Certain partners and S corp. shareholders can spread income from short tax year.

• Author: Herndon, Diane

Rev. Proc. 2003-79 provides procedures for qualifying partners and S corporation shareholders to elect to take into account ratably over four tax years their share of income from a partnership or S corporation attributable to a short tax year ending after May 9, 2002, but before June 1, 2004. The short tax year must result from a change in tax year because the (1) partnership's or S corporation's tax year no longer qualifies as a natural business year or (2) S corporation's tax year no longer qualifies as the ownership tax year.

Background

Generally, Rev. Proc. 2002-38 grants a partnership or S corporation automatic consent to change to a natural business year or (for S corporations) to an ownership tax year. However, if a tax year no longer qualifies as a permitted tax year (e.g., ownership of the S corporation changes or the business changes such that the tax year no longer satisfies the natural-business-year requirements), the taxpayer is using an impermissible annual accounting period and should change to a permitted tax year; see Rev. Proc. 2002-38, Sections 6.05 and 6.06, and Rev. Proc. 2002-39, Section 5.04 (which provide procedures for nonautomatic accounting-period changes).

As a result of a change to a permitted tax year, a partner or S shareholder may be required to include in gross income in a single tax year income and expense items from more than one partnership or S tax year. To mitigate the potentially unfavorable consequences of a change to a permitted year, Rev. Proc. 2003-79 allows eligible partners and S shareholders to elect to spread their share of income from the resulting short tax year ratably over four tax years.

Rev. Proc. 2003-79

The procedure applies to a partner or S shareholder, if the partnership's or S corporation's change in tax year is solely the result of either:

1. The current tax year no longer qualifying as a natural business year under Rev. Proc. 2002-38 or 2002-39 (whichever is applicable); or

2. In the case of an S corporation, its current tax year no longer qualifying as an ownership tax year because a tax-exempt owner is disregarded under Rev. Proc. 2002-38, Section 5.06.

To be eligible for the spread period under Rev. Proc. 2003-79, the short tax year must end after May 9, 2002, but before June 1, 2004. As a consequence of the change in tax year to a permitted year, income and expense items (as defined in Temp. Regs. Sec. 1.702-3T(b)) from more than one partnership or S tax year would, but for...