Calendar or Fiscal? Which Tax Year is Right for your Small Business?
by Caron_Beesley, Community Moderator
- Created: January 7, 2013, 7:51 am
- Updated: January 7, 2013, 7:51 am
Did you start a business last year? No? Are you planning to start one this year? Did you know you can choose the tax year you intend to operate under? Choose well, because there are pros and cons for either method.
A tax year is an accounting period for which you must report your taxable income and business expenses, and the law requires you to operate according to a consistent tax year. The most common is the most obvious: the calendar year. However, businesses can also report based on a fiscal tax year and a short tax year.
Here are some tips for choosing the right period for your small business.
1. Calendar Tax Year
This is a simple and intuitive method adopted by many small business owners, requiring you to track and report income and expenses to the IRS much like individual tax payers do: on an annual basis from January 1 to December 31.
Whether you should use this method is typically determined by how your business is legally structured. For example, if you are a sole proprietor, there is no separation of your business and personal taxes, so a calendar year method is typically required. Likewise, business partnerships or limited liability companies (LLCs) also will generally use the same tax year most business owner(s). S corporations and personal service corporations will also use a calendar year in most cases.
- Generally, anyone can adopt the calendar year. However, if any of the following apply, the IRS requires you to adopt the calendar year:
- You keep no books or records
- You have no annual accounting period
- Your present tax year does not qualify as a fiscal year
- You are required to use a calendar year by a provision of the Internal Revenue Code or the Income Tax Regulations
Read more about the tax implications of your business structure.
2. Fiscal Tax Year
Many corporations and larger firms operate on a fiscal tax year basis – a period of 12 consecutive months ending on the last day of any month that isn’t December. For small businesses that might not have the accounting expertise on-hand to keep everything reconciled, a calendar tax year is easier to manage. But there are exceptions where it may make sense to consider a fiscal year. For example, if you operate a seasonal business, reporting income by calendar year could split your season and give a distorted view of income and expenses.
Likewise, if your business shows most of its expenses in one year and income in another, it may be worth looking into a fiscal tax year so that both periods are included in the same 12-month set.
3. Short Tax Year
Technically, a short tax year (less than 12 months) is not an annual accounting period; instead, it applies to businesses that didn’t exist for the entire tax year or those that changed their tax year period during the year.
If you started your business any time during the tax year, you still need to file a tax return for the time you were in existence. Requirements for filing the return and calculating tax owed are generally the same as the requirements for a return for a full tax year (12 months) ending on the last day of the short tax year.
Can You Change a Tax Year?
Once you’ve adopted a tax year, you may need to get IRS approval to change it. Typically, businesses that change their legal structure may wish to shift from a calendar year to a fiscal year method. In these cases, you will need to file Form 1128, Application to Adopt, Change, or Retain a Tax Year.
Read more from the IRS about Tax Years.
- SBA Guide to Filing and Paying Small Business Taxes
- The IRS Small Business Tax Calendar - A Handy Tax Planning Tool for All Business Owners
- 5 Essential Online Tax Tools for Small Business Owners from IRS.gov
- How to Choose a Tax Professional for Your Small Business
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