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Determine When the Tax Year Starts
A tax year is an accounting period for which you must report your taxable income and business expenses. The law requires you to operate according to a consistent tax year. The most common is to follow a calendar year. However, businesses can also report based on a fiscal tax year (any 12-month period ending on the last day of any month, except December) and a short tax year.
Here are some guidelines for choosing the right tax year for your small business.
Calendar Tax Year
This is a standard method used by many business owners and is determined by your business structure. For example, sole proprietors, partnerships, and LLCs generally adhere to a calendar tax year. As a rule, if any of the following apply, the IRS requires that you must 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
If you file your first tax return using the calendar tax year and you later begin business as a sole proprietor, become a partner in a partnership, or become a shareholder in an S corporation, you must continue to use the calendar year unless you get IRS approval to change it or meet one of the exceptions listed in the instructions to Form 1128, Application To Adopt, Change, or Retain a Tax Year.
Fiscal Tax Year
Many corporations and larger firms operate on a fiscal tax year basis. 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, you may want to consider a fiscal tax year so that both periods are included in the same 12-month set.
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.
Even if you (a taxable entity) were not in existence for the entire year, a tax return is required 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.
Changing Your 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.