How to Choose the Right Tax Year for Your Small Business

Do you know which tax year is right for your business? Should you report your income and expenses on a calendar year or a fiscal year?

One of the biggest mistakes small business owners make during the start-up phase is overlooking and/or misunderstanding their tax obligations. Knowing which tax year to operate within is one of them.

What is a tax year? Every small business owner must figure out their taxable income based on an accounting period called a tax year—the most common being the calendar year, but businesses can also report based on fiscal years and a short tax year.

Operating your business according to a consistent tax year is required by law but how do you determine which tax year is right for your small business?  Below are some tips for finding the right tax year for your business.

Know Your Tax Calendar Options

When it comes to consistently reporting annual income and expenses to the IRS, small businesses have two choices:

a)        Calendar Year

Running from January 1 to December 31, the calendar year is adopted by most small businesses as their tax year simply because it is easy and intuitive.

Who Should Use the Calendar Year Method? Using the calendar year reporting method is generally determined by your business structure:

• If you are a sole proprietor you must use the same tax year as your personal taxes—this is typically a calendar year.
• If you operate a partnership or LLC, you must generally use the same tax year as the majority of its owners.
• An S corporation or a personal service corporation must generally use a calendar year.

Read more about the tax implications of your business structure.

b)       Fiscal Year

A fiscal year is 12 consecutive months ending on the last day of any month other than December 31.  

Who Should Use the Fiscal Year Method? Many large corporations operate on a fiscal year basis and have the accounting expertise to keep everything reconciled. For small business owners, a calendar year is easier to manage, but there are exceptions for which it makes sense to go with a fiscal year. If you operate a seasonal business, for example, reporting income according to a calendar year could split your season and provide a distorted view of income and expenses. Similarly, if your business incurs most of its expenses and receipts in different years, it may be best to select a fiscal accounting period that includes both years.

What about Short Tax Years?

Short tax years (less than 12 months) apply to businesses that didn’t exist for the entire tax year or that changed their accounting period during the year.

Been in Business for Less than a 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 figuring the tax 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.

How to Change Your Tax Year

Remember, you must use your chosen tax year method for your first business tax return and for all subsequent future returns. If you need to change your tax year, for example if you change your business  structure, you will need to file IRS Form 1128, Application to Adopt, Change, or Retain a Tax Year and show that there is a legitimate reason for the change.

Useful Links

• SBA Small Business Tax Guide
• IRS Starting a Business Tax Guide

Related Articles

• Ultimate Guide to Business Taxes
• Reporting Business Income and Expenses: Which Accounting Method is Right for You?
• Making Estimated Tax Payments: A 101 for the Small Business Owner
• Cash vs Accrual Accounting for Taxable Income and Expenses

About the Author

Caron Beesley is a small business owner, a writer, and marketing communications consultant. Caron works with the SBA.gov team to promote essential government resources that help entrepreneurs and small business owners start-up, grow and succeed. Follow Caron on Twitter: @caronbeesley