Benefiting from a fiscal tax year.

• Author: Ellentuck, Albert B.

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Corporations eligible to use a fiscal year should consider it, since preparing tax returns and financial reports outside an external accountant's peak times may save professional fees. Corporations should also consider their own staff workload when selecting a fiscal year to minimize overtime associated with the year-end closing and preparation of financial statements.

Note: Changing to a fiscal year generally requires IRS approval. However, corporations can adopt a fiscal year at formation without IRS approval. Therefore, tax advisers should look carefully at the decision of whether to use a fiscal tax year when a corporation is formed.

Use of a fiscal or a 52-53-week tax year may provide a significant tax planning opportunity for a C corporation and its shareholders. For example, if a corporation has a January 31 year end and its shareholders each have a December 31 year end, payments such as interest on shareholder loans and bonuses to shareholders can be made late in the corporation's tax year but prior to January 31. The corporation can deduct these payments on its January 31 tax return; however, the shareholders do not have to report the income until they file their calendar-year returns, creating an 11-month deferral of tax (although income tax withholding or estimated tax payments on the bonuses or interest may offset at least some of this benefit). However, the related-party rules under Sec. 267 may act to limit the ability of the controlling shareholders and the corporation to manipulate the timing of deductions and related income.

Because most businesses tend to have fluctuations in taxable income from year to year, the use of a fiscal year can provide a leveling effect by shifting income between tax years. Salary payments from the fiscal-year corporation to the calendar-year employee-shareholders can be postponed or accelerated to offset the natural fluctuations in business income from year to year. The use of a fiscal year can also result in deferral of the taxation of earnings, to the extent that deductible payments (compensation, rent, interest) are issued from the corporation to individual stockholders after December 31.

Example: T owns C, a C corporation that reports on a January 31 fiscal year end. (C operates a distributorship and so is not a personal service corporation required to use a calendar year.) C has historically averaged $100,000 of business net income, and T has annually drawn a salary...