When you start a business, you might be faced with deciding how to set up your tax year for your business. Should your accounting period be aligned with the regular calendar year (as you’ve probably been accustomed to with your personal taxes) or should you define your own start and end dates for reporting your tax year?
Who Can Change Their Tax Year?
Before we wade into the nuances of choosing a tax year, it’s important to realize that not every type of business has the flexibility to pick their tax year. For example, sole proprietors don’t exist apart from their owner, and therefore they need to use the calendar tax year (like the owner’s personal tax return). Likewise, partnerships and LLCs typically need to use the same tax year as the majority of the owners. And generally speaking, S Corporations need to follow a calendar tax year.
In the cases above, if you want your business to adopt a different fiscal year, you’ll have to petition the IRS for special permission. The burden will be on you to convince the IRS that you have a real business purpose for using a different tax year.
For this reason, the C Corporation offers the most flexibility in terms of choosing between calendar year and fiscal year. Many accountants will advise their clients to opt for a C Corp if using a fiscal tax year is critical.
What’s the Advantage of Fiscal Year Reporting?
A fiscal tax year is a 12 month-period beginning on a date other than January 1. Calendar tax year reporting is very simple, and you get to follow the same schedule as your personal taxes. So, why would a business want to complicate things by using a different reporting schedule?
The key reason to switch from a calendar year is to better match your business’ income and expenses for the reportable tax year. For example, maybe you have a seasonal business where the bulk of expenses are in the fourth quarter and your income is made in the first quarter. A regular tax calendar would split these times, so your expenses for the season wouldn’t be matched up with the income.
Another example is with companies who seek crowdsourced funding from sites like Kickstarter. For example, let’s say your business received its Kickstarter funds in November (and these funds are taxed as income), but you’re not going to start the project and incur expenses until February. With calendar tax year reporting, you’d have unusually high income for the first year that wouldn’t be offset by expenses. In this case, you might opt to form a C Corp and choose a fiscal year of Nov. 1 – Oct. 31.
How Do You Change Your Reporting Calendar?
If you’ve already filed a tax year for your business, but would like to change your schedule, you’ll need to file IRS Form 1128, Application to Adopt, Change, or Retain a Tax Year.
It’s an important decision, deciding when your business year will begin and end. Weigh all the benefits of each type and make the decision that’s right for your company.
Editor’s note: This was originally written by Nellie Akalp for Small Business Trends.