Choosing the right tax year for your business is a critical decision that can impact your cash flow, tax liabilities, and overall financial planning. The IRS offers two primary options for businesses: the calendar year and the fiscal year. For most small businesses, the calendar year (January 1 to December 31) is the default, but businesses may opt for a fiscal year if it aligns better with their business cycle.
In this blog, we will explore the differences between calendar year and fiscal year tax filing options, the factors to consider when choosing the best tax year for your entity, and how businesses can make changes to their tax year if needed. For U.S. CPA firms and businesses looking to ensure compliance and optimize tax planning, partnering with experienced tax professionals like PEAK Business Consultancy Services (PEAK BCS) can simplify this process. Click here to learn more about our services.
What is a Tax Year?
A tax year is the annual accounting period used by businesses and individuals to report income and expenses to the IRS. There are two primary types of tax years:
- Calendar Year: The calendar year follows the traditional January 1 to December 31 timeframe.
- Fiscal Year: A fiscal year can begin on any day of the year but must consist of 12 consecutive months. It does not necessarily align with the calendar year.
Choosing Between a Calendar Year and a Fiscal Year
1. Calendar Year Tax Filing
The most common tax year for businesses is the calendar year. Most businesses, including sole proprietorships, partnerships, LLCs, and S corporations, default to a calendar year, meaning they file their tax returns for the period running from January 1 through December 31. This filing option simplifies financial reporting for many businesses, as it aligns with the calendar year and makes tracking income and expenses more straightforward.
2. Fiscal Year Tax Filing
In contrast, some businesses may benefit from using a fiscal year, which can end on any date other than December 31. For example, a business may choose a fiscal year that runs from July 1 to June 30 to better align with its operating cycle or business peak periods. Fiscal years are especially common in industries with seasonal operations, such as agriculture, retail, or hospitality, where profits and expenses are more consistent during certain months of the year.
Factors to Consider When Choosing Your Tax Year
Choosing the right tax year for your business depends on a variety of factors. Below are some key considerations to help guide your decision:
1. Business Cycle and Cash Flow
If your business has a peak season that differs from the calendar year, a fiscal year that aligns with that season might be beneficial. For instance, a retailer may prefer a fiscal year that ends after the busy holiday season, allowing them to report higher profits in the same year they earned them. This can smooth out cash flow and tax liabilities.
2. Industry Norms
Some industries commonly adopt fiscal years to better align with industry practices and reporting requirements. For example, tax-exempt organizations and some government entities often operate on a fiscal year basis. It’s also common in the agriculture and entertainment industries to match seasonal patterns of income and expenses.
3. Tax Planning
The timing of your tax year can affect how you manage tax deductions, credits, and the timing of revenue recognition. For instance, by selecting a fiscal year, you may be able to delay income recognition to a later tax year, reducing your overall tax burden in a given year. Alternatively, businesses may benefit from accelerating deductions or income to reduce taxes in a given year. Your tax advisor can help you determine which option provides the best strategic benefit for your business.
4. Filing Simplicity
For many small businesses, the calendar year is the easiest option. It simplifies accounting and financial reporting since it matches the business’s annual cycle of receipts and disbursements. If you are just starting out, you may prefer to stick with the calendar year to avoid the complexity of managing a different tax year.
5. IRS Approval Requirements for a Fiscal Year
While most businesses can choose a calendar year, those wishing to adopt a fiscal year must seek approval from the IRS. If you plan to change from a calendar year to a fiscal year, you must file IRS Form 1128, “Application to Adopt, Change, or Retain a Tax Year.” The IRS will review your request, and if approved, you will be allowed to file according to your fiscal year. However, certain restrictions and exceptions may apply depending on your entity type.
How to Change Your Tax Year
If you are considering changing your tax year from a calendar year to a fiscal year or vice versa, the process requires IRS approval. Here’s how to go about it:
Step 1: File Form 1128
Form 1128 must be filed with the IRS to request a change in your tax year. This form asks for details about your business, why you wish to change your tax year, and whether you have previously filed a request for a change.
Step 2: IRS Approval
The IRS will review your request, and if they approve the change, they will issue a determination letter. If your request is denied, you may need to reconsider your tax year selection or take additional steps to meet the IRS’s requirements.
Step 3: Implement the Change
If approved, the change will take effect for the first tax year that begins after the IRS approval. You will then file your tax returns based on the new tax year, following the rules and regulations specific to your fiscal year end date.
Special Considerations for Different Types of Entities
Sole Proprietors and Single-Member LLCs
Sole proprietors and single-member LLCs are generally required to use a calendar year unless they can demonstrate a business need to adopt a fiscal year. This is typically the simplest option and is the default for most small business owners.
Partnerships and Multi-Member LLCs
Partnerships and multi-member LLCs have more flexibility when it comes to selecting a tax year, but they must follow specific IRS guidelines regarding ownership interests. For example, if more than 25% of the partnership’s income is from foreign sources, special rules apply to determining the appropriate tax year.
Corporations (S and C Corporations)
Both S corporations and C corporations have more leeway in choosing a fiscal year, but they must meet specific IRS requirements and demonstrate a business need. Many larger corporations opt for a fiscal year to better align with their business operations and financial reporting needs.
Why PEAK Business Consultancy Services Is Your Ideal Partner
PEAK Business Consultancy Services (PEAK BCS) is a tax consultancy firm based in India with a wealth of experience in assisting U.S. CPA firms with tax compliance, filing, and strategy. Our team is adept at helping businesses determine the best tax year for their entity, ensuring compliance with IRS regulations and making informed decisions about fiscal year elections.
If you’re a U.S.-based CPA firm looking to streamline your clients’ tax year selection or need expert help managing tax returns under both calendar and fiscal years, click here to explore how PEAK BCS can help.
Conclusion: The Right Tax Year Can Help Maximize Your Tax Efficiency
Choosing the right tax year for your entity can have significant implications on your business’s cash flow, tax obligations, and overall financial strategy. Whether you choose a calendar year or a fiscal year depends on your business cycle, industry practices, and long-term goals. By understanding the rules and working with the right tax professionals, you can optimize your tax filing and take full advantage of your business’s financial situation.
PEAK Business Consultancy Services is your trusted partner in making tax year decisions, optimizing tax filings, and ensuring that your entity remains compliant and efficient. To get expert assistance in choosing the right tax year for your entity or to outsource your tax preparation, visit www.peakbcs.com.
