Adopting, retaining and changing accounting periods.

• Author: O'Connell, Frank J., Jr.

The IRS issued proposed regulations and revenue procedures updating the requirements to adopt, change or retain annual accounting periods under Secs. 441, 442, 706 and 1378. Superseding Rev. Procs. 85-16, 74-33 and 87-32, Notices 2001-34 and 2001-35 provide procedures under Sec. 442 for taxpayers establishing a business purpose and requesting approval of accounting-period changes. The Service requires such approval when a taxpayer wants to maintain a tax year other than that required by the Code and regulations. Secs. 441, 706 and 1378 describe the required tax years of personal service corporations (PSCs), partnerships and S corporations, respectively.

Required Tax Years under Current Law

Sec. 441(b) provides generally that a taxpayer's tax year must coincide with its annual accounting period if the year is a calendar or a fiscal year, or with the calendar year, if the taxpayer was to maintain no books or have no annual accounting period or an annual accounting period that would not qualify as a fiscal year. Under Sec. 441(e), a fiscal year is a 12-month period, ending on the last day of any month except December 31, or a 52-to-53-week year for which the taxpayer elected to determine taxable income.

Under Sec. 441(i)(2), a PSC's required tax year is the calendar year, unless the corporation establishes, with IRS approval, a business purpose for maintaining a different tax year. Under Sec. 706(b)(1)(B), the majority interest's tax year, the principal partner's tax year or the calendar year, determine a partnership's tax year unless regulations provide otherwise. Under Sec. 706(b)(1)(C), a partnership might also maintain a different tax year if it establishes a business purpose for such year and obtains IRS approval. Sec. 1378 requires an S corporation to maintain as its tax year the calendar year ending on December 31 of each year, or any other accounting period for which the corporation established a business purpose with IRS approval.

While PSCs, partnerships and S corporations are subject to different tax-year requirements, each can establish a business purpose for maintaining a tax year different from that otherwise required. Regs. Sec. 1.442-1(b) and Rev. Procs. 85-16, 74-33 and 87-32 provide guidance for establishing such business purpose.

Current Rules for Changing Accounting Periods

Taxpayers wishing to change to a tax year based on business purpose, but not qualifying under Rev. Proc. 87-32 for automatic approval of such change...