SECTION 5. DEFINITIONS

The following definitions apply solely for purposes of this revenue procedure:

.01 Electing S Corporations. “ Electing S corporations” are corporations attempting to make an S election for the short pe

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riod described in section 6.02 of this revenue procedure. See Rev. Proc. 2000–11, 2000–3 I.R.B. 309, for procedures for automatic approval to change an annual accounting period by corporations attempting to make an S election for the taxable year immediately following the short period.

.02 Required Taxable Year. The “required taxable year” is the taxable year determined under § 706(b) in the case of a partnership, § 1378 in the case of an S corporation or an electing S corporation, or § 441(i) in the case of a PSC, without taking into account any taxable year that is allowable by reason of a business purpose (including a grandfathered fiscal year) or a § 444 election.

.03 Permitted Taxable Year . A “permitted taxable year” is the required taxable year, a natural business year, the ownership taxable year, a § 444 taxable year, or any other taxable year for which the taxpayer establishes a business purpose to the satisfaction of the Commissioner.

.04 Natural Business Year . A partnership, S corporation, electing S corporation, or PSC establishes a “natural business year” under this revenue procedure by satisfying the following “25-percent gross receipts test”:

2001–XX. For this purpose, under principles similar to § 1.706–3T for determining the taxable year of a partnership, a shareholder that is tax-exempt under § 501(a) is disregarded if such shareholder is not subject to tax on any income attributable to the S corporation.

.06 Grandfathered Fiscal Year . A grandfathered fiscal year is a fiscal year (other than a year that resulted in a threemonth or less deferral of income) that a partnership or an S corporation received permission to use on or after July 1, 1974, by a letter ruling ( i.e., not by automatic approval).

.07 First Effective Year . The first effective year is the first taxable year for which an adoption, change, or retention in annual accounting period is effective. Thus, in the case of a change, the first effective year is the short period required to effect the change.

.08 Short Period . In the case of a change in annual accounting period, a taxpayer’s short period is the period beginning with the day following the close of the old taxable year and ending with the day preceding the first day of the new taxable year.

.09 Field Office, Area Office, Director . The terms “field office,” “area office,” and “director” have the same meaning as those terms have in Rev. Proc. 2001–1, 2001–1 I.R.B 1 (or any successor). .10 Under Examination .

(a) Except as provided in section 5.10(2) of this revenue procedure, an examination of a taxpayer with respect to a federal income tax return begins on the date the taxpayer is contacted in any manner by a representative of the Service for the purpose of scheduling any type of examination of the return. An examination ends:

(i) in a case in which the Service accepts the return as filed, on the date of the “no change” letter sent to the taxpayer;

(ii) in a fully agreed case, on the earliest of the date the taxpayer executes a waiver of restrictions on assessment or acceptance of overassessment (for example, Form 870, 4549, or 4605), the date the taxpayer makes a payment of tax that equals or exceeds the proposed deficiency, or the date of the “closing” letter (for example, Letter 891 or 987) sent to the taxpayer; or

(1) Prior three years gross receipts .

(a) Gross receipts from sales and services for the most recent 12-month period that ends with the last month of the requested annual accounting period are totaled and then divided into the amount of gross receipts from sales and services for the last two months of this 12-month period.

(b) The same computation as in (1)(a) above is made for the two preceding 12-month periods ending with the last month of the requested annual accounting period.

(2) Natural business year . (a) If each of the three results described in (1) equals or exceeds 25 percent, then the requested annual accounting period is deemed to be the taxpayer’s natural business year.

(b) Notwithstanding paragraph (2)(a), if the taxpayer qualifies under (2)(a) for more than one natural business year, the taxable year producing the highest average of the three percentages (rounded to 1/100 of a percent) described in (1) is the taxpayer’s natural business year.

(3) Special rules . (a) To apply the 25-percent gross receipts test described in (1) for any particular year, the taxpayer must compute its gross receipts under the method of accounting used to prepare its federal income tax returns for such taxable year.

(b) Regardless of the taxpayer’s method of accounting, the taxpayer’s allocable share of income from a passthrough entity ( e.g., an estate, common trust fund (as defined in § 584), controlled foreign corporation (as defined in § 957), foreign personal holding company (as defined in § 552), or passive foreign investment company that is a qualified electing fund (as defined in § 1295)), generally must be reported as gross receipts in the month that the pass-through entity’s taxable year ends.

(c) If a taxpayer has a predecessor organization and is continuing the same business as its predecessor, the taxpayer must use the gross receipts of its predecessor for purposes of computing the 25percent gross receipts test.

(d) If the taxpayer (including any predecessor organization) does not have a 47-month period of gross receipts (36month period for requested taxable year plus additional 11-month period for comparing requested taxable year with other potential taxable years), then it cannot establish a natural business year under this revenue procedure.

(e) If the requested taxable year is a 52–53-week taxable year, the calendar month ending nearest to the last day of the 52–53-week taxable year is treated as the last month of the requested taxable year for purposes of computing the 25-percent gross receipts test.

.05 Ownership Taxable Year . For an S corporation or electing S corporation, an “ownership taxable year” is the taxable year (if any) that, as of the first day of the first effective year, constitutes the taxable year of one or more shareholders (including any shareholder that concurrently changes to such taxable year) holding more than 50-percent of the corporation’s issued and outstanding shares of stock. A shareholder in an S corporation or electing S corporation that wants to concurrently change its taxable year must follow the instructions generally applicable to taxpayers changing their taxable years contained in § 1.442–1(b) and Rev. Proc.

(1) In general .

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(iii) in an unagreed or a partially agreed case, on the earliest of the date the taxpayer (or its representative) is notified by an appeals officer that the case has been referred to an area office from a field office, the date the taxpayer files a petition in the Tax Court, the date on which the period for filing a petition with the Tax Court expires, or the date of the notice of claim disallowance.

(b) An examination does not end as a result of the early referral of an issue to an area office under the provisions of Rev. Proc. 96–9, 1996–1 C.B. 575.

(c) An examination resumes on the date the taxpayer (or its representative) is notified by an appeals officer (or otherwise) that the case has been referred to a field office for reconsideration.

(2) Partnerships and S corporations subject to TEFRA . For a partnership or S corporation that is subject to the TEFRA unified audit and litigation provisions (note that an S corporation is not subject to the TEFRA unified audit and litigation provisions for taxable years beginning after December 31, 1996. See Small Business Job Protection Act of 1996, Pub. L. No. 104–188, § 1317(a), 110 Stat. 1755, 1787 (1996)), an examination begins on the date that the notice of the beginning of an administrative proceeding is sent to the Tax Matters Partner/Tax Matters Person (TMP). An examination ends:

(a) in a case in which the Service accepts the partnership or S corporation return as filed, on the date of the “no adjustments” letter or the “no change” notice of final administrative adjustment sent to the TMP;

(b) in a fully agreed case, when all the partners or shareholders execute a Form 870–P, 870–L, or 870–S; or

(c) in an unagreed or a partially agreed case, on the earliest of the date the TMP (or its representative) is notified by an appeals officer that the case has been referred to the area office from a field office, the date the TMP (or a partner or shareholder) requests judicial review, or the date on which the period for requesting judicial review expires.

§ 443(b) does not apply. If the short period is 359 days or more, it is treated as a full taxable year. If the short period is six days or less, such short period is not a separate taxable year but is added to and deemed a part of the following taxable year. (In the case of a change to or from a 52–53-week taxable year not involving a change of the month with reference to which the taxable year ends, the tax computation under § 443(b) does not apply because the short period will always be 359 days or more, or six days or less.) In the case of a PSC with a short period that is more than six days, but less than 359 days, taxable income for the short period must be placed on an annual basis for the purpose of § 443(b) by multiplying such income by 365 and dividing the result by the number of days in the short period. In such case, the tax for the short period is the same part of the tax computed on such income placed on an annual basis as the number of days in the short period is of 365 days (unless § 443(b)(2) and paragraph (b)(2) of § 1.443–1, relating to the alternative tax computation, apply). But see § 1.706–1(b)(4)(i) for an exception from this annualization requirement for a partnership.

.03 Subsequent Year Tax Returns. Returns for subsequent taxable years generally must be made on the basis of a full 12 months (or on a 52–53-week taxable year) ending on the last day of the requested taxable year, unless the taxpayer secures the approval of the Commissioner to change that taxable year.

.04 Record Keeping/Book Conformity. The books of the taxpayer must be closed as of the last day of the requested taxable year. Except for changes described in sections 4.01(1) or 4.01(3) of this revenue procedure to the taxpayer’s required taxable year or ownership taxable year, respectively, the taxpayer must compute its income and keep its books (including financial statements and reports to creditors) on the basis of the requested taxable year.

.05 Changes in Natural Business Year . If a partnership, S corporation, electing S corporation, or PSC changes to or retains a natural business year under this revenue procedure and that year no longer qualifies as a permitted taxable year, the taxpayer is using an impermissible annual accounting period and should change to a

.11 Issue Under Consideration .

(1) During an examination . A taxpayer’s annual accounting period is an issue under consideration for the taxable years under examination if the taxpayer receives written notification (for example,

by examination plan, information document request (IDR), or notification of proposed adjustments or income tax examination changes) from the examining officer(s) specifically citing the taxpayer’s annual accounting period as an issue under consideration. For example, a taxpayer’s annual accounting period is an issue under consideration as a result of an examination plan that identifies the propriety of the taxpayer’s annual accounting period as a matter to be examined. The question of whether the taxpayer’s annual accounting period is an issue under consideration may be referred to the national office as a request for technical advice under the provisions of Rev. Proc. 2001–2, 2001–1 I.R.B. 79 (or any successor).

(2) Before an area office . A taxpayer’s annual accounting period is an issue under consideration for the taxable years before an area office if the taxpayer’s annual accounting period is included as an item of adjustment in the examination report referred to the area office or is specifically identified in writing to the taxpayer by the area office.

(3) Before a federal court . A taxpayer’s annual accounting period is an issue under consideration for the taxable years before a federal court if the taxpayer’s annual accounting period is an item included in the statutory notice of deficiency, the notice of claim disallowance, the notice of final administrative adjustment, the pleadings (for example, the petition, complaint, or answer) or amendments thereto, or is specifically identified in writing to the taxpayer by the government counsel.