign corporation generally must conform its taxable year for U.S. income tax purposes to a different required year should circumstances arise in which the required year changes, such as when a substantial change in ownership results in a new more than fifty percent U.S. shareholder with a different majority U.S. shareholder year. Such a change in taxable year is treated as initiated by the taxpayer and as having been made with the consent of the IRS.431.19
431.19Prop. Regs. §1.898-4(b)(1).
See III, F, above, for a discussion of required taxable years under §898.
For an additional discussion of specified foreign corporations and their required taxable years, see 930 T.M., Subpart F -- Sections 959-964, 1248 and Related Provisions, and 922 T.M., Foreign Personal Holding Companies.
e.	Tax-Exempt Organizations
Rev. Proc. 85-58 431.20 provides an automatic approval procedure for exempt organizations that wish to change their accounting periods. Organizations that change their accounting periods in accordance with the procedure will be treated as having obtained IRS approval for the change. An organization may not use this procedure if it has changed its accounting period within ten calendar years ending with the calendar year that includes the short year resulting from a change of accounting period. Rev. Proc. 76-10 432 provides an administrative procedure for a central tax-exempt organization to obtain approval for a change of taxable year for its subordinate organizations on a group basis.
431.201985-2 C.B. 740.
4321976-1 C.B. 548.
2.	Automatic Consent for S Corporations, Partnerships, and PSCs
 Rev. Proc. 2002-38,432.1 provides additional circumstances under which the IRS will grant automatic approval for an adoption, change, or retention in annual accounting period for S corporations, partnerships and PSCs. The procedure is available to an S corporation, partnership or PSC that wishes to change to its required taxable year, its natural business year, or its ownership taxable year.432.2 The automatic consent procedures are also available to a partnership, S corporation or PSC that wants to change from a 52-53-week taxable year that references a particular calendar month to a non-52-53-week taxable year that ends on the last day of that same month, and vice versa. 432.3
432.1Rev. Proc. 2002-38, 2002-22 I.R.B. 1037, superseding Rev. Proc. 87-32, 1987-2 C.B. 396.
432.2Rev. Proc. 2002-38, §4.01(1)-(3). See the discussions of permissible tax years for partnerships, S corporations and PSCs, in III, C, D, and E, above.
432.3Rev. Proc. 2002-38, §4.01(4).
The procedure also provides audit protection to taxpayers adopting, changing, or retaining an annual accounting period under the proposed revenue procedure.432.4
432.4Rev. Proc. 2002-38, §8.01.
Rev. Proc. 2002-38 432.5 provides that taxpayers under examination that do not obtain consent of the appropriate director will not generally be within the scope of the notice. Any partnership, S corporation, electing S corporation, or PSC complying with the applicable provisions of Rev. Proc. 2002-38 is deemed to have established a business purpose and to have obtained the approval of the Commissioner to adopt, change, or retain its annual accounting period under §442 and the regulations thereunder.
432.5Rev. Proc. 2002-38, §4.02.
A change (as well as an adoption or retention) in annual accounting period will be approved where the taxpayer establishes a business purpose for the requested annual accounting period and agrees to the Commissioner's prescribed terms, conditions, and adjustments for effecting the adoption, change, or retention. In order to secure approval to change an annual accounting period, Regs. §1.442-1(b) provides that a taxpayer must file an application generally on Form 1128, Application to Adopt, Change, or Retain a Tax Year. Rev. Proc. 2002-38 clarifies that a taxpayer desiring to adopt, change, or retain its annual accounting period, must complete and file an application (i.e., a current Form 1128 or Form 2553, Election by a Small Business Corporation, in the case of an electing S corporation) with the Director, Internal Revenue Service Center, Attention: ENTITY CONTROL, where the taxpayer files its income tax returns.432.6 Taxpayers should write at the top of page 1 of the Form 1128 (or Form 2553): "FILED UNDER REV. PROC. 2002-38." A user fee will not be required. In addition, no copies of Form 1128 (or Form 2553) are required to be sent to the National Office. The taxpayer must attach a copy of the Form 1128 (or Form 2553) to the federal income tax return filed for the first effective year.
432.6Rev. Proc. 2002-38§7.02.
Rev. Proc. 2002-38 does not apply to a change or retention in annual accounting period if the taxpayer is under examination, is before an area office or is before a federal court with respect to any income tax issue and its annual accounting period is an issue under consideration. Rev. Proc. 2002-38 also does not apply to a change or retention in annual accounting period by a partnership or S corporation if, on the date the entity would otherwise file its application with the service center, the entity's annual accounting period is an issue under consideration in the examination of a partner or shareholder's federal income tax return or is an issue under consideration by an area office or by a federal court with respect to a partner or shareholder's federal income tax return. In addition, the notice does not apply if the partnership, S corporation, electing S corporation, or PSC has changed its annual accounting period at any time within the most recent 48-month period (four year period) ending with the last month of the requested taxable year.
Note that a change to a required taxable year or ownership taxable year, a change to or from a 52-53-week taxable year, or a change by a former subsidiary to its former common parent's taxable year in order to comply with the common taxable year requirement of Regs. §1.1502-76(a)(1) are not considered changes in annual accounting period under this revenue procedure.
 Any partnership, S corporation, electing S corporation, or PSC that wants to adopt, change to, or retain an annual accounting period not described in Rev. Proc. 2002-38, §4.01, or that cannot make a change because of a prior change, must obtain the approval of the Commissioner in a nonautomatic change of accounting period request described in Rev. Proc. 2002-39.
Rev. Proc. 2002-38 is generally effective on or after May 10, 2002.
As discussed in VII, A, below, Rev. Proc. 2003-79, 2003-45 I.R.B. 1036, provides that, in some circumstances, a partner or S corporation shareholder may elect to spread ratably over a four-year period the partner's or shareholder's share of income from the partnership's or S corporation's short taxable year that ends after May 9, 2002, and before June 1, 2004 (or, in the case of a taxpayer that uses a 52-53-week taxable year, with reference to the last day of any calendar month after April 30, 2002, and before June 1, 2004). Rev. Proc. 2003-79 applies if, among other requirements, the partnership or S corporation changes its taxable year solely because its current taxable year no longer qualifies as a natural business year under Rev. Proc. 2002-38 or Rev. Proc. 2002-39, or, in the case of an S corporation, the current taxable year no longer qualifies as an ownership taxable year under Rev. Proc. 2002-38. Rev. Proc. 2003-79 sets forth procedures for making the election.
3.	Individuals
In July 2003, the IRS issued Rev. Proc. 2003-62,432.7 which allows individuals filing fiscal year returns to obtain automatic approval to change to a calendar year accounting period.
432.72003-32 I.R.B. 299, modifying, amplifying, and superseding Rev. Proc. 66-50, 1966-2 C.B. 1260, and modifying and superseding Rev. Proc. 81-40, 1981-2 C.B. 604. See also Announcement 2003-49, 2003-32 I.R.B. 339, which accompanies Rev. Proc. 2003-62. Rev. Proc. 2003-62 is based on the proposed revenue procedure issued in Notice 2002-75, 2002-47 I.R.B. 884.
Rev. Proc. 2003-62 is effective for changes in annual accounting periods for which the first effective year ends on or after July 7, 2003. However, if the time for filing Form 1128 with respect to the individual's "short period" has not yet expired (as described below), the individual may elect early application of Rev. Proc. 2003-62. The National Office will process any application pending on July 7, 2003, in accordance with the authority under which it was filed unless the individual who filed the application notifies the national office by the later of Aug. 21, 2003, or the issuance of a letter ruling granting or denying the request that the individual wishes to use Rev. Proc. 2003-62 instead. If the individual does so notify the national office, the individual may be required to modify the application to comply with Rev. Proc. 2003-62.
An individual who complies with Rev. Proc. 2003-62 is deemed to have established a business purpose and to have obtained the Commissioner's approval to change to the calendar year period. Rev. Proc. 2003-62 is the exclusive procedure for individuals to change their annual accounting periods automatically to the calendar year.
An individual wishing to make a change pursuant to Rev. Proc. 2003-62 must file Form 1128 (Application to Adopt, Change, or Retain a Tax Year) with the Director, Internal Revenue Service Center, Attention: ENTITY CONTROL, where the individual files the individual's federal income tax return. The Form 1128 must be filed by the due date (including extensions) of the individual's federal income tax return for the "short period" that is required to effect the change (i.e., the period beginning with the day following the last day of the old taxable year and ending with the day preceding the first day of the new taxable year). The individual must attach a copy of the Form 1128 to the individual's return filed for the short period.
The individual must type or print legibly at the top of the first page of the Form 1128 "FILED UNDER REV. PROC. 2003-62." The individual (or, in the case of married individuals filing a joint return, both the husband and the wife) must sign the form.
An IRS service center may deny a change of accounting period under Rev. Proc. 2003-62 only if: (1) the form is not timely filed; or (2) the individual fails to meet any term or condition of the revenue procedure. If the appropriate director determines that an individual filing Form 1128 under Rev. Proc. 2003-62 changed the individual's annual accounting period without complying with the provisions of Rev. Proc. 2003-62, the IRS ordinarily will deem the individual to have initiated the change without the Commissioner's approval. In such a circumstance, the IRS may deny the change and may require the individual to recompute taxable income or loss in accordance with the individual's former taxable year.
Under Rev. Proc. 2003-62, if an individual's change of annual accounting period results in a short period, the individual must file a federal income tax return for the short period by the due date of that return, including extensions, and must annualize the individual's income and compute the tax in accordance with §443(b) and  (c) and Regs. §1.443-1(b) and  (c). The individual generally must make returns for subsequent taxable years on the basis of a full 12 months ending on the last day of the calendar taxable year.
Rev. Proc. 2003-62 provides that, if the individual generates a net operating loss (NOL) in a short period, the individual may carry the NOL over in accordance with §172, beginning with the first taxable year after the short period. The short-period NOL must be carried back or carried over in accordance with §172 if it is either: (1) $50,000 or less; or (2) less than the NOL generated for the full 12-month period beginning with the first day of the short period.
Rev. Proc. 2003-62 also provides that, if the individual generates an unused general business credit or other unused credit in the short period, the individual must carry the unused credit forward.
Rev. Proc. 2003-62 does not apply to newly married couples. Regs. §1.442-1(d) provides a special rule under which a newly married individual may obtain automatic consent to use his or her spouse's accounting period. See VI, B, 4, below.
Rev. Proc. 2003-62 also does not apply to an individual who has an interest in a passthrough entity432.8 as of the end of the individual's short period. However, an interest in a passthrough entity is disregarded for this purpose if: (1) the passthrough entity would be required under the Code or regulations to change its taxable year to the individual's new calendar year; (2) the passthrough entity is a fiscal-year partnership that is owned equally by two partners, one or both of whom are individuals, and the individual and the partnership both wish to change to the calendar taxable year of the other partner; (3) the individual's new calendar year would result in no change in -- or less deferral of -- income from the entity than under the individual's present taxable year; or (4) the passthrough entity has been in existence for at least three years and the individual's interest in the entity is de minimis.432.9
432.8For Rev. Proc. 2003-62 purposes, a "passthrough entity" is a partnership, trust, estate, common trust fund, controlled foreign corporation (but only if the individual is a U.S. shareholder), foreign personal holding company (but only if the individual is a U.S. shareholder), passive foreign investment company (but only if the individual has elected to treat the company as a qualified electing fund), or a closely held real estate investment trust (but only to the extent the individual is described in §6655(e)(5)(A)). Note that, for taxable years of foreign corporations beginning after Dec. 31, 2004, and for taxable years of U.S. shareholders with or within which such taxable years of foreign corporations, the foreign personal holding company provisions (§§551-558) are repealed. See 2004 American Jobs Creation Act, P.L. 108-357, §413(a).
432.9An interest is de minimis for this purpose if: (1) the amount of income from the passthrough entity is less than or equal to the lesser of (a) 5% of the individual's gross income (without adjustments) from all sources for the three taxable years or (b) $500,000; and (2) the amount of the individual's gross income (without adjustments) from all passthrough entities is less than or equal to the lesser of (a) 5% of the individual's gross income (without adjustments) from all sources for the three taxable years or (b) $500,000.
If an individual's interest in a related passthrough entity is disregarded because the entity must change its taxable year to the individual's new calendar taxable year, the related entity must change its taxable year concurrently under Rev. Proc. 2002-37 or Rev. Proc. 2002-38, whichever is applicable.
In Announcement 2003-49,432.10 the IRS stated that Rev. Proc. 2003-62 is drafted to be consistent with Rev. Proc. 2002-37432.11 (automatic approval for corporations to change their accounting periods) and Rev. Proc. 2002-39432.12 (advance approval for taxpayers to change their accounting periods).
432.102003-32 I.R.B. 339.
432.112002-22 I.R.B. 1030.
432.122002-22 I.R.B. 1046.
Individuals who are not eligible to obtain automatic approval for an accounting period change under Rev. Proc. 2003-62 must secure prior approval for the change pursuant to §442 and the regulations thereunder, as provided in Rev. Proc. 2002-39. See VI, C, below.
4.	Newly Married Couples
A newly married person generally does not need permission to change to the taxable year of his or her spouse in order to be eligible for filing a joint return for the spouse's first or second taxable year ending after the date of marriage.433 The necessary short-period return must contain a statement that it is filed under authority of Regs. §1.442-1(d).434
433Regs. §1.442-1(d).
434Regs. §1.442-1(d).
C. Nonautomatic Taxable Year Changes
1.	 General Rules
Other than as discussed above, taxpayers generally may not obtain approval to change taxable years without establishing a substantial business purpose and agreeing to terms and conditions prescribed by the IRS.435 This section describes these general requirements. Under former the former regulations, the taxpayer and the Commissioner had to enter into an agreement setting forth the terms and conditions. The terms and conditions are now set forth in procedural guidance.436
435Regs. §1.442-1(b)(2).
436C corporations satisfying these general requirements will ordinarily obtain approval. For discussion of additional or special requirements for particular types of taxpayers, see VI, C, 2, 3 and 4, below.
2.	Changes after May 9, 2002
 In May 2002, the IRS simultaneously released three revenue procedures (two of which are of interest to partnerships, S corporations, electing S corporations and PSCs) under §442 along with regulations under §§441, 442, 706, and 1378, which allow partnerships, S corporations, electing S corporations, and personal service corporations (PSCs) to adopt, change, or retain a taxable year.
Rev. Proc. 2002-39436.1 applies to taxpayers outside the scope of automatic approval procedures of Rev. Procs. 2002-37 and 2002-38. Rev. Proc. 2002-39 provides procedures to establish a business purpose and request prior approval to adopt, change, or retain a taxpayer's taxable year.
436.1Rev. Proc. 2002-39, 2002-22 I.R.B. 1046, supersedes Rev. Proc. 85-16, 1985-1 C.B. 517, and Rev. Proc. 74-33, 1974-2 C.B. 489.
Before the issuance of Rev. Proc. 2002-39, the IRS weighed the merits of a taxpayer's stated business purpose for the requested annual accounting period against the amount of distortion of income or other tax consequences resulting from the adoption of, change to, or retention of that annual accounting period. In general, the only circumstance in which a taxpayer's business purpose overcame more than de minimis distortion of income is where the taxpayer was adopting, changing to, or retaining, its natural business year.
Under the revenue procedure, taxpayers wanting to adopt, change to, or retain a natural business year generally will be granted approval as under the previous IRS ruling practice. Establishing a natural business year generally will be the only circumstance under which a partnership, S corporation, electing S corporation, or PSC will be granted approval. However, Rev. Proc. 2002-39 liberalizes the IRS ruling practice for other taxpayers as long as they agree to additional terms, conditions, and adjustments designed to neutralize the tax effects of substantial distortion of income resulting from the change. Prior to Rev. Proc. 2002-39, these other taxpayers generally were denied approval to change their annual accounting period if the change results in more than de minimis distortion of income.
In addition, Rev. Proc. 2002-39,436.2 provides audit protection to taxpayers adopting, changing, or retaining an annual accounting period under the revenue procedure. The revenue procedure also provides that taxpayers under examination that do not obtain consent of the appropriate director will not be within the scope of the proposed revenue procedure and will not receive audit protection.
436.2Rev. Proc. 2002-39, §8.
Generally, a taxpayer may adopt any taxable year that satisfies §441 and the regulations thereunder without the approval of the Commissioner. However, a partnership, electing S corporation, or PSC that wants to adopt a taxable year other than its required taxable year, a 52-53-week taxable year that references its required taxable year, or a taxable year elected under §444, must establish a business purpose and obtain approval under §442.
Rev. Proc. 2002-39 436.3 provides that a request to adopt, change, or retain an annual accounting period ordinarily will be approved if the taxpayer:
436.3Rev. Proc. 2002-39, §5.01.
(a) establishes a business purpose (within the meaning of §5.02) for the requested annual accounting period; and
(b) agrees to the Commissioner's prescribed terms, conditions, and adjustments under which the adoption, change, or retention will be effected.
Rev. Proc. 2002-39 provides that a taxpayer requesting to adopt, change to, or retain an annual accounting period that is the taxpayer's natural business year is deemed to establish a business purpose to the satisfaction of the Commissioner.436.4
436.4Rev. Proc. 2002-39, §5.02(1)(a).
Rev. Proc. 2002-39 436.5 provides that a natural business year is the annual accounting period encompassing all related income and expenses. A natural business year may be established by the following tests:
(1) the annual business cycle test, where the gross receipts from sales and services in the short period and the three preceding years indicate a peak and nonpeak period in the taxpayer's taxable year, the natural business year is deemed to end at, or soon after, the close of the peak period;
(2) the seasonal business test, where the taxpayer's business is operational for only part of the year and, as a result, has insignificant gross receipts during the period the business is not operational, the natural business year is deemed to end at, or soon after, the operations end for the season; and 
(3) the 25% gross receipts test.
436.5Rev. Proc. 2002-39, §5.03.
 Under Rev. Proc. 2002-39,436.6 a taxpayer (including a partnership, S corporation, electing S corporation, or PSC) may also establish a business purpose for the requested taxable year based on all the relevant facts and circumstances. However, the administrative and convenience reasons such as those described in Rev. Rul. 87-57 and the following facts and circumstances will insufficient to establish a business purpose under the revenue procedure:
436.6Rev. Proc. 2002-39, §5.02(1)(b).
(i) the use of a particular year for regulatory or financial accounting purposes;
(ii) the hiring patterns of a particular business;
(iii) the use of a particular year for administrative purposes, such as the admission or retirement of partners or shareholders, promotion of staff, and compensation or retirement arrangements with staff, partners, or shareholders;
(iv) the fact that a particular business involves the use of price lists, model years, or other items that change on an annual basis;
(v) the use of a particular year by related entities; and
(vi) the use of a particular year by competitors.
Rev. Proc. 2002-39, §5.02(2), also provides that a taxpayer (such as a sole proprietor) other than a partnership, S corporation, electing S corporation, or PSC that does not establish a business purpose for the requested annual accounting period under the revenue procedure generally will be deemed to have established a business purpose if it provides a non-tax reason for the requested annual accounting period and agrees to the additional terms, conditions, and adjustments of the proposed revenue procedure.436.7
436.7Rev. Proc. 2002-39, §5.02(2).
Rev. Proc. 2002-39 explains that additional terms, conditions, and adjustments are necessary to neutralize the tax effects of a substantial distortion of income that otherwise would result from the change, including: a deferral of a substantial portion of the taxpayer's income; or shifting of a substantial portion of deductions from one taxable year to another; a similar deferral or shifting in the case of any other person, such as a beneficiary in an estate; the creation of a short period in which there is a substantial NOL, CL, or credit (including a general business credit), or the creation of a short period in which there is a substantial amount of income to offset an expiring NOL, CL, or credit. See VI, D, 1, below for a discussion of the effect on NOL and CL carryovers.
The distortion of income will not be considered substantial and no adjustments will be required for such distortion if the amount of the distortion is less than both 5% of the taxpayer's estimated gross receipts for its current taxable year (computed as if the taxpayer remained on its existing taxable year) and $500,000. An adjustment will be required if the change creates a substantial distortion of income as a result of increasing the deferral of the taxpayer's distributive share of income from a pass-through entity between the taxable year of the pass-through entity and the taxpayer's taxable year.436.8
436.8Rev. Proc. 2002-39, §5.05.
If the deferral of income computed represents a substantial distortion of income, the taxpayer must include the entire amount of the distortion as ordinary income for the first effective year, Rev. Proc. 2002-39, §5.05(c) states. The taxpayer also must report its allocable share of income from the pass-through entity in the taxable year following the first effective year in accordance with general tax principles (e.g., §706). The taxpayer must establish a suspense account for the amount included in ordinary income for the first effective year and deduct this amount ratably over the four taxable years immediately succeeding the first effective year.
In addition, Rev. Proc. 2002-39, §5.05(4), provides that an adjustment will be required if the change creates a substantial distortion of income as a result of the creation of income in the short period to offset expiring NOLs, CLs or credits (including general business credits). The amount of distortion that results from a change is the amount by which any NOLs, CLs, and credits that are carried over to the first effective year and that expire in that year exceed the NOLs, CLs, and credits that could have been used to offset income in the taxpayer's current taxable year (computed as if the taxpayer remained on its existing taxable year). If this distortion is substantial, any NOL, CL, or credit carried over to the first effective year will be allowed to offset income in the first effective year only to the extent that such NOL, CL, or credit could have been used to offset income in the taxpayer's current taxable year. See VI, D, 1, below for a discussion of the effect on NOL and CL carryovers.
Rev. Proc. 2002-39 provides that to request automatic consent to adopt, change, or retain an annual accounting period, a taxpayer (other than an electing S corporation which uses Form 2553, Election by a Small Business Corporation) must complete, sign, and file a current Form 1128, Application to Adopt, Change, or Retain a Tax Year.
 If the taxpayer requests to establish a natural business year, it must provide its gross receipts from sales or services and approximate inventory costs (where applicable) for each month in the requested short period and for each month of the three immediately preceding taxable years. The taxpayer must also indicate whether it has an NOL or CL in the short period required to effect the change and provide the type and amount of any credits generated in the short period.
Taxpayers are required to pay user fees for requests to adopt, change, or retain an annual accounting period under Rev. Proc. 2002-39.436.9 
436.9Rev. Proc. 2005-1, 2005-1 I.R.B. 1, and, for tax-exempt organizations, Rev. Proc. 2005-8, 2005-1 I.R.B. 243, contain the schedule of user fees and provide guidance for complying with the user fee requirements.
Rev. Proc. 2002-39 is generally effective on or after May 10, 2002.
As discussed in VII, A, below, Rev. Proc. 2003-79,436.10 provides that, in some circumstances, a partner or S corporation shareholder may elect to spread ratably over a four-year period the partner's or shareholder's share of income from the partnership's or S corporation's short taxable year that ends after May 9, 2002, and before June 1, 2004 (or, in the case of a taxpayer that uses a 52-53-week taxable year, with reference to the last day of any calendar month after April 30, 2002, and before June 1, 2004). Rev. Proc. 2003-79 applies if, among other requirements, the partnership or S corporation changes its taxable year solely because its current taxable year no longer qualifies as a natural business year under Rev. Proc. 2002-38 or Rev. Proc. 2002-39. Rev. Proc. 2003-79 sets forth procedures for making the election.
436.102003-45 I.R.B. 1036.
3.	Changes before May 10, 2002
a.	General
(1)	Substantial Business Purpose Requirement
In determining whether the taxpayer has established a substantial business purpose for making the change, the IRS considered all the facts and circumstances relating to the change, including the resulting tax consequences. The taxpayer's annual cycle of business activity was considered in determining whether a substantial business purpose had been established.437
437Regs. §1.442-1(b)(2).
(2)	Agreement with Adjustments to Prevent a Substantial Distortion of Income
An agreement with the Commissioner regarding the terms and conditions under which the change would be effected was a prerequisite to the change even though approval was generally granted if the taxpayer established a substantial business purpose. The agreement was the means of remedying any substantial distortions in income. Examples of a "substantial distortion" included: 
(1) deferral of a substantial portion of the taxpayer's income, or shifting of a substantial portion of deductions, from one year to another so as to reduce substantially the tax liability of the taxpayer;
(2) causing a similar deferral or shifting in the case of any other person (such as a partner, a beneficiary, or a shareholder in an S corporation); or
(3) creating a short period in which there was a substantial net operating loss.438
438Regs. §1.442-1(b)(3).
Rev. Proc. 85-16439 describes the procedures for and the circumstances under which approval of a change in accounting period would be granted if the change resulted in a net operating loss for the short taxable period. The IRS would approve a change only if the taxpayer agreed to deduct the net operating loss ratably over a six-year period following the short period in lieu of claiming a net operating loss carryback, unless the taxpayer met one of the following exceptions: 
(1) the net operating loss for the short period was $10,000 or less; or
(2) the change results in a short period of nine months or longer, the net operating loss was greater than $10,000, and the net operating loss for the full 12-month period beginning with the first day of the short period equaled or exceeded the net operating loss for the short period.
4391985-1 C.B. 517, reprinted in the Working Papers, below.
Rev. Proc. 85-16 superseded Rev. Proc. 77-26, 1977-2 C.B. 536, and Rev. Proc.66-6, 1966-1 C.B. 615, which required a 10-year spread of short-period net operating losses.
If the taxpayer met one of these exceptions, then the net operating loss could be carried back and carried over in accordance with the normal rules of §172(b).440
440Rev. Proc. 85-16, §3.
Note: In Rev. Rul. 70-286,441 the IRS ruled that if the ratable spread of the loss for the short period to be carried over to a particular taxable year exceeds the taxable income for that year, the unused excess will lose its original identity and can be treated as an ordinary deduction. Accordingly, a net operating loss for the year could be created.
4411970-1 C.B. 113, obsoleted by Rev. Rul. 2003-99, 2003-34 I.R.B. 388. Rev. Rul. 70-286 was based on Rev. Proc. 66-6, 1966-1 C.B. 615, which required a 10-year spread of short-period net operating losses. As noted above, Rev. Proc. 85-16, 1985-1 C.B. 517, superseded Rev. Proc. 66-6. Moreover, Rev. Proc. 2002-39, 2002-22 I.R.B. 1046 (as modified by Rev. Proc. 2003-34, 2003-18 I.R.B. 856), supersedes Rev. Proc. 85-16 and provides rules for adjusting net operating losses to prevent substantial distortions, effective on or after May 10, 2002, as discussed in VI, C, 2, above.
b.	Requirements for Partnerships, S Corporations, and Personal Service Corporations
Rev. Proc. 87-32 442 provided guidance to partnerships, S corporations or corporations electing to be S corporations, and personal service corporations desiring to adopt, retain, or change taxable years.
4421987-2 C.B. 396, reprinted in the Worksheets, below.
Section 3.01(1)(b) of Rev. Proc. 87-32 provided expeditious approval procedures for any of the above entities seeking to change to a fiscal year that coincides with its natural business year, provided the new taxable year resulted in less income deferral to the owners than the current taxable year.443 Expeditious approval was also available under §3.01(1)(c) to any S corporation (or any corporation electing to be an S corporation) seeking to change to the same taxable year as that of the owners of more than half the corporation's outstanding stock.444
443See III, C, 3, III, D, 3, and III, E, 1, b, above.
444For discussion of this exception, see III, D, 3, above.
Expeditious approval was not available to:
(1) taxpayers that had used this expeditious approval at any time within the last six years ending on or before the date of application;
(2) a personal service corporation seeking to change its taxable year if that taxpayer made an S corporation election (under §1362) for the taxable year immediately following the short taxable year; or
(3) a partnership, an S corporation or a corporation electing to be an S corporation, or a personal service corporation if that taxpayer, as of the date described below, was a partner in a partnership, a beneficiary of a trust or estate, a U.S. shareholder of a controlled foreign corporation, or a shareholder of a domestic international sales corporation. The date referred to is:
(a) in the case of a change in taxable year by a partnership, S corporation, or personal service corporation, the last day of the short taxable year required to effect the change;
(b) in the case of an adoption of a taxable year by a partnership or personal service corporation, the last day of the first taxable year; or
(c) in the case of an adoption, retention, or change of a taxable year by a corporation electing to be an S corporation, the first day of the first taxable year the taxpayer is an S corporation.445
445Rev. Proc. 87-32, §3.01(2).
Note: A partnership may be required to change its taxable year if its "required tax year" changes. (See III, E, 1, above.)
4.	Special Requirements Applicable to Particular Taxpayers
a.	DISCs
A taxable year is required for a domestic international sales corporation (DISC) in order to determine its deemed distribution to its shareholders.446 In Rev. Rul. 76-30,447 the Service explained that a DISC must establish a substantial business purpose when requesting a change in annual accounting period, and it ruled that the preservation of DISC status did not constitute a substantial business purpose.
446§995(b)(1).
4471976-1 C.B. 112.
b.	Formerly Exempt Organizations
Typically, an exempt corporation must file only an annual information return (Form 990) or no return at all pursuant to Regs. §1.6033-1. If as a result of becoming non-exempt it is required to file a Form 1120 return, the corporation is not a "new taxpayer" within the meaning of Regs. §1.442-1. In Rev. Rul. 67-173,448 the IRS ruled that an exempt entity was in existence for the period of time preceding the period for which it must file an income tax return even though it had previously been an exempt entity. Because the corporation was not a "new taxpayer", prior approval of the Commissioner was required to change its year end.
4481967-1 C.B. 101.
The IRS position in Rev. Rul. 67-173 was sustained in Forest City Production Credit Ass'n v. U.S.449 The taxpayer was organized under the Farm Credit Act of 1933 and was exempt from income tax under §501. The taxpayer had been filing information returns on a calendar year basis from its inception until it lost its exemption. At that point, it began filing regular tax returns on a fiscal year basis without the Commissioner's consent. The court rejected the taxpayer's argument that it was a "new" taxpayer. Furthermore, the court pointed out that while it may not have been paying income tax, it was nevertheless liable for FICA taxes during the period of its income tax exemption.
449300 F. Supp. 609 (E.D. Ark., 1969), aff'd, 426 F.2d 819 (8th Cir.1970).
c.	Certain Individuals
Rev. Proc. 2003-62450 provides the exclusive procedure for individuals filing fiscal year returns to obtain automatic approval to change to a calendar year accounting period. The taxpayer must file Form 1128 on or before the due date (including extensions) for filing the federal income tax return for the short period required to effect the change of accounting period.451 Unless the taxpayer receives a letter from the district director denying approval due to untimely filing of Form 1128, the individual can assume the change has been approved.452
4502003-32 I.R.B. 299, effective for changes in annual accounting periods for which the first effective year ends on or after July 7, 2003. Rev. Proc. 2003-62 modifies, amplifies, and supersedes Rev. Proc. 66-50, 1966-2 C.B. 1260, which previously presribed procedures for individuals changing from a fiscal to a calendar year.
451Rev. Proc. 2003-62, §7.02(2). Rev. Proc. 2005-27, 2005-20 I.R.B. 1050, provides that the IRS may issue guidance extending the Form 1128 filing deadlines for individuals serving in the U.S. Armed Forces or serving in support of the Armed Forces in a combat zone or for taxpayers affected by a Presidentially declared disaster or determined by the IRS to be affected by a terroristic or military action. In accordance with an amendment to §7508(a) by §104 of the Military Family Tax Relief Act of 2003, P.L. 108-121, such an extension would likely include service in a contingency operation, as well as in a combat zone.
452Rev. Proc. 2003-62, §§7.01 and 8.01.
Rev. Proc. 2003-62 does not apply to two categories of individuals: (1) certain newly married couples subject to Regs. §1.442-1(d); and (2) any individual that has an interest in a pass-through entity as of the end of the short period. These individuals must follow the general provisions of Regs. §1.442-1(b)(1). Automatic approval is nonetheless available to individuals who own interests in pass-through entities if any of four conditions described in the procedure are met. A pass-through entity is defined generally as a partnership; a trust; an estate; a common trust fund; a controlled foreign corporation; (before 2005) an foreign personal holding company; a passive foreign investment company; and a closely-held real estate investment trust.453 These individuals must follow the general provisions of Regs. §1.442-1(b)(1).
453Rev. Proc. 2003-62, §§4.02 and 5.02.
For further discussion of Rev. Proc. 2003-62, see VI, B, 3, above.
In Rev. Rul. 76-43,454 the Service ruled that a taxpayer who attained the age of 65 in February was not permitted to change from a calendar year to a March 31 year-end, because the purpose of the change was to enable the taxpayer to accelerate the benefit from the retirement income credit provisions of former §37 (now §22). The IRS stated that the taxpayer had failed to establish a substantial business purpose for the change.
4541976-1 C.B. 113.
The IRS also ruled in one situation that an employee cannot establish a business purpose for changing to a fiscal year.455
455PLR 7844042.
D. Considerations in Timing the Change of a Taxable Year
In general, if a change of taxable year requires the Commissioner's approval, the taxpayer must demonstrate a substantial business purpose.456 Although the change maybe motivated primarily by a substantial business purpose, the taxpayer should be alert to the tax consequences of such a change.
456Regs. §1.442-1(b)(1).
1.	NOL and Capital Loss Carryovers
The effect on net operating loss and capital loss carryovers should be considered before making the change. For example, the short period resulting from the change may be the last taxable year for using a net operating loss carryover. If the short-period income is not sufficient to absorb the net operating loss, all or a portion of it may expire unused. The short period may also be the last taxable year for a capital loss carryover, deduction of which would be lost if there are insufficient capital gains in the short period. Under those circumstances, it might be wiser to defer the change in taxable year-end until the following year or later, when the tax consequences may be neutral. Further, with respect to carryovers, a short taxable year is considered a full taxable year for purposes of the carryover period.457 Therefore, the change may significantly reduce the ability to utilize the carryover by actually shortening the number of months in the carryover period.
457§ 441(b)(3).
In May 2002, the IRS issued Rev. Procs. 2002-37 and 2002-39 457.1 providing that, as a term and condition for approval to change accounting periods, taxpayers are prohibited from carrying back an NOL or CL generated in the short period unless the NOL or CL either: (1) is $50,000 or less; or (2) results from a short period of nine months or longer and is less than the NOL or CL for the 12-month period beginning with the first day of the short period.
457.12002-22 I.R.B. 1030 and 2002-22 I.R.B. 1046, respectively.
In April 2003, the IRS issued Rev. Proc. 2003-34,457.2 which removed the 9-month requirement. Taxpayers that generate NOLs or CLs in the short period may carryback those losses if the losses are less than the NOL or CL generated for the 12-month period beginning with the first day of the short period. Rev. Proc. 2003-34 is effective for taxpayers requesting to change annual accounting periods on or after Apr. 8, 2003, and certain qualifying taxpayers that previously changed annual accounting periods, and provides that the taxpayer must wait until the 12-month period has expired to determine whether the exception applies. Under the revenue procedure, taxpayers wishing to forgo the carryback must timely elect to waive the entire carryback period under §172(b)(3), or have a Regs. §1.1502-21(b)(3)(ii)(B) election in place.
457.22003-18 I.R.B. 856.
Rev. Proc. 2003-34 also contains procedures for certain qualified taxpayers that previously changed annual accounting periods to elect to apply this modified carryback provision to all NOLs and CLs attributable to the short period, or, if the short period ends in 2001 or 2002, to elect to apply an alternative carryback provision. In order to qualify to make this election: (1) the taxpayer must have filed an application to change annual accounting periods under Rev. Proc. 2002-37, or received prior approval to change annual accounting periods from the national office, prior to April 8, 2003; (2) the taxpayer must have been prohibited from carrying back an NOL or CL generated in the short period because the short period was less than nine months; (3) the NOL or CL generated in the short period must be less than the NOL or CL for the full 12-month period beginning with the first day of the short period; and (4) the short period necessary to effect the change must have begun on or after February 1, 2000.
Under Rev. Proc. 2003-34, if a qualified taxpayer elects to apply the modified carryback term and condition, NOLs and CLs generated in the short period must be carried back in accordance with §172 or §1212. Alternatively, if a qualified taxpayer has a short period ending in 2001 or 2002, Rev. Proc. 2003-34 allows qualified taxpayers to apply an alternative carryback term and condition, under which short period NOLs qualifying for the exception are carried back to each of the two taxable years preceding the short period (and remaining NOLs must be carried over under §172), and short period CLs are carried back or carried over in accordance with §1212, however taxpayers may not apply the alternative carryback term and condition if the taxpayer's NOL for the short period is subject to certain §172 provisions.
In addition, consolidated groups that previously changed annual accounting periods may make a special election to relinquish certain losses for the short period attributable to certain acquired members.
To elect to apply the modified or alternative carryback term and condition, taxpayers must file a signed and dated statement by September 30, 2003, where the taxpayer files its income tax return.
In July, 2003, the IRS issued Rev. Proc. 2003-62,457.3 which allows individuals filing fiscal year returns to obtain automatic approval to change to a calendar year accounting period. In Announcement 2003-49,457.4 the IRS stated that Rev. Proc. 2003-62 is drafted to be consistent with Rev. Proc. 2002-37 and Rev. Proc. 2002-34. Thus, Rev. Proc. 2003-62 provides that, if the individual generates a net operating loss (NOL) in a short period, the individual may carry the NOL over in accordance with §172, beginning with the first taxable year after the short period. The short-period NOL must be carried back or carried over in accordance with §172 if it is either: (1) $50,000 or less; or (2) less than the NOL generated for the full 12-month period beginning with the first day of the short period.
457.32003-32 I.R.B. 299.
457.42003-32 I.R.B. 339.
2.	Self-Employment Taxes
Another consideration may be the payment of self-employment taxes. Section 1401 imposes an old-age, survivors, and disability insurance tax for each taxable year on the self-employment income of every individual subject to a prescribed maximum limitation for each taxable year.458 The phrase taxable year includes the period for which a return is made if the return is for a period of less than 12 months.459
458§ 1402(b). Note that the maximum limit for the old-age, survivors, and disability insurance taxes imposed on employees and their employers is determined on a calendar-year basis for all taxpayers. §3121(a)(1).
459§ 441(b)(3).
If a change in year-end results in two consecutive short periods, tax up to the annual maximum may be due for each short year even if the periods comprise only one calendar year.460
460Rev. Rul. 69-410, 1969-2 C.B. 167.
3.	LIFO Inventories
Another situation in which the taxable year becomes important involves last-in, first-out (LIFO) inventory method taxpayers. In an inflationary environment, choosing a tax year-end at the time inventory is likely to be at a very high level would typically provide the most tax benefit (through higher costs of goods sold) under the LIFO method.
4.	Natural Business Year
If a corporation's annual accounting period is different from its natural business year, a change to its natural business year is worthy of consideration. Adoption of the natural business year as a reason for a change in the taxable year is a substantial business purpose recognized by the Commissioner.461 Adoption of a natural business year could be difficult or impossible for a corporation with widely diversified and scattered activities, or for an affiliated group of corporations filing a consolidated return. While each member of the group is required to adopt the taxable year of the parent corporation, the members may be engaged in different kinds of seasonal businesses with different natural business years.
461Rev. Proc. 2002-38, 2002-22 I.R.B. 1037.
5.	Other Factors
The taxpayer should also consider business factors such as the timing of regulatory reports and other filings, liquidity at various times of the year for purposes of timing tax payments, and the availability of the personnel required to prepare tax return information.
E. Time and Method of Application Seeking Commissioner's Prior Approval
For a taxpayer that cannot take advantage of automatic consent, in order to secure prior approval of a change in the taxpayer's year-end, the taxpayer must file an application on Form 1128 no earlier than the day following the end of the first effective year and no later than the due date (not including extensions) of the federal income tax return for the first effective year.462
462Rev. Proc. 2002-38, §6.02. However, Rev. Proc. 2005-27, 2005-20 I.R.B. 1050, provides that the IRS may issue guidance extending the Rev. Proc. 2002-38 time for filing for taxpayers serving in, or in support of, the Armed Forces in a combat zone, and for taxpayers affected by a Presidentially declared disaster or determined by the IRS to be affected by a terroristic or military action. In accordance with an amendment to §7508(a) by §104 of the Military Family Tax Relief Act of 2003, P.L. 108-121, such an extension would likely include service in a contingency operation, as well as in a combat zone.
If the taxpayer misses that deadline by no more than ninety days, it may be able to obtain an extension of time for filing. The IRS has indicated that it will grant that relief if the taxpayer establishes: (1) that it acted reasonably and in good faith; and (2) that granting relief will not prejudice the interests of the government.463 The IRS will not consider a taxpayer to have acted reasonably and in good faith if the taxpayer uses hindsight in requesting relief. For example, if facts have changed since the original due date of the election that make an election advantageous to a taxpayer, the IRS will not ordinarily grant relief.464The IRS considers the interests of the government to be prejudiced if granting relief would result in a taxpayer's having a lower tax liability in the aggregate for all taxable years affected by the election than the taxpayer would have had if the election had been timely made (taking into account the time value of money).465 The IRS will consider applications filed more than ninety days late to jeopardize the interests of the government except in very unusual and compelling circumstances.466
463Regs. § 301.9100-3(a).
464Regs. § 301.9100-3(b)(3)(iii).
465Regs. § 301.9100-3(c)(1)(i).
466Regs. §301.9100-3(c)(3). See also Form 1128, Instructions. Rev. Proc. 2005-27, 2005-20 I.R.B. 1050, lists the time-sensitive acts which may be postponed by individuals serving in the Armed Forces in a combat zone or by taxpayers affected by a Presidentially-declared disaster or a terroristic or military action under §7508 or §7508A, respectively.
A corporation entering an affiliated group that files a consolidated return must conform its taxable year with the taxable year of the affiliated group's common parent corporation.467 If that conformance requires a change in the taxable year of the acquired corporation, the Commissioner's approval of the change is automatic. Unlike most other taxpayer situations, the taxpayer need not file Form 1128 in that situation.468
467Regs. § 1.1502-76(a).
468Regs. §1.442-1(c).
Comment: Although Form 1128 does not need to be filed if the Commissioner's prior approval is not required, the taxpayer should attach a statement to the short-period return notifying the IRS of the change and submitting details thereof.
1.	Contents of Form 1128
a.	In General
Form 1128 (Application to Adopt, Change, or Retain a Tax Year) requests the ending dates of the old and new taxable years, the beginning and ending dates of the short period, the taxpayer's method of accounting, and the Service Center where the taxpayer files or will file its return. It also requires a description of the taxpayer's business and principal source of income.
If the taxpayer does not file the application pursuant to an expeditious approval procedure, Form 1128 requires the following information to be provided.
(1) If the applicant has changed or applied to change its taxable year in the last six years, an explanation discussing why another change is necessary.
(2) If the applicant has an accounting method, taxable year, ruling, or technical advice request pending with the National Office, a statement explaining the type of request and the specific issues involved.
(3) The taxable income or loss for the short year and each of the three preceding years.
(4) If the applicant is a U.S. shareholder in a CFC, a statement indicating the name, address, and identifying number of the CFC, a statement of the applicant's percentage of total combined voting power in the CFC, and the amounts the applicant included in gross income under §951 for the short period and the three preceding years.
(5) If the applicant is a U.S. shareholder in a PFIC, a statement indicating the name, address, and identifying number of the PFIC, the applicant's percentage interest in the PFIC, and the amount of ordinary earnings and net capital gain from the PFIC included in the applicant's gross income.
(6) If the applicant is a member of a partnership, beneficiary of a trust or estate, or a shareholder in an S corporation, interest charge DISC, or foreign sales corporation, a statement of the applicant's interest in any interest charge DISC, the amount of income received from any of the foregoing in the short year and the immediately preceding year, and the percentage of the applicant's gross income represented by those amounts.
(7) A statement of the reasons for requesting the change in taxable year.
A taxpayer that is requesting a change in its taxable year in order to conform to its natural business year must attach a statement listing gross receipts and approximate monthly inventory costs (if applicable) for each month in the requested short period and for each month in the three immediately preceding taxable years.469
469Rev. Proc. 74-33, 1974-2 C.B. 489.
b.	Corporations Other Than S Corporations
If the taxpayer is a corporation other than an S corporation, Form 1128 requests the following information: the date of incorporation; and whether the corporation is a member of an affiliated group filing a consolidated return, and, if so, the parent corporation's name, address, and identifying number, the name, address, and identifying number of each member of the group, and the taxable income (or loss) of each member for the three years preceding the short period and for the short period. If the corporation is a personal service corporation, it must also attach a statement showing each shareholder's name, type of entity, address, identifying number, taxable year, and percentage of ownership.
c.	S Corporations
If the applicant is an S corporation, it must indicate the date of its S corporation election; whether any shareholder is applying for a corresponding change in taxable year; if it is using a taxable year other than the required taxable year, how it obtained its fiscal year; and the name, type of entity, address, identifying number, and percentage ownership of each shareholder.
d.	Partnerships
If the applicant is a partnership, Form 1128 requires disclosure relating to the date the business began; whether any partners are applying for a corresponding change in taxable year; each partner's name, type of entity, address, identifying number, taxable year, and percentage of interest in capital and profits. In addition, if any partner is a shareholder of a personal service corporation, the applicant must attach a statement of the name, address, identifying number, taxable year, percentage of interest in capital and profits, and amount of income received from each personal service corporation during the short year and the first preceding year.
e.	Controlled Foreign Corporations
A CFC required to file Form 1128 must attach a statement for each U.S. shareholder which provides the shareholder's name, address, identifying number, taxable year, percentage of total combined voting power, and amount of income included in gross income under §951 for the short year and the three years immediately preceding it. Information must be provided for both corporate and noncorporate shareholders.
f.	Tax-Exempt Organizations
A tax-exempt organization must indicate its form (e.g., corporation or trust) and date of organization, the section under which it is exempt, the form (if any) on which it is required to file its returns, the date its exemption was granted, and whether it is a private foundation terminating its status under §507.
Rev. Proc. 85-58470 provides that exempt organizations may change their accounting periods by timely filing the appropriate information return, Form 990 (Return of Organization Exempt from Income Tax), Form 990-PF (Return of Private Foundation), Form 990-BL (Information and Initial Excise Tax Return for Black Lung Benefit Trusts and Certain Related Persons), or Form 1065 (U.S. Partnership Return of Income), for the short period required to effect the change of the accounting period. The Form should indicate that a change in accounting period is being made. The annual information returns, except the Form 1065, must be filed by the 15th day of the fifth month following the close of the short period.
4701985-2 C.B. 740.
If an organization is not required to file an annual information return, but files a Form 990-T (Exempt Organization Business Income Tax Return), it may change its annual accounting period by timely filing the Form 990-T. If an organization is not required to file an annual information return or a Form 990-T, it is not necessary to otherwise notify the IRS of a change in accounting period, except as provided below.
If an organization previously changed its accounting period within the 10 calendar years ending with the calendar year that includes the beginning of the short period resulting from the accounting period change, and if it had a filing requirement at any time during that 10-year period, the organization must file a Form 1128 with its timely filed information return or Form 990-T, as appropriate, even if the information return or Form 990-T would not otherwise have been required for that year. The Form 1128must be filed by the 15th day of the fifth month following the close of the short period.
Section 521farm cooperatives and §§526- 28 organizations must change their accounting periods by filing a Form 1128. For a discussion of the procedures for changing the accounting period of an organization described in §401(a), see Rev. Proc. 87-27,471 and 371 T.M., Employee Plans--Deductions, Contributions and Funding.
4711987-1 C.B. 769.
g.	Estates
If the applicant is an estate, it must indicate when it was created. It must also attach a statement showing the name, address, identifying number, and taxable year of each beneficiary and each person who is an owner or treated as an owner of any portion of the estate. Last, it must show the distribution deduction and the taxable amounts distributed to each beneficiary for the short year and the two preceding years.
h.	Passive Foreign Investment Companies
If the applicant is a PFIC, it must attach a statement showing each U.S. shareholder's name, address, identifying number, and percentage of interest owned.
2.	S Corporation Filing Backup Request to Change to a Calendar Year in the Event a Fiscal Year Request Is Denied
A corporation electing S corporation status that makes a simultaneous request to change its taxable year to a year other than a calendar year and is denied its request, will generally have an ineffective S corporation election. The regulations indicate that the taxpayer may file, with the first request, a backup request to change to a calendar year. Therefore, if the IRS denies the first request, the second request should keep the S corporation election from being ineffective.472
472Regs. §1.1378-1(e)(2).
Example: Assume that C corporation with a June 30 year-end wishes to elect S Corporation status and change its year-end to July 31. If the Commissioner denies the July 31 year, the S corporation election is invalid. The taxpayer can avoid this by indicating with its election for S corporation status that it will adopt a calendar year-end if a fiscal year is denied.
This approach of filing a backup request may be appropriate in other situations as well, for example, if the taxpayer is trying to expedite IRS approval.
3.	Late Filings
On occasion, taxpayers inadvertently fail to file Form 1128 to change accounting periods by the due date. Such taxpayers may request relief under Regs. §301.9100-3, and where the interests of government would not be prejudiced and such taxpayer can show it has acted reasonably and in good faith, the IRS is likely to grant relief.472.1
472.1Regs. §301.9100-3. See PLR 200238038.
F. Correction of Erroneous Taxable Year
It is clear that the Commissioner's prior approval is almost always necessary if a taxpayer wishes to conform its taxable year to an accounting period it has newly adopted for keeping its books. Such a situation in which a taxpayer changes both its taxable year and its annual accounting period is different from that of a taxpayer that changes its taxable year to conform to its preexisting annual accounting period. In the latter case, the taxpayer has been filing its returns on the basis of an erroneous taxable year and is seeking to correct it.473
473Regs. §1.441-1(b)(1).
If a corporation has regularly maintained its books and records using a calendar year-end but has erroneously filed its federal income tax returns on a fiscal year basis, the consent of the Commissioner is not required in order to change its tax year-end to its book year-end.474
474Rev. Rul. 58-256, 1958-1 C.B. 215. Cf. Atlas Oil and Refining Corp. v. Comr., 17 T.C. 733(1951), acq., 1952-1 C.B. 1; Brooklyn City R.R. Co. v. Comr., 27 B.T.A. 77 (1932), acq., 1958-2 C.B. 4, aff'd, 72 F.2d 274 (2d Cir.1934).
Such a change is a change from a nonconforming to a conforming method.475
475See §441(b)(1),  (c); Regs. §1.441-1(b).
This type of change does not require a short-period return or annualization of the short-period income. Instead, the first return for the correct taxable year and the immediately preceding return for the 12-month erroneous period overlap, resulting in a double reporting of taxable income for the overlapping months. That part of the tax for the erroneous period, applicable to the overlapping income, is treated as an advance payment on the tax payable on the first return for the correct taxable year.476
476American Hide and Leather Co. v. U.S., 284 U.S. 343 (1932).
Example: Assume Corporation Y has an established annual accounting period ending June 30 but has erroneously been filing calendar-year returns. Assume also that its calendar-year return for 1996 included taxable income of $75,000 on which it paid tax of $13,750. Assume it files a fiscal-year return for the six months ended June 30, 1997, showing taxable income of $50,000 on which it pays a tax of $7,500.
The IRS will require adjustment of the 1997 fiscal year return to a 12-month return by inclusion of the taxable income for the overlapping months of July through December, 1996. Assume that the actual taxable income for those months is determinable and that it amounts to $60,000.
Accordingly, the IRS will increase taxable income reported on the June 30, 1997 fiscal-year return to $110,000, resulting in additional tax of $18,150. At the same time, however, the IRS will treat that part of the calendar-year 1996 tax applicable to the overlapping income of $60,000 as an advance payment on the fiscal-year 1997 tax.
If the actual overlapping income cannot be separately determined, it can be estimated by apportioning the total taxable income for the erroneous taxable year in the ratio of the number of overlapping months to the total number of months covered by the erroneous return. Thus, if Y's advance payment must be estimated, it would be estimated as follows: 
                                                                       
      Taxable income for                                               
        erroneous taxable year                   $75,000               
                                                                       
      Tax on above                                            $13,750  
        Less: estimated taxable                                        
        income for erroneous                                           
        taxable year excluding                                         
        overlapping months                                             
        (6/12 X $75,000)                         $37,500               
                                                                       
      Tax on above                                            $ 5,625  
      Estimated overlapping income               $37,500               
      Tax on above (treated                                            
        as advance payment)                                   $ 8,125  

1.	Effect on Statutory Period Limiting Time for Assessment of Deficiencies
Even if returns are mistakenly filed on the basis of an erroneous taxable year, they are nonetheless "returns" effective to start the running of the statutory period limiting the time for assessment of deficiencies.477 While the limitation period begins to run only when the returns for the erroneous taxable years (which include information for the correct taxable years) have been filed, the limitation period technically relates to the correct taxable year.478
477Paso Rables Mercantile Co. v. Comr., 33 F.2d 653(9th Cir. 1929). See also American Hide & Leather Co. v. U.S., 284 U.S. 343 (1932).
478Id.
2.	Effect of Fiscal Year Adoption by New Corporation After Initial Dormant Period That Includes December 31
A new corporation that fails to establish and keep books of account before the expiration of the calendar year of its incorporation must use the calendar year as its accounting period, even though it was dormant during this period.479 This situation is distinguished from a situation where the corporation keeps books, but files on the basis of an erroneous taxable year.480
479§ 441(g).
480See VI, F, above.
If a corporation that did not initially keep books of account later does so, and wishes to file its return using the fiscal year corresponding to its annual accounting period for book purposes, it must secure the prior approval of the Commissioner as for any change in accounting period. (See VI, C, above.)
VII. Short-Period Taxable Years
If a taxable year is a short period, less than 12 calendar months, a separate return is generally necessary for the short period.481 A short-period return is not necessary, however, if (1) the short period is six days or less, or 359 days or more, and (2) the short period results in a change to or from a 52-53-week taxable year.482 A 52-53-week taxable year is not considered a short period, although it may be a few days short of 12 calendar months.
481§ 443(a).
482Regs. § 1.443-1(a)(1).
A short period generally results if a taxpayer changes its annual accounting period or is not in existence during a full 12-month taxable year.483 If a corporation becomes a member of an affiliated group of corporations filing a consolidated return, a short-period return must be filed for the period ending on the day before the corporation joins the affiliated group.484 In addition, short-period years are created when corporation are acquired in certain tax-free reorganizations, liquidation transactions, or stock purchases treated as asset sales under §338.485 In the context of a short taxable year, the term "taxable year" means "the period for which the return is made, if a return is made for a period of less than 12 months."486 This rule is important with respect to carryover periods as the short-year is treated as reducing the carryover period by a full year.487
483§ 443(a).
484Regs. § 1.1502-76(b)(1)(i).
485§§ 338(a), 381(b)(1).
486§ 441(b)(3).
487Id. See also §7701(a)(23) and Regs. § 1.172-4(a)(2).
A. Change of Annual Accounting Period
When a taxpayer changes its annual accounting period, and it changes its taxable year to conform, a separate return is necessary for the short period of less than 12 months beginning with the day following the close of the old taxable year and ending with the day preceding the first day of the new taxable year.488
488Regs. § 1.443-1(a)(1).
Example: Assume a calendar year taxpayer changes to a fiscal year-end of September 30 with the first day of the fiscal year being on October 1, 1997.
The taxpayer must file a short-period return for the period of January 1, 1997, through September 30, 1997.
A parent corporation that changes its annual accounting period and taxable year to conform to that of its subsidiaries may, with its subsidiaries, elect to file a consolidated return for the short period.489
489Rev. Rul. 55-80, 1955-1 C.B. 387.
In October 2003, the IRS provided limited relief to partners and S corporation shareholders adversely affected by the short taxable year that results from certain accounting period changes by partnerships and S corporations under Rev. Procs. 2002-38489.1 and 2002-39,489.2 which are discussed in VI, B, 2 and VI, C, 2, respectively, above. Sections 6.05 and 6.06 of Rev. Proc. 2002-38 and §5.04 of Rev. Proc. 2002-39 provide that if a taxpayer (including a partnership or S corporation) changes to or retains a natural business year or an ownership taxable year but that year no longer qualifies as a permitted taxable year, the taxpayer is using an impermissible annual accounting period and should change to a permitted taxable year under Rev. Proc. 2002-38 or Rev. Proc. 2002-39 (whichever applies). (For discussions of permissible tax years for S corporations and partnerships, see III, D and E, respectively, above.) The IRS was concerned that, because of the entity's short year that results from such a change to a permitted taxable year, a partner or S corporation shareholder may be required to include in gross income in a single taxable year income items and expense items from more than one taxable year of the entity.
489.12002-22 I.R.B. 1037.
489.22002-22 I.R.B. 1046.
Rev. Proc. 2003-79,489.3 therefore, provides that a partner or S corporation shareholder within the scope of the revenue procedure may elect to spread ratably over a four-year period the partner's or shareholder's share of income from the partnership's or S corporation's short taxable year that ends after May 9, 2002, and before June 1, 2004 (or, in the case of a taxpayer that uses a 52-53-week taxable year, with reference to the last day of any calendar month after April 30, 2002, and before June 1, 2004).489.4 Rev. Proc. 2003-79 applies if: (1) the partnership or S corporation changes its taxable year solely because (a) its current taxable year no longer qualifies as a natural business year under Rev. Proc. 2002-38 or Rev. Proc. 2002-39 or (b) in the case of an S corporation, its current taxable year no longer qualifies as an ownership taxable year because a tax-exempt owner is disregarded under §5.06 of Rev. Proc. 2002-38; (2) as a consequence of the change, income items and expense items from more than one taxable year of the entity would, but for the provisions of the revenue procedure, be includible in the income of the partner or shareholder in a single taxable year; and (3) the partner's or shareholder's share of income items exceeds the partner's or shareholder's share of expense items attributable to the entity's short taxable year.
489.32003-45 I.R.B. 1036.
489.4For a discussion of the 52-53-week taxable year, see IV, above.
A partner or shareholder making the election under Rev. Proc. 2003-79 must apply Regs. §1.702-3T(b),  (d),  (e),  (f), and  (g), with the following modifications: (1) the term "partner" in Regs. §1.702-3T means any partner or S corporation shareholder within the scope of the revenue procedure; (2) the term "partnership" includes S corporations; (3) the term "distributive share" includes a shareholder's pro rata share of S corporation items; and (4) references to "section 806 of the 1986 Act" should be replaced with "Proc. 2002-38 or Rev. Proc. 2002-39, whichever applies." For a discussion of Regs. §1.702-3T, see 712 T.M., Partnerships--Taxable Income; Allocation of Distributive Shares; Capital Accounts.
To make the election under Rev. Proc. 2003-79, a partner or S corporation shareholder must record the ratable income amount on (a) a timely filed original federal income tax return for the taxable year of the partner or shareholder with or within which the partnership's or S corporation's short taxable year ends or (b) on an amended federal income tax return filed before April 13, 2004, if the partner or shareholder filed before November 24, 2003, a federal income tax return for the taxable year with or within which the entity's short taxable year ends. The partner of S corporation shareholder must also attach to the original or amended return for the taxable year with or within which the entity's short taxable year ends, and to the federal income tax return for every other taxable year of the spread period, a completed Form 8082, Notice of Inconsistent Treatment or Administrative Adjustment Request, containing an explanation in Part III similar to the following: "Election under Rev. Proc. 2003-79 to apply a ratable 4-year spread of the share of income attributable to a change in annual accounting period."
B. Taxpayer Not in Existence for Entire Taxable Year
Because a new taxpayer's first taxable year typically does not begin on the first day of its desired taxable year, the first year is typically a short taxable year. Likewise, a taxpayer's final taxable year typically does not end on the last day of a full year. If a taxpayer is not in existence for the entire taxable year, a return is necessary only for the short period during which the taxpayer is in existence.
Example: A corporation organized on August 1 and adopting a calendar year as its annual accounting period must file a return for the short period from August 1 to December 31, and returns for each calendar year thereafter. A corporation dissolving on December 10 that files its returns for the calendar year must file its final return for the short period from January 1 to December 10.490
490Regs. § 1.443-1(a)(2).
The death of a taxpayer also creates a situation in which the taxpayer is not in existence for the entire taxable year. Although a return for a decedent is treated as a short-period return for determining the decedent's includible items of income and expense, the due date of the return and the computation of the tax are determined as if the decedent survived the full taxable year.491
491§ 6013(c). See also IRS Publication 559 (Survivors, Executors, and Administrators) at p. 6.
If a married couple has shared the same taxable year in the past, the death of one spouse before the last day of the taxable year will cause the husband and wife to incur different taxable years. The surviving spouse may nevertheless file a joint return with the decedent as long as no separate return is made by the decedent, no executor or administrator has been appointed, and no executor or administrator is appointed before the last day prescribed by law for filing the return of the surviving spouse.492 The return shall be treated as if the taxable years of both spouses ended on the date of the closing of the surviving spouse's taxable year for purposes of §15 (effect of changes), §443 (returns for periods of less than 12 months) and §7851(a)(1)(A) (applicability of revenue laws).493 If a fiduciary is appointed, the fiduciary may disaffirm the joint return, within one year from the last day for filing the return of the surviving spouse, by making a separate return for the decedent's final year.494
492§ 6013(a)(3).
493§ 6013(c).
494§ 6013(a)(3).
Note that the filing of a joint return in this situation does not change the character of the decedent's taxable year. The inclusion of income and deductions with respect to the decedent will be based on the short taxable year.495 This point is important because the Code recognizes the decedent and its estate as separate entities, with an allocation of taxable income between the two entities. The estate is allocated items of gross income that are not properly includible in the decedent's final return with respect to the short period ending on the date of the decedent's death.496
495See Poorbaugh v. U.S., 69-1 USTC Para.9134 (W.D. Pa. 1968), rev'd on other issues and rem'd, 423 F.2d 157 (3d Cir. 1969).
496§ 691. See also, Poorbaugh.
Example: Assume that calendar year taxpayer H died on March 31 and is survived by his spouse W. An allocation of taxable income between the short period ending on March 31 and the period after March 31 is necessary. W may file a joint return with the decedent. That return is due on W's regular due date and tax is computed without the need to annualize decedent's short-period income. The income attributable to the estate is handled in the usual manner.
Nonresident aliens desiring to file joint returns and attempting to use income averaging have claimed unsuccessfully that they were "not in existence" for tax purposes until they become resident aliens. In Nico v. Comr.,497 the taxpayers were both nonresident aliens through May 1, 1971, but became resident aliens from May 2 through December 31, 1971. The taxpayers sought to file a joint return for 1971, but were aware of the fact that the privilege is not available under §6013(a)(1) if either spouse is a nonresident alien "at any time during the taxable year." The taxpayers asserted that they were "not in existence" (within the meaning of §443(a)(2)) before May 2, 1971, and consequently, their taxable year was the short year May 2 through December 31, 1971. The Tax Court rejected this claim, requiring the taxpayers to file separate returns for the full calendar year 1971, rather than a joint return for a short year.
49767 T.C. 647 (1977), aff'd in part, rev'd in part, and rem'd, 565 F.2d 1234 (2d Cir. 1977).
In More v. Comr.,498 the taxpayers were both Cuban residents who fled Cuba for the U.S. after Castro rose to power. The taxpayers had no taxable income for the taxable years 1960 through 1963, while their taxable income for 1964 was in excess of $200,000. The taxpayers sought to take advantage of income averaging for the year 1964. Former §1303(b) denied income averaging to any taxpayer who was a nonresident alien during the "base period" (in this case, the taxable years 1960-1963). The taxpayers asserted that their 1960 "taxable year" constituted only that part of the calendar year 1960 during which they were resident aliens. However, because the taxpayers' circumstances did not conform to any of the three situations specified in §443 supporting a short period return, the court stated that the taxpayers had a full calendar year taxable year for 1960. Consequently, they were nonresident aliens during part of that year, and the income averaging provisions of former §1303(b) were unavailable to the taxpayers for 1964.
49866 T.C. 27 (1976), aff'd, 77-2 USTC Para.9531 (2d Cir. 1977).
C. Termination Assessments in Jeopardy Situations
If the IRS finds that collection of the income tax of a taxpayer for the current or preceding taxable year will be jeopardized, it may make a determination of tax and serve notice and demand on the taxpayer for immediate payment of the tax for the current taxable year and for the preceding taxable year to the extent unpaid.499
499§ 6851(a); Regs. § 1.6851-1(a)(1).
After any such termination assessment, the taxable income for the year may be reterminated by the appropriate district director if, and as often as, additional income is received by the taxpayer subsequent to the first termination assessment. For each determination, the tax liability is recomputed from the beginning of the taxable year to the latest termination date, followed by service of notice and demand for immediate payment, with previous payments being applied to reduce the liability so determined.500
500Regs. § 1.6851-1(a)(2).
Except for departing aliens,501 no return is required for a period covered by a termination assessment other than for a full taxable year.502 Notwithstanding any termination assessment, a taxpayer must file a return in accordance with §6012 for the taxpayer's full taxable year.503 A full taxable year in this context means the taxpayer's usual annual accounting period determined without regard to the termination assessment under §6851. The tax computed for the full taxable year is reduced by the amount of any termination assessment payments.
501See Regs. § 1.6851-2.
502Regs. § 1.6851-1(a)(3).
503Id.
Note: Termination assessment payments can be avoided if the taxpayer furnishes a bond satisfactory to the appropriate district director, ensuring full payment of the jeopardy tax.504
504§ 6863.
D. Date for Filing Short-Period Returns
Because short periods are taxable years, the normal rules for determining due dates of returns apply. Except for short periods ending with the termination of a taxpayer's existence, short periods must end on the last day of a calendar month, or with reference to the last day of a calendar month.505
505See §441(d),  (e).
1.	Corporations
The due date for filing short-period returns of dissolved corporations is the fifteenth day of the third calendar month following the month of dissolution.506
506§ 6072(b).
In the case of a consolidated return, the due dates can differ in some instances depending on the due date of an acquiring group's return. For example, a short-period return of a subsidiary entering or leaving a consolidated group is due no later than the due date of the consolidated return.507
507See Regs. § 1.1502-76(c). For a thorough discussion of due dates in consolidated return situations, see 754 T.M., Consolidated Returns -- Elections and Filings.
Short-period returns of corporations changing to a 52-53-week taxable year are due the fifteenth day of the third calendar month following the calendar month of reference.508
508Regs. § 1.6072-2(a). See also §441(f)(2)(A)(ii).
Foreign corporations that transact their business and keep their books and records abroad (meaning outside of the U.S. and Puerto Rico) are guaranteed an automatic three-month extension without being required to file for such an extension on any particular form.509 Taxpayers may obtain automatic extensions of six months beyond the statutory due date for filing returns by filing Form 7004 (Application for Automatic Extension of Time to File U.S. Corporation Income Tax Return) and paying not less than the estimated balance due.510
509Regs. § 1.6072-2(b).
510Regs. § 1.6081-3.
2.	Individuals, Estates, and Trusts
In the case of individuals, estates, and trusts, returns are due on or before the fifteenth day of the fourth month following the close of the taxable year.511 The return for a decedent for a fractional part of a year is due the fifteenth day of the fourth month following the close of the 12-month period that began with the first day of the fractional part of the year.512 Therefore, the death of an individual does not accelerate the due date of the return.
511§ 6072(a).
512Regs. § 1.6072-1(b).
Example: T, a single individual who files tax returns on a calendar year basis, dies on January 10, 1997. The final return for T is due April 15, 1998.
Nonresident alien individuals and foreign trusts are generally not required to file before the fifteenth day of the sixth month following the close of the taxable year.513
513Regs. § 1.6072-1(c).
3.	Partnerships
In general, a partnership return is to be filed on or before the 15th day of the fourth month following the close of the taxable year of the partnership. If all the partners are nonresident aliens, however, the return is due on or before the 15th day of the sixth month following the close of the taxable year of the partnership.514
514Regs. § 1.6031-1(e)(2) (effective for tax years ending on or before Dec. 31, 1999) and Regs. §1.6031(a)-1(e)(2) (effective for tax years beginning after Dec. 31, 1999).
E. Computation of Taxable Income and Tax for Short Periods
If a short taxable year occurs as a result of a taxpayer's initial or final year in existence, taxable income and tax on that taxable income is computed as if the short period were in fact a full 12-month taxable year.515 A net operating loss may be carried back or forward to such a short taxable year. A short taxable year is a taxable year for carryover and carryback purposes.516 Taxable income for a short period resulting from a termination assessment is also computed as if the short period were a full year.517
515Regs. § 1.443-1(a)(2).
516Regs. § 1.172-4(a)(2). See also Rev. Rul. 65-163, 1965-1 C.B. 205 (NOL is applied against the actual short-period income before it is annualized).
517§ 6851(a); Regs. § 1.6851-1(b)(2).
In all cases of change in a taxable year to conform with a change in the annual accounting period, the taxable income on which the short-period tax is computed must either be "annualized" or based on an actual 12-month period beginning or ending with the short period.518 The taxpayer must apply these methods to all items includible in the short year. This includes partnership items based on a full partnership year.519 Each of these methods is discussed below.
518§ 443(b).
519Leonard L. Politte, M.D., Inc. v. Comr., 101 T.C. 359 (1993).
If a parent corporation has received IRS permission to change its annual accounting period to conform to that of its subsidiaries, it must file a short-period return, which it may elect to file as a consolidated return with its subsidiaries. It must annualize the consolidated taxable income for the short period.520 A corporation entering an affiliated group, which must conform its taxable year to that of the affiliated group if the group files consolidated returns, must file a short-period return covering the period between the end of its preceding taxable year and its entry into the affiliated group.521 In such a situation, the corporation is not required under §443(b) to annualize its income for the period before affiliation.522 The same is true of the short period created by a corporation's departure from an affiliated group.523
520Rev. Rul. 55-80, 1955-1 C.B. 387.
521Regs. § 1.443-1(a)(1); Regs. § 1.1502-76.
522Regs. § 1.443-1(b)(1)(iii); Regs. § 1.1502-76(b)(2). See Erwin Properties, Inc. v. Comr., 43 T.C. 888 (1965) (holding that §443(b) is inapplicable to a corporation joining an affiliated group, because it files a short return not by reason of a change in taxable year but in compliance with the consolidated return regulations), acq., 1967-1 C.B. 2. See also Rev. Rul. 70-378, 1970-2 C.B. 178, obsoleted by Rev. Rul. 2003-99, 2003-34 I.R.B. 388; Rev. Rul. 67-189, 1967-1 C.B. 255 (revoking Rev. Rul. 57-602, 1957-2 C.B. 611, to the contrary), obsoleted by Rev. Rul. 2003-99, 2003-34 I.R.B. 388. The IRS's conclusion in Rev. Ruls. 70-378 and 67-189 is now contained explicitly in Regs. §1.1502-76(b)(2) ("annualization under section 443 is not required of [the subsidiary] solely because it has a short year as a result of becoming a member").
523Rev. Rul. 74-585, 1974-2 C.B. 143.
Comment: Neither the annualization method nor the alternative 12-month method applies with respect to the accumulated earnings tax,524 the personal holding company tax,525 the computation of undistributed foreign personal holding company income for taxable years of foreign corporations beginning prior to January 1, 2005 and for taxable years of U.S. shareholders with or within which such taxable years of foreign corporations end,526 the computation of taxable income of a regulated investment company,527 or the computation of taxable income of a real estate investment trust.528
524§ 536.
525§ 546.
526§557, as amended by the 2004 American Jobs Creation Act, P.L. 108-357, §413(a). For taxable years of foreign corporations beginning after Dec. 31, 2004 and for taxable years of U.S. shareholders with or within which such taxable years of foreign corporations end, the personal holding company provisions under §§551 through 558 are repealed.
527§ 852(b)(2)(E).
528§ 857(b)(2)(C).
For the computation of these special purpose taxes or special purpose taxable incomes, the short periods are treated in the same manner as a full 12-month taxable year.
1.	Annualization of Taxable Income for Computation of Short-Period Tax
"Annualization" is the placing of the short-period taxable income on an annual basis by multiplying the income by 12 and dividing the result by the number of months in the short period. The "annualized" tax is therefore computed in the ordinary way on the annualized income, but is then reduced to the actual tax liability by multiplying the annualized tax by the number of months in the short period and dividing the result by 12.529 For an example illustrating the annualization method of computing the short-period tax, see the Working Papers, below.
529§ 443(b). If the taxpayer uses a 52-53-week taxable year, the short period income is annualized on a daily basis. Regs. § 1.443-1(b)(1)(ii).
If the amount of a tax credit depends on the amount of any item of income or deduction, that item of income or deduction is separately annualized for purposes of computing the credit. That credit applies against the tax computed on the basis of the annualized income.530 If the limitation on the amount of any credit is based on taxable income, taxable income means annualized taxable income.531
530Regs. § 1.443-1(b)(1)(vi).
531Id.
2.	Alternative Method to Annualization
If the short period (1) includes the peak period of a cyclical business, (2) includes a substantial amount of nonrecurring income, or (3) for any other reason, the short period taxable income is abnormally high, the taxpayer may wish to apply to the IRS for permission to use the alternative method of annualization.532 Under this method the tax is the greater of (1) the tax on the taxable income for the short period or (2) a fractional part of the tax on the actual taxable income for the 12-month period beginning generally on the first day of the short period.533 The numerator of the fraction is the short-period taxable income and the denominator is the 12-month taxable income.534 If the old taxable year was a 52-53-week taxable year, the 12-month period is the old 52-53-week period beginning with the first day of the short period.535 In no case may the tax be greater under the alternative 12-month method than the tax computed by the annualization method, even though the taxpayer may have applied to the appropriate district director to have the tax computed by the 12-month method.536
532§ 443(b)(2).
533§ 443(b)(2). If the taxpayer goes out of existence or disposes of substantially all of its assets during the 12-month period beginning on the first day of the short period, the 12-month period is redefined as the 12 months ending at the close of the last day of the short period. Id.
534Id.
535Regs. § 1.443-1(b)(2)(ii).
536Regs. § 1.443-1(b)(2)(i) (last sentence).
The taxable income for the 12-month period is computed under the law applicable to the short period, and it is computed as if the 12-month period were an actual annual accounting period of the taxpayer. All items that fall in the 12-month period are included even if they are extraordinary in amount or of an unusual nature. If any other item partially applicable to the 12-month period can be determined only at the end of a taxable year that includes only part of the 12-month period, the taxpayer, subject to review by the Commissioner, must apportion the item to the 12-month period in the manner that will most clearly reflect income for the 12-month period.537
537Regs. § 1.443-1(b)(2)(iii)(a). For an example illustrating the method of computing a short-period tax by the 12-month alternative method, see the Working Papers, below.
a.	Determination of Cost of Goods Sold for Short Periods
A taxpayer permitted or required to use inventories, must apportion cost of goods sold to any portion of a full taxable year included in the 12-month period. Unless a more exact method is available (as would be the case if the taxpayer normally took inventories for that period), the cost of goods sold for any short period included in a full taxable year of the taxpayer is determined as a fraction of the cost of goods sold for the entire taxable year. The fraction is equal to the ratio of gross receipts from sales during the months of the short period included in the 12-month period to gross receipts from sales for the entire taxable year.538
538Regs. § 1.443-1(b)(2)(iii)(b).
Example: The short taxable year is January 1 to September 30, 1997. The 12-month period is the calendar year 1997. The three-month period, October 1 to December 31, 1997, is part of the new taxable year ending September 30, 1998. The cost of goods sold for the three-month period is expressed by the following formula: 
                                                                        
                                            s                           
                                          -----              C = c      
                                            S                           

Where s represents the gross receipts from sales for the three-month period; S represents the gross receipts from sales for the entire fiscal year ending September 30, 1998; C represents the cost of goods sold for the entire fiscal year; and c represents the cost of goods sold for the three-month period.539
539Id.
The Commissioner in granting permission to a taxpayer to change its annual accounting period may require as a condition of permitting the change that the taxpayer take a closing inventory upon the last day of the 12-month period if it wishes to obtain the benefits of the 12-month alternative method for computing the short-period tax. In that case, the inventory will be used only for the purpose of computing the short-period tax by the 12-month method, and the taxpayer will not be required to use it in computing the taxable income for the taxable year in which the inventory is taken.540
540Regs. § 1.443-1(b)(2)(iii)(c).
b.	Time and Method of Making Application for Use of the 12-Month Alternative Method
Every taxpayer that changes its taxable year to conform with a change in its annual accounting period must use the annualization method of computing the tax on its short-period return if the return shows taxable income, unless at the time the taxpayer files its short-period return it is able to determine that the 12-month alternative method is applicable. This will be possible only if the 12-month period ends on the last day of the short period as a result of the taxpayer going out of existence or disposing of substantially all of its assets.541 In that case the computation of the tax is based on the 12-month period ending with the last day of the short period.542 The taxpayer must attach a return covering that 12-month period to the short-period return as a part thereof, and the return and attachment will be considered as an application for the use of the 12-month alternative method under §443(b)(2).543
541Regs. § 1.443-1(b)(2)(ii).
542Regs. § 1.443-1(b)(2)(v)(b).
543Id.
In all other cases a taxpayer applies for use of the 12-month alternative method by making a claim for refund or credit after the completion of the 12-month period beginning with the first day of the short period.544 Such a taxpayer must compute tax for the short period based upon regular annualization principles.545 The taxpayer must also file the short-period return based on the general method within the regular time allowed for such a filing, which is often before the end of the 12-month period used in the alternative method.546
544Regs. § 1.443-1(b)(2)(v)(a).
545Regs. § 1.443-1(b)(2).
546Id.
Thereafter, the taxpayer may claim the benefit of the alternative method of computing the tax on the short period via a claim for credit or refund.547 The claim must set forth the computation of the taxable income and the tax thereon for the 12-month period. If the appropriate district director determines that the taxpayer has established the amount of its taxable income for the 12-month period, any excess of the tax paid for the short period over the tax computed by the alternative 12-month method will be credited or refunded to the taxpayer in the same manner as in the case of an overpayment.548
547Regs. § 1.443-1(b)(2)(v)(a).
548Id.
The claim for credit or refund must be filed no later than the time (including extensions) prescribed for filing the return for the taxpayer's first taxable year that ends with or after the 12 months beginning with the beginning of the short period.549
549Id.
Example: Assume that the short period is January 1, 1996, to September 30, 1996. The 12-month period ends on December 31, 1996. The first taxable year that ends on or after December 31, 1996, is the fiscal year ending September 30, 1997. The taxpayer must file its application no later than the time prescribed for filing the return for the fiscal year ending September 30, 1997. If the taxpayer obtains an extension of time for filing the return for that fiscal year, it may file its application during the period of the extension.550
550Id.
If taxpayer does not file the application within the time prescribed, the short-period tax computed by the annualization method remains the tax, even though the tax computed by the alternative method would be less.551
551Visintainer v. Comr., 187 F.2d 519 (10th Cir. 1951).
3.	Alternative Minimum Tax
Section 443(d) provides rules relating to the computation of the §55 alternative minimum tax imposed on a taxpayer filing a short-period return. It provides that the alternative minimum taxable income shall be annualized, the tax computed on that amount, and the result multiplied by the number of months in the short period divided by 12.
4.	Individuals -- Special Rules
An individual must reduce his or her personal exemptions to an amount that bears the same ratio to the full amount of the exemptions as the number of months in the short year bears to 12.552 The standard deduction is not available in individuals' short years resulting from changes of taxable years.553
552§ 443(c). The personal exemption is annualized on a daily basis for 52-53-week taxable years. Regs. § 1.443-1(b)(1)(v).
553Regs. § 1.443-1(b)(1)(iv).
An individual must utilize the tax rates of §1, rather than tax tables, in order to compute the tax liability for a short period that requires a §443(b) annualization for tax computation purposes.554
554§ 3(b)(1).
VIII. Final Taxable Year
If a taxpayer is not in existence for the entire taxable year, a return is required for the short period during which the taxpayer was in existence. For example, a dissolving corporation that files its returns on a calendar year basis must file a return for the short period from January 1 through the date it goes out of existence.555 In general, the filing and payment of tax requirements for a short period ending with the date the taxpayer goes out of existence are the same as for the filing of return and payment of tax requirements for a taxable year of 12 months ending on the last day of the short period.556 For example, if a calendar year partnership dissolves on February 2, its final return is due June 15. The final return for a decedent, however, is not due until the fifteenth day of the fourth month after the close of the 12-month period that begins with the first day of the short year.557 In addition, a taxpayer filing a joint return with the individual's spouse who died during the year is allowed to continue to be included in the joint return, and therefore, the due date is not accelerated.558 A taxpayer that is not in existence for the entire taxable year is not required to annualize its income for the resulting short period.559
555Regs. § 1.443-1(a)(2).
556Id.; Regs. § 1.6072-1, and  2.
557Regs. § 1.6072-1(b).
558§ 6013(c).
559See §443(b); Regs. § 1.443-1(a)(2).
The general rule that a taxable year must end on the last day of a month has no application to a taxpayer's final return. When a taxpayer goes out of existence, its taxable year must end at that time. For example, business activities that continue after the dissolution of a corporation or after the death of an individual become attributable to another entity, such as a liquidating trust, a partnership, or an estate.560
560See Patterson Produce Co. v. Comr., 4 B.T.A. 950 (1926), acq., VI-1 C.B. 5.
A. Corporations
Federal income tax law establishes its own tests for determining when a corporation goes out of existence, and, therefore, state and local law is not controlling. Under the federal tests, a corporation's existence may end before, at, or after the time of formal dissolution under the law of the state or country of incorporation.
1.	How a Corporation's Existence May End Before Formal Dissolution -- De Facto Dissolution
A corporation's existence ends, and its final taxable period closes, when it ceases business and dissolves, retaining no assets. The corporation's existence ends regardless of whether the corporation is treated as a continuing corporation under state law for certain limited purposes connected with winding up its affairs, such as for suing and being sued.561 State law usually requires a corporation to remain in existence until it has satisfied or made provision for all of its liabilities and distributed all of its assets.562
561Regs. § 1.6012-2(a)(2).
562Cf. Rev. Rul. 71-129, 1971-1 C.B. 397. Fletcher, 16A Fletcher Cyclopedia of the Law of Private Corporations §8007.35 (perm. ed. 1995).
A corporation may effect a de facto dissolution, thereby terminating its existence for federal income tax purposes, before its formal dissolution under state law.563 Once a corporation effects a de facto dissolution the corporation's existence has ceased for federal tax purposes, even if it has never been formally dissolved and its existence is continued indefinitely under the state law.564 The requirement for filing federal returns does not apply to a corporation not in existence for federal tax purposes, regardless of its status under the law of its state of incorporation.565
563Although not legally dissolved under applicable state or federal law, a de facto dissolution occurs when the activities of the corporation end and there remains no intention to continue any activities. See ABC Brewing Corp. v. Comr., 224 F.2d 483 (9th Cir. 1955) (holding that a corporation had de facto dissolved when its regular business had ceased and it distributed its assets). But see American Coast Line, Inc. v. Comr., 159 F.2d 665 (2d Cir. 1947) (corporation that had ceased business and been inactive for several years, but continued to pay franchise taxes in order to preserve its corporate charter, was still in existence for federal tax purposes), and Rev. Rul. 56-483, 1956-2 C.B. 933 (corporation that ceased business and disposed of all of its assets except a small sum of cash retained to pay state taxes to preserve the corporate charter is required to file federal income tax returns).
564Rev. Rul. 60-51, 1960-1 C.B. 169.
565Regs. § 1.6012-2(a)(2).
Considerable weight is attached to complete liquidation as a test for determining the end of a corporation's existence, as well as whether the liquidation was before dissolution under the state law.566 In one case, after a corporation had distributed all of its assets (subject to its liabilities) pursuant to stockholders' and directors' resolutions to dissolve, it was found to be nothing but an empty shell, without capital, income or expenses. Therefore, its final taxable period ended with the date of distribution, even though the corporation had not surrendered its charter.567
566Messer v. Comr., 438 F.2d 774 (3d Cir. 1971); J. Ungar, Inc. v. Comr., 244 F.2d 90 (2d Cir. 1957); Novo Trading Corp. v. Comr., 113 F.2d 320 (2d Cir. 1940).
567Kamin Chevrolet Co. v. Comr., 3 T.C. 1076 (1944), acq., 1944 C.B. 15. See also Rev. Rul. 61-191, 1961-2 C.B. 251.
2.	Activities Preventing the Termination of Corporate Existence
By itself inactivity of a corporation is not sufficient to terminate its existence if there is no intention to dissolve, even if the corporation ceases business and distributes its assets in liquidation. For example, the payment of franchise or other state taxes for the purpose of preserving the corporate charter during the years of inactivity is evidence of an intention to continue the corporation's existence, even if the corporation has distributed all of its assets in liquidation and all of its outstanding capital stock has been surrendered and canceled.568 It is conceivable that a valid de facto dissolution could have been accomplished in such a case, but the subsequent activities rendered it ineffective to terminate the obligation to file federal income tax returns.569
568American Coast Line, Inc. v. Comr., 159 F.2d 665 (2d Cir. 1947). See also Rev. Rul. 56-483, 1956-2 C.B. 933.
569See Rev. Rul. 56-483, 1956-2 C.B. 933.
If a dissolved corporation retains valuable assets such as a tax refund or other claims for which suit will be brought during the continuing period, the corporation has not completely liquidated. Since it has retained assets, it is considered to continue in existence.570 Under the corporate laws of most states, a dissolved corporation is still treated as a continuing corporation for certain limited purposes connected with winding up its affairs,571 but that limited existence does not prevent a dissolution for federal income tax purposes.572 If state law does not provide for a period of continuing existence or if this period has expired, the corporation's existence is over upon dissolution.573 Because state law provides the legal existence of a corporation, it is beyond the power of the federal income tax law to keep alive a corporation legally terminated by the state law of incorporation.574 Nevertheless, the dissolved entity may still be taxable as a corporation if it is an association under §7701(a)(3).
570Regs. § 1.6012-2(a)(2). See also Schick v. Comr., 45 T.C. 368 (1966), acq., 1966-2 C.B. 7 (corporation distributed most of its assets before January 31, 1959, but retained a valuable, income-producing purchase money note and mortgage until after October 31, 1959; its proper taxable year beginning November 1, 1958 ended an October 31, 1959, not January 31, 1959).
571Fletcher, 16A Fletcher Cyclopedia of the Law of Private Corporations §8113 (perm. ed. 1995).
572Regs. § 1.6012-2(a)(2); Neill v. Phinney, 245 F.2d 645 (5th Cir. 1957); U.S. v. Kingman, 170 F.2d 408 (5th Cir. 1948); Allegheny Broadcasting Corp. v. Comr., 12 T.C. 552 (1949), acq., 1950-2 C.B. 1, aff'd, 179 F.2d 844 (3d Cir. 1950); Union Bus Terminal, Inc. v. Comr., 12 T.C. 197 (1949), acq., 1950-2 C.B. 4, aff'd, 179 F.2d 399 (5th Cir. 1950).
573Rockwood v. U.S., 39 F.2d 984 (Ct. Cl. 1930); Joel v. Comr., 9 B.T.A. 1027 (1928), acq., VII-1 C.B. 16; Hub Shoe Co. v. Comr., 2 B.T.A. 836 (1925), acq., IV-2 C.B. 3.
574See U.S. v. Loo, 248 F.2d 765 (9th Cir. 1957); Wheeler's Peachtree Pharmacy, Inc. v. Comr., 35 T.C. 177 (1960), 1961-2 C.B. 5.
Note: The "check-the-box" regulations permit many businesses to elect whether to be classified as associations, taxable as corporations, or as partnerships.575
575Regs. § 301.7701-3. For an example of the determination of this issue under prior law, see Coast Carton Co. v. Comr., 149 F.2d 739 (9th Cir. 1945).
a.	Immediate Reactivation
Immediate reactivation of a corporation following complete liquidation prevents a de facto dissolution. A corporation was unable to effect a de facto dissolution, even though it distributed all of its assets and all of its outstanding capital stock was surrendered and canceled, because immediately thereafter the corporation acquired assets in exchange for a new issue of its capital stock to carry on a new type of business. In effect, the immediate reactivation converted the liquidation into a partial liquidation.576
576Rev. Rul. 60-50, 1960-1 C.B. 150.
b.	F Reorganizations
The applicability of the above described immediate reactivation rule to F reorganizations involving multiple corporations is less clear. The IRS indicated in one instance that the taxable year of the transferor corporation terminates upon the reorganization.577 The issue before the IRS in that ruling, however, concerned only that rule's applicability to the taxable year of a subsidiary liquidated under §332 and former §334(b)(1), a type of liquidation that is also considered to be a multiple party F reorganization.578 In another ruling the IRS permitted the transferee corporation in an F reorganization to retain the transferor's taxable year.579
577TAM 7943009.
578Rev. Rul. 75-561, 1975-2 C.B. 129, obsoleted by Rev. Rul. 2003-99, 2003-34 I.R.B. 388. Rev. Rul. 75-561 applied pre-TEFRA law.
579PLR 9304023.
3.	Termination of Corporate Existence, but Continuation of Activities
a.	Status of Trustees in Dissolution
If a corporation, legally dissolved under the state law other than by lapse or forfeiture of its charter, is not completely liquidated, the undistributed assets are generally transferred to receivers or trustees in dissolution, who administer and wind up the corporation's affairs. Neither bankruptcy nor the appointment of a receiver will end the taxable year of a corporation.580
580In re Sussman, 289 F.2d 76 (3d Cir. 1961); Stoller v. U.S., 320 F.2d 340 (Ct. Cl. 1963); Martin v. Comr., 56 T.C. 1294 (1971). Cf. Willingham v. U.S., 289 F.2d 283 (5th Cir. 1961) (holding for net operating loss carryover purposes, a corporation commenced business as a new business enterprise on the date the plan of bankruptcy became operative).
If a receiver or trustee in dissolution, by order of a court of competent jurisdiction, by operation of law, or otherwise has possession of or holds title to all or substantially all the property or business of a corporation, the receiver or trustee must file the income tax returns for the corporation in the same manner and form as a continuing corporation would be required. The receiver or trustee must file these returns regardless of whether it is operating the property or business of the corporation.581
581Regs. § 1.6012-3(b)(4).
Note: Trustees in dissolution represent the corporation. They are to be distinguished from liquidating trustees appointed by the stockholders to receive and liquidate assets actually or constructively distributed in liquidation by the corporation. Such liquidating trustees represent the stockholders, and are not required to file corporation returns.582 If the liquidation is unreasonably prolonged, or the trust's business activities are sufficient to demonstrate a loss or abandonment of the purpose of liquidation, the trust is no longer respected as a liquidating trust.583
582Cold Metal Process Co. v. Comr., 247 F.2d 864 (6th Cir. 1957); Comr. v. Merchants Nat'l Bldg.. Corp., 131 F.2d 740 (5th Cir. 1942).
583See Regs. § 301.7701-4(d).
b.	Continuation of Dissolved Corporation's Business Without Liquidation
It is possible for a corporation dissolved under the state law to continue business after formal dissolution with little or no change in its form of organization. When this happens, it is usually because the charter has lapsed, been forfeited, or has otherwise been canceled through operation of law. There may be no intention to liquidate the corporation.
If a corporation's business continues under those circumstances after the expiration of its charter or the termination of its existence under state law, it is generally treated as an association taxable as a corporation.584 If, upon the lapse of its corporate status, the business is operated as a sole proprietorship or a partnership, its corporate existence terminates for federal tax purposes. Although the business may be operated as an association, it may still experience a short period taxable year as a result of its lack of corporate existence under state law.585
584Coast Carton Co. v. Comr., 149 F.2d 739 (9th Cir. 1945); Crocker v. Comr., 84 F.2d 64 (7th Cir. 1936); Zimmerman v. Comr., 31 B.T.A. 754 (1934), nonacq., XIV-1 C.B. 41. See Rev. Rul. 84-170, 1984-2 C.B. 245, in which an insurer's state charter was formally revoked but the superintendent of insurance was required to continue to file federal income tax returns for the company for the period of possession.
585See VIII, A, 3, c, below.
Note: The "check-the-box" regulations permit many businesses to elect whether to be classified as associations, taxed as corporations, or as partnerships.586
586Reg. §301.7701-3. See 700 T.M., Choice of Entity, for a discussion of the "check-the-box" regulations.
c.	Lapse, Forfeiture, or Other Involuntary Cancellation of Charter
The legal life of a corporation may terminate upon the expiration of a prescribed period of years or it may have perpetual existence. The limited period of life may be prescribed by state law or it may be provided in the charter. Renewal or extension of the term is generally provided under state law and the charter itself may provide for renewal or extension.
Note: In general, renewal or extension of a limited-term charter is available only by affirmative action of the corporation to meet prescribed requirements. A corporation ordinarily must meet those requirements before the expiration of the original term, but in some states, the law permits renewal of the charter within a limited period after it lapses.587 In most states, the corporation's existence is continued for a prescribed period after expiration of the charter for the purpose of liquidating the corporation and winding up its affairs.588
587Fletcher, 16A Fletcher Cyclopedia of the Law of Private Corporations §§7980- 81 (perm. ed. 1995).
588Id., §8113.
Forfeiture of a corporation's charter generally results from the failure of the corporation to comply with conditions imposed by state law for the corporation's existence. In many states, payment of the franchise or other state taxes or fees is such a condition. The charter may usually be reinstated by remedying the default, such as by payment of the delinquent tax, including interest and penalties.
If the charter expires or is forfeited, the question of whether reinstatement of the charter or reincorporation under state law results in a continuing entity or a new taxable entity is dependent upon the state law. If state law provides that a forfeited or lapsed charter may be revived within a prescribed period of time, or upon reinstatement, the charter stands as if no forfeiture had occurred. In that case, the old entity can continue in existence for federal income tax purposes without a break between the lapse or forfeiture and the reinstatement (assuming the state law provisions are satisfied).589
589Suburban Inv. Co. v. Comr., 1 B.T.A. 1121 (1925), acq., IV-2 C.B. 4; Rev. Rul. 54-269, 1954-2 C.B. 114.
On the other hand, there is authority for the proposition that if state law makes the forfeiture or lapse irrevocable, and reinstatement or reincorporation gives the organization the status of a new corporation, the corporation is treated as a new taxpayer for federal income tax purposes.590 In addition, the final taxable year of the old entity would end with the actual or constructive transfer of its assets and business to the new corporation.591
590New Colonial Co. v. Helvering, 292 U.S. 435 (1934).
591Id.
4.	Final Period of a Dissolving or Liquidating Corporation in a Tax-Free Exchange or Liquidation
The final taxable year of a liquidated subsidiary or a transferor corporation ends on the date of completion of the distribution or exchange in the following types of tax-free liquidations and reorganization exchanges. 
(1) Tax-free liquidations in which the basis of the subsidiary's assets in the hands of the parent is the same as the subsidiary's basis for the assets (§332 liquidations).
(2) A statutory merger or consolidation (§368(a)(1)(A), (a)(2)(D) and (a)(2)(E)).
(3) An exchange of substantially all the properties of the transferor corporation for voting stock of the transferee corporation or its parent (§368(a)(1)(C)).
(4) A transfer to a corporation of all or a part of its assets in a transaction that qualifies as a reorganization under §368(a)(1)(D).
(5) A transfer by a corporation of all or part of its assets in a Title 11 or similar case such that the transaction qualifies as a reorganization under §368(a)(1)(G).
The requirement for a final return also applies to a corporation that makes a §338 election. Under this election, the basis of the subsidiary's stock held by the parent becomes the basis of the subsidiary's assets. Although an actual distribution does not occur upon the completion of this election, at the date of acquisition the corporation is treated as if it had distributed all of its assets in complete liquidation under §337. (These rules are discussed in depth in the regulations under §338.)592
592§ 338(a). See also 788 T.M., Stock Purchases Treated as Asset Acquisitions -- §338.
5.	Special Information Return Must Be Filed Upon Adoption of Resolution or Plan for Dissolution or Liquidation
Within 30 days after the adoption of any resolution or plan for dissolution of a corporation or the complete or partial liquidation of its capital stock, the corporation is required to file a Form 966 (Corporate Dissolution or Liquidation) with the appropriate district director showing: 
(1) The name and address of the corporation;
(2) The place and date of incorporation;
(3) The date of the adoption of the resolution or plan and the dates of any amendments thereof or supplements thereto; and
(4) The IRS Service Center where the last income return of the corporation was filed and the taxable year covered thereby.
An additional Form 966 must also be filed for any amendment or supplement to the resolution or plan adopted after filing the previous return. The additional return must report all required information not included in the previous Form 966. A certified copy of the amendment or supplement must be attached to the additional Form 966.593
593Regs. § 1.6043-1.
B. Partnerships
The termination of a partnership's taxable year is not necessarily governed by the dissolution or liquidation of the partnership under state or local law. For federal income tax purposes, a partnership terminates only if no part of any business, financial operation, or venture of the partnership continues to be carried on by any of its partners in a partnership, or within a 12-month period there is a sale or exchange of 50% or more of the total interest in partnership capital and profits.594 Therefore, a partnership's taxable year does not close as a result of the death of a partner, the entry of a new partner, the liquidation of all or a portion of a partner's interest, or the sale or exchange of partnership interests amounting to less than 50% within a 12-month period.595
594§ 708(b).
595§ 706(c)(1).
A partnership taxable year does terminate, however, with respect to a partner that liquidates, sells or exchanges its entire interest; for taxable years beginning after December 31, 1997, a partnership year will also terminate with respect to a partner who dies.596 For a detailed discussion of termination of a partnership, see 718 T.M., Dispositions of Partnership Interests; Termination of a Partnership.
596§ 706(c)(2).
C. Individuals
In general, the final taxable year of a taxpayer occurs when the taxpayer dies.597 Note that because a final return of a decedent is not a short taxable year, the annualization computations of §443 are not required.598 In addition, a decedent's final return is not due until its normal due date.599
597Regs. § 1.443-1(a)(2). Borin v. U.S., 62-2 USTC Para.9817 (N.D. Tex. 1962), rev'd and rem'd on other issues, 322 F.2d 685 (5th Cir. 1963).
598Regs. § 1.443-1(a)(2). See also Bankers Trust Co. v. Bowers,295 F. 89 (2d Cir. 1923); T.D. 3547, III-1 C.B. 237.
599Regs. § 1.6072-1(b).
Nonresident aliens who have no U.S.-source effectively connected income and departing aliens do not file a final return, per se, as they may still have filing requirements in the U.S. in subsequent periods. Departing aliens are, however, required to present a certificate of compliance with income tax obligations or provide evidence that the certificate is not required.600
600§ 6851(d); Regs. § 1.6851-2.
D. Estates and Trusts
The termination of an estate occurs at the end of the period of administration or settlement.601 The period of administration or settlement is the period required by the administrator or executor to perform the ordinary duties of administration, such as the collection of assets and the payment of debts, taxes, legacies, and bequests whether longer or shorter than the period specified by local law.602 The period of administration of an estate cannot be unduly prolonged. If the administration of an estate is unreasonably prolonged, the estate is terminated for federal income tax purposes after the expiration of a reasonable period for the performance by the executor of all the duties of administration.603 The estate is also terminated when all the assets have been distributed except for a reasonable amount that is set aside in good faith for the payment of unascertained or contingent liabilities or expenses (not including a claim by a beneficiary in the capacity of beneficiary).604
601Regs. § 1.641(b)-3(a).
602Id.
603Id.
604Id.
The determination of whether a trust is terminated for tax purposes generally depends upon whether the property held in trust has been distributed to the persons entitled to succeed to the property upon termination of the trust rather than upon the technicality of whether the trustee has rendered a final accounting.605 A trust does not automatically terminate upon the occurrence of the event by which the duration of the trust is measured. A reasonable time is permitted after such an event for the trustee to perform the duties necessary to complete the administration of the trust.606 Thus, if under the terms of the trust's governing instrument, the trust is to terminate upon the death of the life beneficiary and the corpus is to be distributed to the remaindermen, the trust continues after the death of the life beneficiary for a period reasonably necessary to a proper winding up of the affairs of the trust.607 Like estates, the winding up cannot be unduly postponed or the trust will be considered terminated for federal income tax purposes.608 A trust is also considered terminated when all the assets have been distributed except for a reasonable amount set aside for payment of unascertained or contingent liabilities (not including a claim by a beneficiary in the capacity of beneficiary).609
605Regs. § 1.641(b)-3(b).
606Id.
607Id.
608Id.
609Id. See also, Green v. U.S., 67-1 USTC Para.9338 (N.D. Tex. 1967).
E. Election to Terminate Individual's Taxable Year in Title 11 Cases
If a debtor in a case under Chapter 7 (relating to liquidations) or Chapter 11 (relating to bankruptcy reorganizations) of title 11 of the U.S. Code is an individual, the debtor may generally elect to treat his or her taxable year as two taxable years.610 In this situation, the debtor may elect to end the taxable year with the commencement date611 and begin a new year following the commencement date. This irrevocable election may be made only on or before the due date for filing the return for the taxable year ending with the commencement date.612 The taxpayer must annualize income for both short years.613 The debtor's spouse may join in the election, if they file a joint return.614
610§ 1398(d)(2)(A). The election is unavailable if the debtor has no property other than property that the debtor may treat as exempt property under §522 of title 11 of the United State Code. §1398(d)(2)(C).
611Under §1398(d)(3), the commencement date is the date on which the case under title 11 of the U.S. Code commences.
612§ 1398(d)(2)(D).
613§ 1398(d)(2)(F).
614§ 1398(d)(2)(B).

WORKING PAPERS
Table of Worksheets
LEGISLATIVE HISTORY
Worksheet 1		1986 Blue Book Explanation of Restrictions on Adoption of a Fiscal Year by Pass-Through Entities and Personal Service Corporations [Staff of the Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986 (P.L. 99-514), May 4, 1987].
INTERNAL REVENUE DOCUMENTS
Worksheet 2		Publication 538 -- Accounting Periods and Methods
Worksheet 3		Procedure for Determining Whether a Natural Business Year Exists for Purposes of a Change in Accounting Period [Rev. Proc. 74-33, 1974-2 C.B. 489, clarified by Rev. Proc. 87-32].
Worksheet 4		Procedure for Changing Accounting Periods When NOL Is Incurred During the Resulting Short Tax Year [Rev. Proc. 85-16, 1985-1 C.B. 517].
Worksheet 5		Procedures for Pass-Through Entities and Personal Service Corporations to Obtain IRS Approval of a Change in Accounting Period [Rev. Proc. 87-32, 1987-2 C.B. 396, modifying and superseding in part Rev. Proc. 83-25].
Worksheet 6		Required Taxable Years for Specified Foreign Corporations [Rev. Proc. 90-26, 1990-1 C.B. 512].
Worksheet 7		Procedure for Corporations to Obtain IRS Approval of a Change in Accounting Period [ Rev. Proc. 92-13, 1992-1 C.B. 665 (as corrected by Rev. Proc. 92-13A, 1992-1 C.B. 668), modifying and superseding Rev. Proc. 84-34].
Worksheet 8		Modification to Rev. Proc. 92-13 [Rev. Proc. 94-12, 1994-1 C.B. 565].
Worksheet 9		Former Procedures for Corporations to Obtain Automatic IRS Approval of a Change in Accounting Period [Rev. Proc. 2000-11, 2000-3 I.R.B. 309, superseding Rev. Proc. 92-13, 1992-1 C.B. 665].
Worksheet 10		Preamble to Final Regulations on Changes in Accounting Periods, T.D. 8996, 67 Fed. Reg. 35009 (5/17/2002).
Worksheet 11		Announcement 2002-53, 2002-22 I.R.B. 1063, Relating to Changes in Accounting Periods.
Worksheet 12		Rev. Proc. 2002-37, 2002-22 I.R.B. 1030, Relating to Automatic Consent for Accounting Periods for Certain Corporations.
Worksheet 13		Rev. Proc. 2002-38, 2002-22 I.R.B. 1037, Relating to Automatic Consent for Accounting Periods for Certain Flow-Through Entities.
Worksheet 14		Rev. Proc. 2002-39, 2002-22 I.R.B. 1046, Relating to Obtaining Approval for Accounting Periods.

Worksheet 1
1986 Blue Book Explanation of Restrictions on Adoption of a Fiscal Year by Pass-Through Entities and Personal Service Corporations [Staff of the Joint Committee on Taxation, General Explanation of the Tax Reform Act of 1986 (P.L. 99-514), May 4, 1987].
(533)
G. Taxable Years of Partnerships, S Corporations, and Personal Service Corporations (Sec. 806 of the Act and secs. 706, 1378, 441, and 267 of the Code)94
94 For legislative background of the provision, see: H.R. 3838 as reported by the Senate Committee on Finance on May 29, 1986, sec. 304; S. Rep. 99-313, pp. 163-167; Senate floor amendment, 132 Cong. Rec. S 8190 (June 23, 1986); and H. Rep. 99-841, Vol. II (September 18, 1986), pp. 317-320 (Conference Report).
Prior Law

Partnerships.--Prior law required a partnership adopting or changing a taxable year to use the same taxable year as all of its principal partners (or the calendar year, if all of the partnership's principal partners do not have the same taxable year and the partnership is adopting a taxable year), unless the partnership established to the satisfaction of the Secretary of the Treasury a business purpose for selecting a different taxable year (sec. 706). A partnership that adopted its taxable year prior to April 2, 1954, was not required to change its taxable year regardless of whether the taxable year adopted is the same as the taxable year of all of the principal partners (Treas. Reg. sec. 1.706-1(b)(6)).

In 1972, the Internal Revenue Service announced in Revenue Procedure 72-51(1972-2 C.B. 832) that requests by a partnership to adopt or change to an accounting period differing from that of the principal partners generally will be approved where the adoption of such change would result in the deferral of income to the partners of three months or less.

S corporations.--Prior law required a corporation that made an election to be taxed as an S corporation, or an S corporation that changed its taxable year to adopt a "permitted year" (sec. 1378). A permitted year is a calendar year or any other accounting period for which the S corporation establishes a business purpose to the satisfaction of the Secretary of the Treasury. A corporation that was an S corporation for a taxable year that includes December 31, 1982 (or that was an S corporation for a taxable year beginning in 1983 by reason of an election made on or before October 19, 1982) was allowed to retain a taxable year that is not a permitted year. However, if more than 50 percent of the stock of such an S corporation is newly owned stock, the S corporation was required to change its taxable year to a permitted year. Revenue Procedure 83- 25 (1983-1 C.B. 689) provides procedures that the Internal Revenue Service will follow in approving a request by a corporation electing S corporation status that desires to change, adopt, or retain a taxable year other than a calendar year. Revenue Procedure 83-25 provided that requests will be approved where the taxable year results in the deferral of income to shareholders of three months or less.
534

Personal service corporations.--A personal service corporation generally was allowed to adopt any taxable year on its first Federal income tax return that conformed with its annual accounting period. A personal service corporation desiring to change its taxable year was generally required to first obtain the consent of the Secretary of the Treasury.

Deferral of income.--Under present law, partners in a partnership take into account their allocable share of income, gain, loss, deduction or credit of the partnership for their taxable year in which the partnership's taxable year ends. The items of income, gain, loss, deduction or credit are computed at the partnership level and reflect the partnership's (not the partner's) taxable year. To the extent that the partner's and the partnership's taxable years are not the same, a deferral of income can result. For example, assume a partnership has a taxable year ending in June, while an individual partner has a calendar year. The partner will include in his income tax return for the current calendar year his distributive share of partnership items that arose in the first six months of the current calendar year and his share of such items that arose in the last six months of the prior calendar year. Partnership items arising in the last six months of the current calendar year will not be included in the partner's return until the following calendar year. Thus, the recognition of six months' of partnership income has been deferred by the partner until the following taxable year.

A similar deferral may be accomplished through the use of a personal service corporation. For example, assume a personal service corporation with a taxable year ending in January pays its calendar year employee-owners a minimal salary during the year and, immediately prior to the close of the corporation's taxable year (during January), declares a bonus to the employee-owners equal to the profits of the corporation. The corporation obtains a deduction for the bonus paid (reducing its current year taxable income to zero) and the employee-owners report the bonus income as part of their income for the taxable year that ends eleven months later. The effect is to defer taxation on eleven months of income earned in one year until the following year.
Reasons for Change

The Congress believed that the prior law allowed an improper deferral of income for certain partners, shareholders in S corporations, and owners of personal service corporations. Where prior law allowed income earned by a partnership, S corporation or personal service corporation to be subjected to Federal income tax in a taxable year later than that in which it was earned, the value of the income earned is understated. This deferral of income was normally available only to certain types of taxpayers, resulting in preferential treatment of certain taxpayers at the overall expense of others. The Congress believed that requiring a partnership, S corporation, or personal service corporation to change its taxable year would impose less of a burden on the taxpaying public than other methods of eliminating the deferral.
535
Explanation of Provision

In general, the Act requires that all partnerships, S corporations, and personal service corporations conform their taxable years to the taxable years of their owners. An exception to the rule is made in the case where the partnership, S corporation, or personal service corporation establishes to the satisfaction of the Secretary of the Treasury a business purpose for having a different taxable year. The deferral of income to owners for a limited period of time, such as the three months or less rule of present law, is not to be treated as a business purpose.

The Act provides that a partnership may not have a taxable year other than the taxable year of the partners owning a majority interest in partnership profits and capital. If partners owning a majority of partnership profits and capital do not have the same taxable year, the partnership must adopt the same taxable year as its principal partners. If the principal partners of the partnership do not have the same taxable year and no majority of its partners have the same taxable year, the partnership must adopt a calendar year as its taxable year unless a different taxable year is provided by regulations. In each case, the partnership may use a different taxable year if it establishes to the satisfaction of the Secretary of the Treasury a business purpose therefor.

For example, assume a partnership has one principal partner which is a fiscal year corporation owning an interest of 10 percent in partnership profits and capital. The remainder of the partners are individuals on a calendar taxable year; none of these individuals owns a sufficient interest in the partnership to be a principal partner. Under prior law, the partnership would have been required to adopt the fiscal taxable year of the corporate partner (i.e., the taxable year of its principal partner). Under the Act, the partnership is required to adopt a calendar taxable year (i.e., the taxable year of the majority of its partners).

The Congress intended that a partnership not adopt the taxable year of the partners owning a majority interest in partnership profits and capital, unless partners with the same taxable year have owned a majority interest in partnership profits and capital for three consecutive taxable years of the partnership. This rule is to be phased-in over a three year period. In applying this rule, ownership in taxable years beginning before 1987 is not taken into account. If the taxable year of a partnership is determined by the taxable year of the partners owning a majority interest in partnership profits and capital, the Congress did not intend that a further change in the taxable year of the partnership be required for either of the two taxable years of the partnership following the year of change.95
95 A technical correction may be required to accomplish this result.

An S corporation must adopt a calendar year, regardless of when the corporation elected to be taxed as an S corporation. Also, a personal service corporation must adopt a calendar year.

For purposes of this provision, a personal service corporation is a corporation the principal activity of which is the performance of personal service if services are substantially performed by employ-
536

ee-owners. An employee-owner is any employee of the corporation who owns any of the outstanding stock of the corporation. In determining whether an employee owns stock in the corporation, the constructive ownership rules of section 318 apply, except that the attribution of stock owned by a corporation to the employee is applied without regard to any requirement that the employee own a certain percentage of the value of the stock of that corporation. For the purpose of this provision, a corporation that has elected S corporation status will not be considered a personal service corporation.

A corporation was not intended to be considered a personal service corporation for the purpose of this provision unless more than ten percent of the stock (by value) in such corporation is held by employee-owners.96
96 A technical correction may be required to accomplish this intent.

 The Congress intended that a corporation engaged in the rendering of personal services be excluded from this definition only if the personal services rendered by owner-employees do not materially contribute to the revenue of the corporation. Review of other employees work by an owner-employee in his professional capacity constitutes contribution by the owner-employee with regard to the work reviewed.

The Congress intended that in the case of a corporation that is a member of an affiliated group filing a consolidated return, all members of such group are taken into account in determining whether or not such corporation meets the definition of a personal service corporation. For example, a corporation may be treated as a personal service corporation where the owner-employees rendering the requisites services are owners of the parent, but employees of a subsidiary. In determining if the principal activity of the corporation is the provision of personal services, the activities of all members of the consolidated group are to be considered.97
97 A technical correction may be required to accomplish this intent.

An exception to the rules requiring a certain taxable year is provided in each case where the partnership, S corporation, or personal service corporation establishes to the satisfaction of the Secretary of the Treasury a business purpose for having a different taxable year.

The Congress intended that any partnership that received permission to use a fiscal year-end (other than a year-end that resulted in a three-month or less deferral of income) under the provisions of Rev. Proc. 74-33, 1974-2 C.B. 489, be allowed to continue the use of such taxable year without obtaining the approval of the Secretary of the Treasury. Similarly, any S corporation that received permission to use a fiscal year-end (other than a year-end that resulted in a three-month or less deferral of income), which permission was granted on or after the effective date of Rev. Proc. 74-33, shall be allowed to continue the use of such taxable year without obtaining the approval of the Secretary of the Treasury.

Moreover, any partnership, S corporation, or personal service corporation may retain a taxable year, under procedures established by the Secretary of the Treasury, if the use of such year meets the requirements of the "25% test" as described in Rev.
537

Proc. 83-25, 1983-1 C.B. 689 (i.e., 25% or more of the taxpayer's gross receipts for the 12-month period in question are recognized in the last two months of such period and this requirement has been met for the specified three consecutive 12-month periods).

In addition, the Secretary of the Treasury may prescribe other tests to be used to establish the existence of a business purpose, if, in the discretion of the Secretary of the Treasury, such tests are desirable and expedient towards the efficient administration of the tax laws. It was not the intent of the Congress that a partnership, S corporation or personal service corporation that does not meet the "25% test" be automatically denied the use of a taxable year other than the taxable year otherwise mandated by this provision. It is anticipated that the applications of all taxpayers will be considered based on each taxpayer's facts and circumstances.

The Congress intended that (1) the use of a particular year for regulatory or financial accounting purposes; (2) the hiring patterns of a particular business, e.g., the fact that a firm typically hires staff during certain times of the year; (3) the use of a particular year for administrative purposes, such as the admission or retirement of partners or shareholders, promotion of staff, and compensation or retirement arrangements with staff, partners, or shareholders; and (4) the fact that a particular business involves the use of price lists, model year, or other items that change on an annual basis ordinarily will not be sufficient to establish that the business purpose requirement for a particular taxable year has been met. Although the above items are not themselves sufficient to establish a business purpose, they may be considered in connection with other items by the Secretary of the Treasury in determining whether a taxpayer has a business purpose for a particular taxable year. The fact that a particular fiscal year allows deferral of income for a limited period of time under no circumstances establishes a business purpose.

In determining the taxable year to which a taxpayer is required to change by reason of this provision, Congress intended that changes in taxable years of other persons required by the provision to change taxable years be taken into account. Such changes are to be taken into account regardless of the time at which they take place, so long as they are determinable. For example, a partnership that historically used a January fiscal year has partners that are personal service corporations that historically used a June fiscal year. The personal service corporations are required to adopt a calendar year by this provision. Since the taxable year of the personal service corporation partners determines the taxable year of the partnership, the partnership also is required to adopt a calendar year.98 The fact that the partners will be changing their taxable years is immaterial for the purpose of determining whether or not the majority interest test is met.
98If the change in the taxable year of the partnership did not take into account the change in the taxable year of its personal service corporation owners, the partnership could be considered to be required to first adopt a June year and later, after its partners had been required to adopt a calendar year, adopt the calendar year itself.

A partnership, S corporation, or personal service corporation that changes to a taxable year required by this provision will be
538

treated as having made the change with the consent of the Secretary of the Treasury. In the case of a partnership or an S corporation required by this provision to change taxable years, each partner or owner that would otherwise be required to include items from more than one taxable year of the partnership or S corporation in any one of its taxable years is to take into account the excess of income over expenses for the short taxable year of the partnership or S corporation ratably in each of the first four taxable years of the partner or owner beginning after December 31, 1986, unless the partner or owner elects to include all such income in its taxable year that the short taxable years ends in or within. In the case of a personal service corporation, the taxable income in the short taxable year resulting from the change of taxable year is annualized under section 443.

The rule allowing partners or shareholders of a partnership or S corporation to include items of income from the short year of the partnership or S corporation in each of the partner or shareholder's four taxable years beginning after December 31, 1986 is applicable regardless of what type of entity the partner or S corporation shareholder is. Thus, a personal service corporation that is a partner in a partnership required to adopt a new taxable year as a result of this provision is eligible to include the partner's distributive share of partnership income over four taxable years so long as it would otherwise be required to include the items from more than one taxable year of the partnership in any one of its taxable years. The rule is applicable to income from an S corporation only if such corporation was an S corporation for a taxable year beginning in 1986.

The ratable four year inclusion applies only in cases where the partner or S corporation shareholder would otherwise be required to include items from more than one taxable year of the partnership or S corporation in any one of its own taxable years. For example, a personal service corporation with a June fiscal year is a partner in a partnership that also uses a June fiscal year. Both the personal service corporation and the partnership are required to change to the calendar year. The changes are considered to occur simultaneously. In this case, the personal service corporation will include its share of partnership items from the last full fiscal year of the partnership in its full year ending in June, and its share of partnership items from the short year of the partnership in its short year (which is of equal length as the partnership's short taxable year). As the personal service corporation has not been required to include items from more than one taxable year in any one of its taxable years, the rule providing for ratable inclusion over four years of the excess of its share of partnership income in excess of expenses does not apply.

The Act extends the provisions of section 267 to provide that a personal service corporation and its employee-owners are treated as related taxpayers regardless of the amount of the corporation's stock owned, directly or indirectly, by the employee-owner. Thus, a personal service corporation may not deduct payments made to employee-owners prior to the time that such employee-owner would include the payment in gross income.
539

The Congress anticipated that the Secretary of the Treasury will promulgate regulations regarding the use of the 52-53 week taxable year to prevent the evasion of the principles of this provision. It is anticipated that the regulations will provide that, for the purpose of determining when taxable income is included by a partner or S corporation shareholder, a 52-53 week taxable year of a partner, shareholder, partnership, or S corporation will be treated as ending on the last day of the calendar month ending nearest to the last day of such 52-53 week taxable year. For example, a calendar year partner will include its share of taxable income from a partnership with a 52-53 week taxable year ending on January 3, 1988, in its 1987 calendar year Federal income tax return. The Secretary of the Treasury may also prescribe similar rules to prevent the evasion of the principles of the provision through the use of a 52-53 week taxable year by personal service corporations and the shareholder employees of such corporations. It is also anticipated that the Secretary of the Treasury will suspend the operation of Treas. Reg. sec. 1.441-2(c) allowing taxpayers in certain cases to adopt, or change to, a 52-53 week taxable year without the approval of the Secretary of the Treasury.

Some partnerships and S corporations that adopted a taxable year providing a deferral of income to owners of three months or less were required to include the amount of deferral obtained in income over a 10-year period. Any portion of such amount not taken into income as of the effective date of the provision may be used to reduce the income attributable to any short taxable year required by the provision.

The Congress also intended that common trust funds taxed under section 584 of the Code be required to use a calendar year. To the extent a participant in a common trust fund is required to include items from more than one taxable year of the common trust fund in any of its taxable years, the items from the short taxable year of the common trust fund are to be included in income ratably over a four taxable year period, in the same manner as if the common trust fund were a partnership and the participant in the common trust fund were a partner.99
99 A technical correction may be required to accomplish this intent.
Effective Date

The provision is effective for taxable years beginning after December 31, 1986. Entities required to change their taxable years as a result of this provision will be required to file a return for the short taxable year that begins with the first day of their current taxable year beginning after December 31, 1986, and ends in accordance with the taxable year to which the entity changes.
Revenue Effect

The provision is estimated to increase fiscal year budget receipts by $165 million in 1987, $467 million in 1988, $477 million in 1989, $390 million in 1990, and $213 million in 1991.
Worksheet 2
Publication 538 -- Accounting Periods and Methods
Worksheet 2	Click Icon to View Worksheet
Worksheet 3
Procedure for Determining Whether a Natural Business Year Exists for Purposes of a Change in Accounting Period [Rev. Proc. 74-33, 1974-2 C.B. 489, clarified by Rev. Proc. 87-32].
Worksheet 3	Click Icon to View Worksheet
Worksheet 4
Procedure for Changing Accounting Periods When NOL Is Incurred During the Resulting Short Tax Year [Rev. Proc. 85-16, 1985-1 C.B. 517].
Worksheet 4	Click Icon to View Worksheet
Worksheet 5
Procedures for Pass-Through Entities and Personal Service Corporations to Obtain IRS Approval of a Change in Accounting Period [Rev. Proc. 87-32, 1987-2 C.B. 396, modifying and superseding in part Rev. Proc. 83-25].
Worksheet 5	Click Icon to View Worksheet
Worksheet 6
Required Taxable Years for Specified Foreign Corporations [Rev. Proc. 90-26, 1990-1 C.B. 512].
Worksheet 6	Click Icon to View Worksheet
Worksheet 7
Procedure for Corporations to Obtain IRS Approval of a Change in Accounting Period [Rev. Proc. 92-13, 1992-1 C.B. 665 (as corrected by Rev. Proc. 92-13A, 1992-1 C.B. 668), modifying and superseding Rev. Proc. 84-34].
Worksheet 7	Click Icon to View Worksheet
Worksheet 8
Modification to Rev. Proc. 92-13 [Rev. Proc. 94-12, 1994-1 C.B. 565].
Worksheet 8	Click Icon to View Worksheet
Worksheet 9
Former Procedures for Corporations to Obtain Automatic 
IRS Approval of a Change in Accounting Period
[Rev. Proc. 2000-11, 2000-3 I.R.B. 309, superseding Rev. Proc. 92-13, 1992-1 C.B. 665].
Worksheet 9	Click Icon to View Worksheet
Worksheet 10
Preamble to Final Regulations on Changes in Accounting Periods,
 T.D. 8996, 67 Fed. Reg. 35009 (5/17/2002).
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Parts 1, 5c, 5f, 18, and 602
[TD 8996]
RIN 1545-AX15
Changes in Accounting Periods

AGENCY: Internal Revenue Service  (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

SUMMARY: This document contains final regulations relating to certain adoptions, changes, and retentions of annual accounting periods.  The final regulations are necessary to update, clarify, and reorganize the rules and procedures for adopting, changing, and retaining a taxpayer's annual accounting period.  The final regulations primarily affect taxpayers that want to adopt an annual accounting period under section 441 or that must receive approval from the Commissioner to adopt, change, or retain their annual accounting periods under section 442.

DATES: Effective Date:  These regulations are effective May 17, 2002.

Applicability Date: These regulations are applicable for taxable years ending on or after May 17, 2002.

FOR FURTHER INFORMATION CONTACT:  Michael Schmit or Roy Hirschhorn at (202) 622-4960 (not a toll-free number).

SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act

The collections of information contained in these final regulations have been reviewed and approved by the Office of Management and Budget in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 3507(d)) under control number 1545-1748. Responses to these collections of information are required for certain taxpayers to adopt, change, or retain an annual accounting period. 

An agency may not conduct or sponsor, and a person is not required to respond to, a collection of information unless the collection of information displays a valid control number assigned by the Office of Management and Budget.

The estimated annual burden per respondent varies from 20 minutes to one hour, depending on individual circumstances, with an estimated average of 30 minutes. 

Comments concerning the accuracy of this burden estimate and suggestions for reducing this burden should be sent to the Internal Revenue Service, Attn: IRS Reports Clearance Officer, W:CAR:MP:FP:S, Washington, DC 20224, and to the Office of Management and Budget, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503.

Books or records relating to this collection of information must be retained as long as their contents may become material in the administration of any internal revenue law.  Generally, tax returns and tax return information are confidential, as required by 26 U.S.C. 6103.
Background

On June 12, 2001, the IRS and Treasury Department published in the Federal Register proposed amendments to regulations under section 441 (period for computing taxable income), and sections 442, 706, 898, and 1378 (regarding the requirement to obtain the approval of the Commissioner to adopt, change, or retain an annual accounting period) [REG-106917-99 (66 FR 31850)]. Written and electronic comments were solicited, and a public hearing was scheduled for October 2, 2001.  Several comments were received, and are discussed below.  Because no requests to speak were received, the public hearing was cancelled.  After consideration of all comments, the proposed regulations under sections 441, 442, 706, and 1378 are adopted as revised by this Treasury decision.
Summary of Comments and Explanation of Revisions
1. Comments and Changes Relating to §1.441 of the Proposed Regulations
A. Definition of 52-53-week taxable year

The proposed regulations both define the term taxable year consisting of 52-53-weeks and provide an Example illustrating a 52-53-week taxable year that ends on a particular day of the week that last occurs in a calendar month or that is nearest to the last day of that calendar month.  A commentator observed that many taxpayers have difficulty correctly applying the rules for 52-53-week taxable years, and suggested that certain explanatory text contained in the Example be moved to the regulations text itself where it would be more apparent and helpful. This suggestion has been adopted in the final regulations.
B. Changes to or from a 52-53-week taxable year

The proposed regulations generally provide that changes to or from a 52-53-week taxable year are treated as changes in annual accounting periods that require the approval of the Commissioner, and describe some specific instances in which such approval may be obtained automatically under administrative procedures to be published by the Commissioner.  Consistent with the general framework of the regulations, the descriptions of these specific changes have been removed from the final regulations.  Taxpayers should see Rev. Proc. 2002-37 and Rev. Proc. 2002-38, 2002-22 I.R.B., for situations in which automatic approval for changes to or from a 52-53-week taxable year will be granted.  The final regulations clarify that a taxpayer will not be granted automatic approval for a change from one 52-53-week taxable year to another 52-53-week taxable year, even if both years reference the same calendar month. 
C. Short periods of 6 days or less

The proposed regulations provide special rules for certain short periods required to effect a change in annual accounting period to (or from) a 52-53-week taxable year.  The proposed regulations provide that if the short period is 6 days or less, such short period is not a separate taxable year but is instead added to and deemed a part of the following taxable year.  

One commentator suggested that taxpayers be permitted the option of adding such a short period to either: (1) the following taxable year (as the proposed regulations would require); or (2) the prior taxable year, whichever convention is used by the taxpayer for financial accounting purposes. 

The IRS and Treasury Department believe that adopting the commentator's suggestion in this case would present certain administrative difficulties, complicate tax administration, and possibly encourage the use of hindsight in tax reporting.  After careful consideration, the IRS and Treasury have concluded that it is in the best interests of sound tax administration to have a uniform and certain rule applicable in all such situations.  Thus, the final regulations do not adopt this suggestion.  
D. Application of effective date rules to 52-53 week-taxable years 

The proposed regulations provide a general rule concerning the application of certain effective dates as they apply to taxpayers employing 52-53-week taxable years.  In response to comments, the final regulations clarify that this rule also applies to administrative guidance published by the Commissioner.

A comment was received suggesting that additional Examples be provided illustrating how particular terms other than those "expressed in terms of taxable years beginning, including, or ending with reference to the first or last day of a specified calendar month," apply to 52-53-week fiscal-year taxpayers.  In response to this comment, clarifying language and an additional Example have been provided in the final regulations.
E. Definitions of "pass-through entity" and "owner of a pass-through entity"

The proposed regulations provide rules for certain pass-through entities and owners of pass-through entities relating to the treatment of certain taxable years ending with reference to the same calendar month.  These rules are designed to prevent substantial deferral and distortion of income reporting.

The IRS and Treasury have become aware of a potentially abusive situation involving the deferral of income reporting in the case of closely-held Real Estate Investment Trusts (REITs) (within the meaning of section 6655(e)(5)(B)) and certain owners of interests in closely-held REITs (within the meaning of section 6655(e)(5)(A)). 

For estimated tax purposes, certain owners of interests in closely-held REITs are required to recognize income from the REIT in a manner similar to partners in a partnership.  Unlike a partnership, however, REITs are not required to use a taxable year that conforms to the taxable year of their owners but rather are required to use a taxable year ending December 31 pursuant to section 859.  Thus, the potential for deferral of estimated taxes exists with respect to certain owners of interests in closely-held REITs, including owners with 52-53-week taxable years that reference December 31, as well as fiscal-year owners.  

In an attempt to reduce the potential for deferral of estimated taxes in the case of certain owners of interests in closely-held REITs, the final regulations have been modified to add: (1) a closely-held REIT (within the meaning of section 6655(e)(5)(B)) to the definition of a pass-through entity; and (2) an owner of an interest (within the meaning of section 6655(e)(5)(A)) in a closely-held REIT to the definition of an owner of a pass-through entity.  Thus, these owners of interests in a closely-held REIT with 52-53-week taxable years that reference December 31 will be required under the final regulations to recognize income from the closely-held REIT as if their taxable year ends on December 31.  
F. Accrual of foreign taxes

The IRS recognizes that changes to the taxable year of a taxpayer may shift the taxable year in which foreign taxes are treated as accruing for U.S. purposes.  The IRS also recognizes that similar results may occur in the case of taxpayers that use a 52-53-week taxable year, which will not always include the last day of the taxpayer's taxable year in a foreign jurisdiction.  The IRS is working on guidance that it expects will be issued this year to ensure that changes in U.S. taxable years, or the use of a 52-53-week taxable year, do not result in unintended and inappropriate consequences for foreign tax credit purposes. Comments are requested on the changes necessary and appropriate to address the accrual of foreign taxes in these situations.
2. Comments and Changes Relating to §1.442 of the Proposed Regulations
A. Time and manner for filing an application 

The proposed regulations provide specific rules for the time and manner of filing an application to adopt, change, or retain an annual accounting period.  Consistent with the general framework of the regulations, the IRS and Treasury have concluded that it is more appropriate to remove the specific time and manner requirements for filing applications for adoptions, changes, and retentions in annual accounting period from the final regulations, and provide them instead in administrative procedures published by the Commissioner.  See Rev. Proc. 2002-37, Rev. Proc. 2002-38, and Rev. Proc. 2002-39.  The IRS and Treasury believe that providing these rules in administrative guidance, rather than in regulations, allows the IRS more flexibility to respond in the future to the changing needs of taxpayers and the IRS.  

The proposed regulations provide that an application for non-automatic approval of an annual accounting period change may be filed no earlier than the day following the close of the first effective year and no later than the 15th day of the third calendar month following the close of the first effective year.  One commentator suggested that such applications be permitted to be filed no earlier than the later of: (1) the first day of the short period resulting from the proposed tax year change; or (2) 60 days prior to the end of the short period.

The IRS currently allows taxpayers to file applications with the national office within the referenced 60-day period and believes that many taxpayers take advantage of early filing, even knowing that their applications lack adequate information, in an effort to obtain priority over other applications processed by the national office.  However, the lack of adequate financial and other required information common to such early applications requires that the IRS devote additional resources to properly develop and process the applications.  Ultimately, this causes a delay in processing both the early applications, and other applications as well.  For this reason, the administrative guidance issued concurrently with these final regulations do not adopt this suggestion.  However, the IRS and Treasury Department intend to study filing patterns under the new rules, and will consider expanding or modifying the time frame for filing applications with the national office if circumstances warrant. 

One commentator recommended that instead of requiring all taxpayers to file the application by the 15th day of the third calendar month following the close of the first taxable year in which the taxpayer wants the adoption, change, or retention to be effective (the first effective year), as the proposed regulations provide, the due date for the application should be the due date of the taxpayer's return for the short period, without extensions.  The IRS and Treasury believe that such a rule will be simpler for taxpayers (such as individuals and partnerships) and the IRS.  Accordingly, this change is adopted in the administrative guidance issued concurrently with these final regulations.  
B. Changes to required taxable years by pass-through entities  

One commentator suggested that the proposed regulations be modified to waive the Form 1128, "Application to Adopt, Change, or Retain a Tax Year," filing requirement in the case of partnerships, S corporations, and personal service corporations (PSCs) changing to a "required taxable year" for the first taxable year for which such change is required.  Alternatively, the commentator recommended use of an "automatic consent" procedure similar to the procedure outlined in the proposed regulations for subsidiaries changing tax years to conform to the periods of their affiliated groups.  The commentator reasoned that changes to statutorily required taxable years should not require the Commissioner's prior approval through any filing or application process. 

Except in very limited circumstances (e.g., adoptions of required years, certain section 444 terminations, and certain section 859 changes) applications historically have been required for changes to a required taxable year by a pass-through entity.  The IRS and Treasury Department believe that the statutes that require such entities to use or change to a particular taxable year must be read in conjunction with the general requirement under section 442 to obtain the prior approval of the Commissioner to change an existing taxable year.  Moreover, the applications serve to provide the IRS with necessary information about the entity's annual accounting period.  Accordingly, this comment was not adopted in the final regulations or the administrative guidance issued concurrently with these regulations. 
C. Book conformity requirements 

The proposed regulations conform the record keeping requirement for taxpayers using a fiscal year to that of §1.446-1(a)(4), which allows for a reconciliation between the taxpayer's books and return.  However, the preamble to the proposed regulations noted that, as a term and condition of obtaining approval to adopt, change to, or retain an annual accounting period under section 442, certain taxpayers nevertheless may be required, under administrative procedures published by the Commissioner, to compute income and keep their books (including financial statements and reports to creditors) on the basis of the requested annual accounting period.  In fact, strict book conformity is a general requirement in the administrative procedures for approval to make many changes. See, e.g., Rev. Proc. 2002-37.

One commentator objected to the proposed elimination of procedures contained in the existing regulations under section 442 under which certain corporations are granted automatic approval to change their taxable year without a strict book conformity requirement (i.e., by satisfying the general book conformity rules of section 446).  The commentator recommended that either the final regulations retain these automatic consent rules or, alternatively, that the administrative procedures eliminate the strict book conformity requirement. 

The IRS and Treasury Department believe it is appropriate to apply the more lenient book conformity rule of section 446 in the case of a taxpayer adopting, changing to, or retaining a required or ownership taxable year and in the case of a foreign corporation that is required by foreign law to use a particular year for financial accounting purposes.  See, e.g., Rev. Proc. 2002-39.  However, for all other changes under the administrative procedures, the IRS and Treasury Department continue to believe that strict book conformity is an appropriate term and condition of a voluntary change in annual accounting period, as it provides assurance that the change is motivated by business, as opposed to tax, considerations.  In addition, the IRS and Treasury believe, for reasons stated in the preamble to the proposed regulations, that tax administration and taxpayers are better served by providing the specific rules for adoptions, changes, and retentions of annual accounting periods in administrative pronouncements, rather than regulations.  Accordingly, the comment has not been adopted.  
3. Comments and Changes Relating to Partnerships, S Corporations, and Personal Service Corporations (PSCs) 

A comment was received recommending that the limitation on additional required taxable year changes in the proposed regulations for partnerships using a majority-interest taxable years, be extended to partnerships using other required taxable years (e.g., to principal partners' taxable years and to least-aggregate-deferral taxable years).  The limitation for changes to a majority interest taxable year is specifically provided in section 706(b)(4)(B).  No such statutory authority exists for providing similar limitations in the case of other required taxable year changes by partnerships.  Accordingly, this comment was not adopted in the final regulations.  However, the Treasury Department is considering this comment in connection with a legislative simplification study.

The proposed regulations (consistent with the existing temporary regulations) generally provide for a 1-year testing period for determining whether a taxpayer is a PSC.  In the preamble to the proposed regulations, the IRS and Treasury Department responded to a comment received in connection with the original notice of proposed rulemaking cross-referenced by the temporary regulations.  The original commentator suggested that the testing period be expanded to the three preceding taxable years in order to minimize instances in which taxpayers become PSCs due to temporary or aberrational conditions.  In response, the IRS and Treasury Department indicated that they would consider alternatives to the current 1-year period if similar requests were received in comments to the proposed regulations now that taxpayers have significantly more experience with the 1-year rule.

Although some comments were received recommending a general 3-year testing period for both PSCs and S corporations, the suggestions were not directed to particular taxpayer burdens stemming from the 1-year testing period for a PSC or the original concern about taxpayers becoming a PSC because of temporary or aberrational conditions.  Rather, commentators suggested that a general 3-year testing period rule would reduce repetitive "required tax year" changes, and promote tax-year certainty.  

The IRS and Treasury Department believe that these reasons do not warrant extending the 1-year testing period for PSCs and S corporations because the current required taxable year framework for PSCs and S corporations should not result in repetitive required taxable year changes.  Once a PSC or S corporation has changed to its required taxable year (i.e., a calendar year), any further changes would be voluntary rather than required.  Accordingly, this suggestion has not been adopted in the final regulations. 
Effect on Other Documents

Rev. Rul. 57-589 is obsolete.  

Rev. Rul. 65-316 (1965-2 C.B. 149) is obsolete. 

Rev. Rul. 68-125 (1968-1 C.B. 189) is obsolete.

Rev. Rul. 69-563 is obsolete.

Rev. Rul. 74-326 (1974-2 C.B. 142) is obsolete.

Rev. Rul. 78-179 (1978-1 C.B. 132) is obsolete.
Special Analyses

It has been determined that this Treasury decision is not a significant regulatory action as defined in Executive Order 12866.  Therefore, a regulatory assessment is not required.  It also has been determined that section 553(b) of the Administrative Procedure Act (5 U.S.C. chapter 5) does not apply to these regulations. It is hereby certified that the collections of information in these regulations will not have a significant economic impact on a substantial number of small entities.  This certification is based upon the fact that few small entities are expected to adopt a 52-53-week taxable year, triggering the collection of information, and that for those who do, the burden imposed under §1.441-2(b)(1)(ii) will be minimal.  Therefore, a Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the Internal Revenue Code, the notice of proposed rulemaking preceding these regulations was submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small business.
Drafting Information

The principal authors of these regulations are Roy A. Hirschhorn and Michael F. Schmit of the Office of Associate Chief Counsel (Income Tax and Accounting).  However, other personnel from the IRS and Treasury Department participated in their development.
Worksheet 11
Announcement 2002-53, 2002-22 I.R.B. 1063, Relating to Changes in Accounting Periods.
Worksheet 11	Click Icon to View Worksheet
Worksheet 12
Rev. Proc. 2002-37, 2002-22 I.R.B. 1030, 
Relating to Automatic Consent for Accounting Periods for Certain Corporations.
Worksheet 12	Click Icon to View Worksheet
Worksheet 13
Rev. Proc. 2002-38, 2002-22 I.R.B. 1037, 
Relating to Automatic Consent for Accounting Periods for Certain Flow-Through Entities.
Worksheet 13	Click Icon to View Worksheet
Worksheet 14
Rev. Proc. 2002-39, 2002-22 I.R.B. 1046, 
Relating to Obtaining Approval for Accounting Periods.
Worksheet 14	Click Icon to View Worksheet

BIBLIOGRAPHY
OFFICIAL
Principal Statutory Provisions:
I.R.C. (1986): Sections 280H, 441, 442, 443, 444, 706, 898, 1378, 7519.
Principal Regulations:
See regulations issued under the Code provisions listed above.
Treasury Rulings:
Rev. Proc. 63-7, 1963-1 C.B. 485.
Rev. Proc. 66-6, 1966-1 C.B. 615.
Rev. Proc. 66-13, 1966-1 C.B. 626.
Rev. Proc. 66-50, 1966-2 C.B. 1260.
Rev. Proc. 74-33, 1974-2 C.B. 489.
Rev. Proc. 75-54, 1975-2 C.B. 594.
Rev. Proc. 76-10, 1976-1 C.B. 548.
Rev. Proc. 77-26, 1977-2 C.B. 536.
Rev. Proc. 81-40, 1981-2 C.B. 604.
Rev. Proc. 85-16, 1985-1 C.B. 517.
Rev. Proc. 85-58, 1985-2 C.B. 740.
Rev. Proc. 87-27, 1987-1 C.B. 769.
Rev. Proc. 87-32, 1987-2 C.B. 396.
Rev. Proc. 90-26, 1990-1 C.B. 512.
Rev. Proc. 92-13, 1992-1 C.B. 665.
Rev. Proc. 92-13A, 1992-1 C.B. 668.
Rev. Proc. 97-1, 1997-1 I.R.B. 11.
Rev. Proc. 94-12, 1994-1 C.B. 565.
Rev. Rul. 54-269, 1954-2 C.B. 114.
Rev. Rul. 54-273, 1954-2 C.B. 110.
Rev. Rul. 55-80, 1955-1 C.B. 387.
Rev. Rul. 56-483, 1956-2 C.B. 933.
Rev. Rul. 57-276, 1957-1 C.B. 126.
Rev. Rul. 57-589, 1957-2 C.B. 298.
Rev. Rul. 57-602, 1957-2 C.B. 611.
Rev. Rul. 58-256, 1958-1 C.B. 215.
Rev. Rul. 60-50, 1960-1 C.B. 150.
Rev. Rul. 60-51, 1960-1 C.B. 169.
Rev. Rul. 61-191, 1961-2 C.B. 251.
Rev. Rul. 65-163, 1965-1 C.B. 205.
Rev. Rul. 65-316, 1965-2 C.B. 149.
Rev. Rul. 66-68, 1966-1 C.B. 197.
Rev. Rul. 67-173, 1967-1 C.B. 101.
Rev. Rul. 67-189, 1967-1 C.B. 255.
Rev. Rul. 68-125, 1968-1 C.B. 189.
Rev. Rul. 69-410, 1969-2 C.B. 167.
Rev. Rul. 69-563, 1969-2 C.B. 104.
Rev. Rul. 70-286, 1970-1 C.B. 113.
Rev. Rul. 70-378, 1970-2 C.B. 178.
Rev. Rul. 71-129, 1971-1 C.B. 397.
Rev. Rul. 72-184, 1972-1 C.B. 289.
Rev. Rul. 74-326, 1974-2 C.B. 142.
Rev. Rul. 74-585, 1974-2 C.B. 143.
Rev. Rul. 75-561, 1975-2 C.B. 129.
Rev. Rul. 76-30, 1976-1 C.B. 112.
Rev. Rul. 76-43, 1976-1 C.B. 113.
Rev. Rul. 76-482, 1976-2 C.B. 127.
Rev. Rul. 76-497, 1976-2 C.B. 128.
Rev. Rul. 78-96, 1978-1 C.B. 131.
Rev. Rul. 78-179, 1978-1 C.B. 132.
Rev. Rul. 78-322, 1978-2 C.B. 228.
Rev. Rul. 80-352, 1980-2 C.B. 160.
Rev. Rul. 84-170, 1984-2 C.B. 245.
Rev. Rul. 85-22, 1985-1 C.B. 154.
Rev. Rul. 85-83, 1985-1 C.B. 292.
Rev. Rul. 87-57, 1987-2 C.B. 117.
Rev. Rul. 91-30, 1991-1 C.B. 61.
Rev. Rul. 92-65, 1992-2 C.B. 94.
Cases:
ABC Brewing Corp. v. Comr., 224 F.2d 483 (9th Cir. 1955).
Allegheny Broadcasting Corp. v. Comr., 12 T.C. 552 (1949), acq., 1950-2 C.B. 1, aff'd, 179 F.2d 844 (3d Cir. 1950).
American Coast Line v. Comr., 159 F.2d 665 (2d Cir. 1947).
American Hide & Leather Co. v. U.S., 284 U.S. 343 (1931).
Atlas Oil & Refining Co. v. Comr., 17 T.C. 733 (1951), acq., 1952-1 C.B. 1.
Bankers Trust Co. v. Bowers, 295 F.2d 89 (2d Cir. 1923).
Borin v. U.S., 62-2 USTC Para.9817 (D. Tex. 1962), rev'd and rem'd, 322 F.2d 685 (5th Cir. 1963).
Brooks v. Comr., 6 T.C. 504 (1946).
Brooklyn City R. R Co. v. Comr., 27 B.T.A. 77 (1932), acq., 1958-2 C.B. 4, aff'd, 72 F.2d 274 (2d Cir. 1934).
Brown v. U.S., 1968-2 USTC Para.9657 (D. Fla. 1968).
Calhoun v. U.S., 370 F. Supp. 434 (D. Va. 1973).
C. H. Leavell & Co. v. Comr., 53 T.C. 426 (1969).
Coast Carton Co. v. Comr., 10 T.C. 894, nonacq., 1948-2 C.B. 5, aff'd, 149 F.2d 739 (9th Cir. 1945).
Coddington v. Comr., 10 B.T.A. 712 (1928).
Cold Metal Process Co. v. Comr., 247 F.2d 864 (6th Cir. 1957).
Dougherty v. Comr., 60 T.C. 917 (1973).
East Coast Motors, Inc. v. Comr., 35 B.T.A. 212 (1936).
Erwin Properties, Inc. v. Comr., 43 T.C. 888 (1965), acq., 1967-1 C.B. 2.
Florida Grocery Co. v. Comr., 1 B.T.A. 412 (1925), acq., IV-1 C.B. 2.
Forest City Productions Credit Assn. v. U.S., 300 F. Supp. 609 (D. Ark. 1969), aff'd, 426 F.2d 819 (8th Cir. 1970).
Freudmann v. Comr., 10 T.C. 775 (1948), acq., 1948-2 C.B. 2.
Gill v. U.S., 258 F.2d 553 (5th Cir. 1958).
Godson v. Comr., 5 T.C.M. 648 (1946).
Green v. U.S., 67-1 USTC Para.9338 (D. Tex. 1967).
Hash v. Comr., 4 T.C. 878 (1945), acq., 1945 C.B. 3, aff'd, 152 F.2d 722 (4th Cir. 1945).
Hub Shoe Co. v. Comr., 2 B.T.A. 836 (1925), acq., IV-2 C.B. 3.
J. Ungar, Inc. v. Comr., 244 F.2d 90 (2d Cir. 1957).
Joel v. Comr., 9 B.T.A. 1027 (1928), acq., VII-1 C.B. 16.
Kamin Chevrolet Co. v. Comr., 3 T.C. 1076 (1944), acq., 1944 C.B. 15.
Kingman, U.S. v., 170 F.2d 408 (5th Cir. 1948).
Klempner v. Glenn, 82 F. Supp. 626 (D. Ky. 1949).
Loo, U.S. v., 248 F.2d 765 (9th Cir. 1957).
Leonard L. Politte, M.D., Inc., v. Comr., 101 T.C. 359 (1993).
MacLean v. Comr., 73 T.C. 1045 (1980).
Martin v. Comr., 56 T.C. 1294 (1971).
Merchants Nat'l Bldg. Corp. Comr. v., 131 F.2d 740 (5th Cir. 1942).
Messer v. Comr., 438 F.2d 774 (3d Cir. 1971).
More v. Comr., 66 T.C. 27 (1976), aff'd, 77-2 USTC Para.9531 (2d Cir. 1977).
Neill v. Phinney, 245 F.2d 645 (5th Cir. 1957).
New Colonial Co. v. Helvering, 292 US. 435 (1934).
Nico v. Comr., 67 T.C. 647 (1977), aff'd in part, rev'd & rem'd in part, 565 F.2d 1234 (2d Cir. 1977).
Novo Trading Corp. v. Comr., 113 F.2d 320 (2d Cir. 1940).
Paso Robles Mercantile Co. v. Comr., 33 F.2d 653 (9th Cir. 1929).
Patterson Produce Co. v. Comr., 4 B.T.A. 950 (1926), acq., VI-1 C.B. 5.
Poorbaugh v. U.S., 69-1 USTC Para.9134 (D. Pa. 1968), rev'd and rem'd, 423 F.2d 157 (3d Cir. 1969).
Rittenberg v. U.S., 166 F. Supp. 523 (D. La. 1958), aff'd, 267 F.2d 605 (5th Cir. 1959).
Rockwood v. U.S., 39 F.2d 984 (Ct. Cl. 1930).
Rouss v. Bowers, 4 B.T.A. 516 (1926), aff'd, 30 F.2d 628 (2d Cir. 1929).
Schick v. Comr. 45 T.C. 368 (1966), acq., 1966-2 C.B. 7.
Semmes, Bowen & Semmes v. U.S., 30 Fed. Cl. 134 (1993).
Stern v. Comr., 11 B.T.A. 1309 (1928).
Stoller v. U.S., 320 F.2d 340 (Ct. Cl. 1963).
Stonegate of Blacksburg, Inc. v. Comr., 33 T.C.M. 956 (1974).
Stryker v. Comr., 36 B.T.A. 326 (1937), acq., 1937-2 C.B. 27.
Suburban Inv. Co. v. Comr., 1 B.T.A. 1121 (1925), acq., IV-2 C.B. 4.
Sutow v. Comr., 64 T.C.M. 537 (1992).
Sussman, In re, 289 F.2d 76 (3d Cir. 1961).
Union Bus Terminal Inc. v. Comr., 12 T.C. 197 (1949), acq., 1950-2 C.B. 4, aff'd, 179 F.2d 399 (5th Cir. 1950).
Vance v. Comr., 56 T.C.M. 1408 (1989).
Visintainer v. Comr., 187 F.2d 519 (10th Cir. 1951).
Waldron Co. v. Comr., 2 B.T.A. 715 (1925).
Wheeler's Peachtree Pharmacy, Inc., v. Comr., 35 T.C. 177 (1960), acq., 1961-2 C.B. 5.
Wilson v. U.S., 267 F. Supp. 89 (E.D. Mo. 1967).
Williamson v. Comr., 22 T.C. 684 (1954).
Willingham v. U.S., 289 F.2d 283 (5th Cir. 1961).
Younger Bros., Inc. v. Comr., 8 B.T.A. 333 (1927), acq., VII-2 C.B. 44.
Zimmerman v. Comr., 31 B.T.A. 754 (1934), nonacq., XIV-1 C.B. 41.
UNOFFICIAL
Periodicals:
1985
Mendelson, "Planning for the Closely Held Corporation: Accounting Methods and Other Options, 43 N.Y.U. Inst. Fed. Tax'n, 18.
1987
August, "S Corporations: New Taxable Year Conformity Rules Under Tax Reform: Application to S Corporations," 3 J. of Partnership Tax., No. 4, 370.
August, "S Corporations: New Taxable Year Conformity Rules Under Tax Reform -- Part II: Application to Partnerships and Personal Service Corporations, 4 J. of Partnership Tax., No. 1, 44.
Combs, "Calendar-Year Relief Provision Included as Part of Final Budget Reconciliation Bill," 13 Wash. Tax. Rev. 12.
Frank, Polllack and Hook, "Choice or change of taxable year still offers opportunities for tax savings," 38 Tax. for Acct.
1988
Godshalk, "Will a Section 444 Election Bind a Taxpayer to a Tax Year?," 69 J. Tax'n No. 4, 206.
Rombro, "Fiscal year Regs. create hurdles for electing partnerships, S corporations and PSCs," 17 Tax'n Law. No. 2, 116.
Sabin, "Accounting Periods and Methods," 46 N.Y.U. Inst. on Fed. Tax'n 38.
1989
Grasso, "Depreciation deductions for short tax years: Cutting through the complexity," 43 Tax'n Acct. No. 5, 312.
Grauer, "Debunking the Myth of the Historic Supremacy of Annual Accounting for Income Taxes: A Coalescence of Non-Literal Interpretation with Original Intent Analysis," 67 Wash. U. L.Q. No. 1, 165.
Hills, "Practical Applications of the Short-Year Depreciation Rules," 67 TAXES No. 8, 544.
1990
Franklin, McBride and Storrer, "Determining Whether to Make a Section 444 Fiscal Year Election: A Present Value Analysis," 1 J. S Corp. Tax'n No. 3, 212.
1991
Johnson, "The Taxpayer's Duty of Consistency," 46 Tax L. Rev. No. 4, 537.
Lang, "Elections: Terminating Taxable Year When Title 11 Case Commences," 15 Rev. Tax'n of Individuals No. 3, 266.
1992
Hanna, "A Partnership's Business Purpose Taxable Year: A Deferral Provision Whose Time Has Passed," 45 Tax Law. No. 3, 685.
Padwe, "20 Years of Tax Accounting: A Romp Through the Alphabet Soup of Statutory (and Other) Changes," 57 Tax Notes No. 7, 931.
1993
Horvitz and Lipton, "What Constitutes a Change in Method of Accounting," 20 J. Corp. Tax'n No. 3, 265.
Plutte and Rollinson, "Proposed Regulations Issued Under Section 898," 22 Tax Mgmt. Int'l J. 243.
1995
Collins and Young, "Consolidated Returns: Section 446: A Trap for the Unwary in the Treatment of Transactions Between Members of a Consolidated Group," 22 J. Corp. Tax'n No. 1., 76.
1997
Morgan and Bayles, "Rev. Proc. Simplifies Voluntary Accounting Method Changes," 59 Tax'n for Acct. No. 1, 4.
1999
Conjura and Gibbs, "New Procedures, Broader Scope for Automatic Changes in Accounting Method," 93 J. Tax'n No. 3, 176.