If you’ve recently started a business, you may be wondering how to choose a fiscal year. Should it be the same as the calendar year or go from, say, June 1-May 31? And how will that choice affect your small business taxes and accounting strategy as your grow?
Don’t take these questions lightly—it’s important to make the right decision the first time because it is difficult to change your fiscal year down the road.
Fiscal Year vs. Calendar Year
Before we go into which tax year is right for your business, the definition of fiscal year (from our glossary of accounting terms that every entrepreneur should know) provides useful context:
“Your fiscal year is the timeline that you budget your annual finances for. This may or may not start and stop at the same time as a calendar year (January 1- December 31). Say your fiscal year is June 1 – May 31, what you spend on August 18, 2015, will be part of your 2016 fiscal year.”
Your fiscal year is the 12-month period that encompasses your business’s annual finances. This may very well be the same as the standard calendar year, but often when you hear the term fiscal year it’s referring to a 12-month timeline that ends on a last day of any month other than December.
Why your business might be required to use the calendar year:
There’s a reason most businesses choose to be on the normal calendar tax year: It is much simpler. This is especially true for smaller businesses that don’t have the accounting expertise or bandwidth to keep track of adjusted deadlines.
The IRS requires you to use the calendar year for your small business taxes if the following apply to you:
- You don’t have bookkeeping records (yet)
- You don’t have an annual accounting period (yet)
- You are following a code of tax regulation that requires the calendar year
The IRS also requires certain entity types use the regular calendar year. Flow-through (aka pass-through) business entities are closely tied to their owners, and their respective tax calendar(s). Because individuals typically use the calendar year as their fiscal year, so do these entities. Flow-through entities include:
- Sole proprietors and partnerships
- LLCs (limited liability companies)
- S corporations
So, the majority of companies using a different fiscal year are C corporations. However, the IRS has been known to make exceptions if an LLC or S corporation can provide a justifiable reason to use anything other than a calendar year. (Sorry, no exceptions for sole proprietors.)
Reasons to use a different fiscal year for your business taxes:
Using a fiscal tax year other than the calendar year can complicate your bookkeeping and taxes. It typically requires support from experienced accounting and bookkeeping professionals. That being said, taxpayers that have the resources can find an alternative fiscal year beneficial under certain circumstances that revolve around their unique business activities.
Some–typically larger, public–businesses that have an annual event or period that brings in big income or incurs large expenses will wait until those are reconciled to close their books for the year. These events can be anything from industry trends to major annual events, but are commonly based on seasonality.
A tax firm, for example, might use May 31 as their fiscal year-end because the majority of their work wraps up on April 15 and it takes them another five or six weeks to collect all payments from their customers.
Companies that rely on holiday sales that would normally cross through the calendar year can benefit from adjusting their fiscal year. For example, if you’re a small gift wrapping shop or a family snow resort, your business is going to be much bigger during the holiday season and will likely spill into the new year.
In addition to full-length fiscal/calendar years, some businesses (taxable entities) that only exist for a short-term during each year due to seasonality or ending the business altogether can use a short tax year. In this case, the business is only responsible for filing a tax return for the time they conduct business that year. To use another seasonal/holiday example, this could be useful for a Halloween costume pop-up shop that only exists between August and November each year and might have a short tax year that ends on November 31.
You know what they say, “It’s Tax O’Clock somewhere!”
As you can imagine, your business’s fiscal year can affect your annual tax filing in a few different ways. In case you haven’t heard, the IRS is a stickler for deadlines and dates. It’s for good reason, though: They want to ensure they are tracking how revenue moves through the economy during a given period of time.
That being said, finding your deadline for paying and filing your federal taxes (or filing for an extension) is pretty simple based on your fiscal year and type of entity. You can use basic addition or subtraction to determine how the date shifts as you change your fiscal year end. But don’t worry about grabbing your calculator, we’ve done the math for you:
Psst! As a rule of thumb, most business that change their fiscal year keep their end dates aligned with the start and end of a typical business quarter: March 31, June 30, September 30, (and December 31)
Changing your business’s fiscal tax year
If you’ve determined that adopting an alternative fiscal tax year is going to be best for your small business, you’ll need to take the appropriate steps to make this change official.
The first step is letting the IRS know. This is pretty straightforward for C corporations; file Form 1128, which is typically auto-approved. S corporations and other flow-through entities that already have a required tax year will use Form 8716 to request permission and demonstrate a valid case for the change.
In addition to filing the correct paperwork, you will need to plan your accounting and tax calendar with the proper adjustments. The other accounting and tax responsibilities tend to be very specific to each type of business. It’s best to have an experienced bookkeeper or accountant on your side to identify what dates to be aware of and create policies around your company’s custom tax strategy to make a switch like this as easy as possible.
Sources:
https://www.irs.gov/Businesses/Small-Businesses-&-Self-Employed/Tax-Years, http://www.inc.com/guides/2010/06/choosing-a-calendar-or-fiscal-year.html
