Choosing an Annual Year For Small Businesses
Choosing a tax year for your business affects your decision on filing taxes and may have severe repercussions if you miss the deadline. A poor decision can also lead to exponentially higher tax bills. You will want to choose a filing date that works best with your business cycle and income fluctuation.
A tax year for your business becomes essential when your business starts to turn a profit. It is crucial to be aware of the tax implications of filing taxes in different fiscal years.
If you are a beginner and have little to no knowledge of tax year, keep reading to familiarize yourself with the basics.
What is a tax year?
A tax year is a 12-month consecutive accounting period that a company conducts business. Most people are familiar with an end date of December 31st, which follows a calendar year of January 1st through December 31st. However, a company can change its 12-month period to form a unique business year.
As a business owner, it’s best to determine your tax year from the beginning. Doing so will eliminate the hassle of requesting a change from the IRS. Once you’ve chosen your consecutive 12-month tax year, you must continuously file your taxes with the fiscal year selected or apply for an automatic approval request. Note, any change must get permission from the IRS.
There are typically two types of tax years with an additional exception: Calendar Year, Fiscal Year, and Short Year (exception).
What is a Calendar Year?
A calendar year is a 12 month accounting period beginning from January 1 to December 31. Not surprisingly, this type of tax year is used by most small businesses. A calendar year is the most straightforward tax year you can choose. It aligns with an individual tax return, making it easier to file as a Sole Proprietor, LLC, Partnership, or other entity.
Anyone can adopt the calendar year; however, the IRS mandates some businesses to choose it as their tax year. For example, businesses that don’t have bookkeeping or records of their business transactions cannot select a fiscal year. The same goes for a company that does not have an annual accounting period. In addition, any business that requested tax years that don’t qualify for a fiscal year or violates the provisions set by law must follow the Jan 1st – Dec 31st tax year.
What is a Fiscal Year (FY)?
This tax year is also known as an accounting year, tax period, or accounting period. It is a 12-month interval designated by your business for keeping its books and reporting to the federal government on how much money it made over that year.
Many new businesses commonly ask “what does FY in business mean?”
Most companies refer to the fiscal year as FY followed by the year. For example, you may have heard of budget costs for FY20, or expenses for FY21, or forecasting projections for FY22, and so forth.
A Fiscal year can end the last day of the month, like February 28th, or on the same day at the end of the month every year. Such as every last Saturday of February.
What is a 52-53 week?
A 52-53 week is an elected fiscal year to end on the last day of a chosen weekday of the month. Like the previous example, if a business wants to select an end date of “the last Sunday of September” instead of September 30th, it can. 52-53 weeks may cause a tax year to end on the 52nd or 53rd week of the year.
What is a short-year tax?
A short year refers to its given name. It is a tax year that is less than 12 months. A short year usually happens if a business formed mid-year, shut down before the year ends, or changes its accounting period. Neither which way, you must file a tax return on the short year.
Let’s look at some examples.
Suppose you are a new business owner who started your business on April 7th; A short tax year may be necessary as your business started mid-year. Now suppose you are adopting the calendar year moving forward. When you file your business return, it will be from April 7th to December 31st. Once the new year begins, you’ll be able to adopt the January 1st to December 31st tax year.
Now, let’s say you’re an established entity that decided to switch your accounting period. You want to adopt a new fiscal year from your original Oct 1st -Sept 30th year-end to a July 1st through June 30th year-end. Once the switch is complete, you’ll file a short tax year from October 1st to June 30th. Then, moving forward, you’ll be able to file a July 1st – June 30th return.
What is the difference between the Calendar year and Fiscal year?
Both Calendar and Fiscal year serve the same purpose: to keep records of your company’s income and expenses. However, there are a few differences. For starters, a Sole Proprietor, LLC, or C corporation with a calendar year must file its tax return by the following year on April 15th. However, with a fiscal year, the deadline to file a tax return is the 15th of the fourth month after the end date of the fiscal year.
A Partnership or an S corporation’s deadline for a calendar year is March 15th. However, the deadline for a fiscal year for Partnerships and S-corps is the 15th day of the third month.
For example, if an LLC’s fiscal year ends September 30th 2021, the deadline to file taxes is January 15th 2022. But for an S corp, the deadline is December 15th 2021. Do note that; IRS can extend filing deadlines if the business files an extension.
Another difference is, of course, the tax year itself. A fiscal year can be set for the last day of any month except for December. In contrast, a calendar year can only end on December 31st, imitating an actual full year.
Last but not least, a fiscal year can elect a 52-53 week; however, a calendar year cannot.
What is the most common Fiscal year?
Other than the infamous calendar year, the most common fiscal year depends on the type of business. Government agencies mainly operate on an October 1st to September 30th fiscal year. But a non-profit organization, on the other hand, commonly has a July 1st through June 30th year-end. If a business is in retail, it will often have a tax year of February 1st through January 31st.
Why would a company choose a Fiscal year?
There are many reasons why a company would choose to use a fiscal year rather than a calendar year. Some businesses are seasoned based, where most of their revenue is realized in the fourth quarter. For example, retailers are most busy during the holiday season starting from October or November and typically slow down by mid to end of January.
Here are a few reasons why a business would choose a fiscal year below:
Flexible with business needs
Since a fiscal year doesn’t have to end on December 31, it can be set to meet your company’s specific needs. For example, if you are an entertainment company that does most sales within the second half of the year, setting up a fiscal year to end in July might make more sense.
A shift in market trends
Several retail companies started using a November/December fiscal year because this is usually the best time to capture the holiday market. It helps plan for the fourth quarter and allows retailers to take advantage of the shift in market trends.
Reporting obligations and tax benefits
The benefit of using a fiscal year allows you to better match your company’s income and expenses with the tax reporting periods. It will enable you to save money and accurately track taxable income when filing taxes.
Pro Advice: A company cannot “Adopt or Change” a fiscal year simply for tax benefits or reducing tax liability ONLY. A reasonable cause should be the primary basis of the change. For example, e-commerce, whose revenue is mostly incurred during the holiday season, would most likely qualify to have a fiscal year of February 1st to Janurary 31st. Otherwise, if a valid or reasonable explanation of the change is not given, the IRS may reject your request and require adopting the calendar year.
How Do I Change My Company’s Fiscal Year or Tax Year?
To change your business’ fiscal year, you must file a specific form with the IRS. Keep in mind that this is not a one-time process, and you are required to complete the form every year for which you are using a fiscal year.
See steps below:
- First, determine your fiscal year. Take your busiest quarter into consideration to accurately report your income and expenses for your business tax year. Remember, the end date usually falls on the last day of the month unless you have a 52-53 week fiscal year. This means that choosing a date in the middle of the month is not an option but rather maybe the last Saturday in September instead of September 30th.
- Once you have determined which tax period applies to you, hire an Accountant like myself to guide you through the change or go to the IRS website and file Form 1128 (Application to Adopt, Change, or Retain a Tax Year)
- After submission, your application will be reviewed and processed. It usually takes about 45 days. Once approved, you will receive your new tax period in the mail.
Choosing the correct tax year for your business is not an easy task. It includes careful consideration as well as research on market trends.
The most straightforward tax year is a calendar year. Sole Proprietors and LLC’s widely use it. This tax year aligns with an individual’s tax return of January 1st through December 31st.
The type of business can determine a Business’s fiscal year. For example, Government agencies usually adopt the October 1st through Septemeber 30th year. To apply for a fiscal year, you must determine which tax year best fit your business and fill out form 1128. If you need help changing or choosing a tax year, it’s best to speak with an Accountant.