Changing a corporation's tax year.
In many cases, a corporation's year-end change will qualify for automatic or expeditious-approval. In other cases, IRS approval will be required prior to the change.
* Automatic Approval
A year-end change will be automatically approved by the Service if the corporation is entering an affiliated group that files a consolidated return and is changing to conform to the group's year-end. In addition, a change is automatic if the corporation meets all of the following conditions:
1. The corporation has not changed its year-end in the last 10 calendar years.
2. The short year will not report an NOL.
3. Taxable income for the short year, if annualized, is at least 80% of taxable income for the full tax year preceding the short year.
4. Any "special status" held by the corporation (as a personal holding company, a corporation that is an exempt organization, a foreign corporation not engaged in a trade or business within the US., a Western Hermisphere trade corporation or a China Trade Act corporation) applies to both the short year and the preceding year. In other words, if the corporation is a tax-exempt organization in the short year, it must also be exempt in the preceding year.
5. An S election is not made in the tax year immediately after the short year.
6. The corporation is not a member of a partnership.
If a corporation meets these conditions, the tax-year change can be made by filing a statement with the return for the short period by the return's due date (including extensions). It must state that the corporation is changing its year-end pursuant to Regs. Sec. 1.442-1(c) and must indicate that these conditions are met.
* Expeditious Approval
A corporation that does not qualify for automatic approval may nevertheless qualify for expeditious approval of a year-end change. According to Rev. Proc. 92-13, for changes for which the short period ends on or after Jan. 21, 1993, the corporation must not:
1. Be eligible for an automatic change under Regs. Sec. 1.442-1(c)(2);
2. Have changed its year-end at any time within the last six calendar years (or the years of the corporation's existence, if less than six);
3. Be a member of a partnership, a beneficiary of a trust or an estate, or a shareholder of an interest-charge domestic international sales corporation (IC-DISC) or a foreign sales corporation (FSC) at the end of the short period; or
4. Be an IC-DISC or a FSC, an S corporation (or attempt to make an S election effective for the year following the short tax year), a personal service corporation or certain other organizations as specified in Rev. Proc. 92-13, or a shareholder in certain organizations specified therein.
Form 1128, Application To Adopt, Change, or Retain a Tax Year, is used to apply for expeditious approval.
One drawback of expeditious approval (as opposed to automatic approval) is that a corporation requesting expeditious approval must conform to Rev. Proc. 92-13. One significant condition is that, if the short period has an NOL in excess of $10,000, the loss generally must be amortized and deducted over a six-year period beginning with the first tax year after the short year. An exception to this general rule applies if the short period is at least nine months and the loss is less than the loss for the 12-month period beginning with the first day of the short period. If the exception applies or the loss is $10,000 or less, the normal NOL carryback and carryover rules apply.
* Corporations Not Qualifying for Expeditious or Automatic Approval
If a corporation cannot qualify for either expeditious or automatic approval, it will have to request approval from the IRS before making a year-end change. In such cases, the corporation must request the change on Form 1128, which must be filed by the 15th day of the second month after the close of the short year. Approval will generally be granted if:
1. The Service and the corporation agree to terms, conditions and adjustments incident to the change in order to prevent substantial distortion of income; and
2. A substantial business purpose for the change is proven.
Substantial distortions include the deferral of a substantial portion of income, the shifting of a substantial portion of deductions, and the creation of a short period in which there is a large NOL.
A change to a natural business year generally will qualify as a change having a substantial business purpose. An example of a corporation with a natural business year is a farm supply business with sales up in the spring, summer and autumn, and down substantially in the winter. A year-end of October 31 might be appropriate for such a business.
Impact of Change in Tax Year
The tax adviser must consider the impact of the change to a calendar tax year on Ace's capital loss carryover. The first tax year following the year ended June 30, 1998, whether it is a full tax year or a short year, will be the last opportunity for the corporation to utilize its capital loss carryover.
Consequently, unless capital gains can be generated in the short period ending Dec. 31, 1998, Ace could lose its last opportunity to use the carryover (since capital losses can be carried forward for only five tax years). Ace's tax adviser could recommend that it postpone the change in tax year until 1999, when it will have capital gains to offset the capital loss. Thus, the short period would end on Dec. 31, 1999, and the capital gains generated in the tax year ending June 30,1999 could be used to offset the capital loss carryover.
Because the short year ended Dec. 31, 1998, is expected to result in a NOL, Ace does not qualify for automatic approval of the year-end change. However, Ace qualifies for expeditious approval. Although Form 1128 will have to be filed, the year-end change can be made without prior IRS approval. However, the NOL must be amortized over six years; it cannot be utilized more quickly by means of a carryback or carryover.
As an alternative, the tax adviser could recommend Ace accelerate revenues or reduce expenses during the short period to eliminate the NOL. If the NOL in the short period can be eliminated, Ace can qualify for automatic approval if the annualized short-period taxable income is at least 80% of the taxable income of the full year preceding the short year.
If capital gains sufficient to offset the capital loss carryover cannot be generated in the short period ending Dec. 31, 1998, the practitioner should recommend that the year-end change be postponed and that the short period end on Dec. 31, 1999, so the corporation can use its capital loss carryover.
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|Title Annotation:||case study|
|Author:||Ellentuck, Albert B.|
|Publication:||The Tax Adviser|
|Date:||May 1, 1998|
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