A fiscal year may minimize workload compression and cashflow concerns for proprietorships. For example, an internal bookkeeping function may be better performed without the pressure to simultaneously prepare payroll tax and information returns, or a retail operation may find a year-end that does not coincide with the busiest shopping time of the year to be desirable. A fiscal year may also better match the proprietor's liquidity with required estimated tax payment dates. Under Sec. 706(b) majority or principal partner rules, a fiscal-year individual may be able to favorably influence the required tax years of a partnership in which he is an owner. Minority or nonprincipal partners may therefore be able to defer income by admitting a fiscal-year individual as the majority partner or the sole principal partner. Because a partner cannot (without the Service's consent) change from a calendar to a fiscal year to affect the partnership's required tax year, the fiscal-year individual must have adopted his tax year before being admitted to the partnership (which would generally require adoption on the individual's initial tax filing). The opportunity to select a fiscal year on the first tax return filed by an individual will likely be lost unless a parent or a tax adviser suggests it as an option for a young person filing his first return. The decision to elect a fiscal year should not be made without considering the requirements to maintain accounting records on a fiscal-year basis and to later (if desired) change to a calendar year.
Sec. 441(c) defines an annual accounting period to be the period for which an individual regularly computes his income in keeping his books. Because the law does not require individuals to maintain books and records, it may be difficult to demonstrate that the books have been maintained for the fiscal year. Letter Ruling (TAM) 7844042 stated "... record keeping or bookkeeping is understood as the recording of transactions of a taxpayer or business in books of account. Informal notes or records, such as a summary of account income and expense, salary statements, checks stubs, and expense receipts do not constitute books." Sec. 441(g) mandates a calendar year for any taxpayer who fails to maintain books. The fiscal-year individual (or a parent responsible for tax filings of a fiscal-year minor) must recognize the need to maintain books and records more detailed than those of a typical taxpayer.
In Brooks, 6 TC 504 (1946), a chronological record of income and expenses converted by the taxpayer's accountant into a summary "ledger" was held to not constitute books and records, because there was no book to record dividend and interest receipts, cost and acquisition dates of rental real estate property, and improvements or depreciation thereon. The accountant's ledger did not cure these defects, because it was always in the accountant's possession and was not used for any purpose. In Rev. Proc. 92-13, the IRS interpreted Sec. 441(c) to require conformity of the book year-end and the taxpayer's financial statement year-end. Thus, the fiscal-year taxpayer should use a personal financial planning software package to maintain records on a fiscal-year basis and should provide only fiscal-year records to creditors or other interested parties.
If the fiscal-year individual later desires to change to a calendar year, it is generally possible to do so by filing Form 1128, Application to Adopt, Change, or Retain a Tax Year, which the taxpayer may assume to be approved unless the Service informs him otherwise (Rev. Proc. 66-50). However, if the individual reports income from a flowthrough entity, or operates a proprietorship, Regs. Sec. 1.442-1 (b)(1) requires that permission to change be obtained from the IRS.
If the fiscal-year individual later marries a calendar-year individual, a joint return cannot be filed unless the spouses have the same year-end. Regs. Sec. 1.442-1(e) will allow the spouses to automatically change to the same tax year, provided the spouse who changes tax year files a short-period return that includes a statement that the year-end is being changed. This short-period return is due by the fifteenth day of the fourth month following the end of the short year. If the couple is not married by the due date of the short-period return, they must wait until the end of the tax year following the marriage to file a joint return.
Example: Husband H has a January 31 fiscal year-end and wife W has a calendar year-end. H and W married on Aug. 15, 1999. If the couple files on H's fiscal year, they must wait until the year following the wedding to file jointly, because W's short-period return for Jan. 1-Jan. 31, 1999 was due on May 15, 1999, which preceded the wedding date. Their first joint return would be for the period Feb. 1,2000-Jan. 31, 2001. W47 would then file a separate return for calendar 1999 and a short-period return for the period Jan. 1-Jan. 31,2000. If the wedding instead occurred on May 7, 1999 (prior to the due date of W's short-period 1999 return), H and W could have filed a joint return for the period Feb. 1, 1999-Jan. 31, 2000. In either case, W must itemize for the short period and must prorate her personal exemption. The tax is computed by annualizing the short-period income; all withholdings for the calendar year of the change are reported on the return for the last tax year that begins within that calendar year. Thus, for a May 7 wedding, W's 1999 withholdings (including those in January) will all be reported on the joint return for the period Feb. 1, 1999-Jan. 31,2000.
Parents with minor children might consider adopting a fiscal year for those children on their first tax returns. A fiscal year may later prove helpful if a child becomes a majority or principal partner in a partnership and, in some cases, if a business is operated as a proprietorship. The growth in limited liability companies as operating business entities may increase the opportunities to favorably use a fiscal year. The decision should not be made without considering the need to maintain books and records consistent with the fiscal year and an "exit strategy" if the child later prefers a calendar year or must conform tax years with a spouse so that a joint return may be filed.
FROM JAMES R. HAMILL, CPA, PH.D., UNIVERSITY OF NEW MEXICO, ALBUQUERQUE, NM, AND MAGGIE ZAHM, CPA, ROGOFF ERICKSON DIAMOND & WALKER LLP, ALBUQUERQUE, NM (NOT ASSOCIATED WITH DFK INTERNATIONAL)
Philip E. Moore, CPA, MBA Brown, Dakes & Wannall, P.C. DFK International Fairfax, VA
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|Title Annotation:||accounting periods|
|Publication:||The Tax Adviser|
|Date:||Oct 1, 1999|
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