Tax Guru – Ker$tetter Letter

Helping real people win the tax game.

Allowable S Corp Tax Years

Posted by taxguru on July 26, 2012

Q:

Subject: S Corporation

Hello, I was doing some research on S corporations and came across your website through a Google search. You noted several times that a disadvantage of electing S corp status is that you must use a calendar year-end. Can you please provide a reference citing this requirement? IRS Form 2553 specifically allows the corporation to select a tax year, whether it be calendar year or fiscal year, so I’m curious to see what you are referencing.

Regards,

 

A:

Until the mid-1980s, an S corp was allowed to have a fiscal year ending at the end of any month, just as with C corps.  Then there was a new law or regulation passed that required all S corps to switch to a December 31 tax year.  I can remember having to do a lot of short year 1120S returns to make this transition for clients’ S corps.

Basically, the reason for the requirement was to keep the S corp tax year in sync with the tax year of its owners.  If a majority of the owners have a different tax year, that is justification for using a similar tax year for their S corp. Since almost all individuals have a calendar tax year, S corps they own are required to use that same tax year.

Here is The Code section dealing with this:

§ 1378(a) General rule
For purposes of this subtitle, the taxable year of an S corporation shall be a permitted year.

§ 1378(b) Permitted year defined
For purposes of this section, the term “permitted year” means a taxable year which—

§ 1378(b)(1) is a year ending December 31, or

§ 1378(b)(2) is any other accounting period for which the corporation establishes a business purpose to the satisfaction of the Secretary.

For purposes of paragraph (2), any deferral of income to shareholders shall not be treated as a business purpose.

Here is the applicable section on Page 1 of the instructions for Form 2553:

7. It has or will adopt or change to one of the following
tax years.
a. A tax year ending December 31.
b. A natural business year.
c. An ownership tax year.
d. A tax year elected under section 444.
e. A 52-53-week tax year ending with reference to a year
listed above.
f. Any other tax year (including a 52-53-week tax year)
for which the corporation establishes a business purpose.

While they do mention using a different year, in practical application, this is rarely granted by IRS except in cases where the shareholders also have a non-calendar tax year.  When the S corp has a different tax year than its owners, it makes it more complicated for IRS to match things up between them, which is why they don’t like it.

If you feel you have a good case for using a non calendar tax year for your S corp, you can try to convince IRS to allow it.  I seriously doubt it will be granted; but I would be interested in hearing about your results with this request.

I hope this helps you understand the rules regarding S corp tax years.

Good luck

Kerry Kerstetter

 

 

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