SECTION 9. REVIEW BY DIRECTOR

.01 In general .02 National office consideration

.01 Audit protection

(1) In general (2) Exceptions .02 Subsequently required changes

(1) In general (2) Retroactive change or modifica-

.01 Taxable year defined .

(1) In general . Section 441(b) and § 1.441–1(b)(1) of the regulations provide that the term “taxable year” generally means the taxpayer’s annual accounting period, if it is a calendar or fiscal year, or, if applicable, the taxpayer’s required taxable year.

(2) Annual accounting period . Section 441(c) and § 1.441–1(b)(3) provide that the term “annual accounting period” means the annual period (calendar year or fiscal year) on the basis of which the taxpayer regularly computes its income in keeping its books.

(3) Required taxable years . Section 1.441–1(b)(2) provides that certain taxpayers must use the particular taxable year that is required under the Code and the regulations thereunder (the “required taxable year”). For example, a partnership, S corporation, electing S corporation, or personal service corporation (PSC) has a required taxable year that generally conforms to the taxable years of its partners, shareholders, or employeeowners pursuant to §§ 706(b), 1378, and 441(i), respectively. Similarly, a specified

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foreign corporation has a required taxable year that generally represents the taxable year of its majority U.S. shareholder pursuant to § 898. However, § 1.441–1 (b)(2)(ii) describes exceptions under which certain taxpayers may use a taxable year other than their required taxable year. For example, a partnership, S corporation, electing S corporation, or PSC may have a taxable year other than its required taxable year if it elects to use a 52–53-week taxable year that references its required taxable year, makes an election under § 444, or establishes a business purpose and obtains approval under § 442 for that taxable year. See also §§ 706(b), 1378, and 441(i). .02 Adoption of taxable year . Generally, a taxpayer may adopt any taxable year that satisfies § 441 and the regulations thereunder without the approval of the Commissioner. However, a partnership, electing S corporation, or PSC that wants to adopt a taxable year other than its required taxable year, a 52–53-week taxable year that references its required taxable year, or a taxable year elected under § 444, must establish a business purpose and obtain approval under § 442. See § 1.441–1(c).

counting period, regardless of whether the change is to a required taxable year.

.04 Retention of taxable year . In certain cases, a partnership, S corporation, electing S corporation, or PSC will be required to change its taxable year unless it establishes a business purpose and obtains the approval of the Commissioner under § 442, or makes an election under § 444, to retain its current taxable year. See § 1.441–1(d). For example, a corporation with a June 30 fiscal year that either becomes a PSC or elects to be an S corporation, and as a result is required to use the calendar year, must obtain the approval of the Commissioner to retain its current fiscal year. Similarly, a partnership using a taxable year that corresponds to its required taxable year generally must obtain the approval of the Commissioner to retain that taxable year if its required taxable year changes as a result of a change in ownership. But see § 706(b)(2)(B).

successor) for corporations; Rev. Proc. 2001– XX, [insert cite] (or any successor) for partnerships, S corporations, electing S corporations, and PSCs; and Rev. Proc. 66–50, 1966–2 C.B. 1260 (or any successor) for individuals.

.06 Business purpose .

.05 Approval of an adoption, change, or retention .

(1) In general . Section 1.442–1(b) provides that in determining whether a taxpayer has established a business purpose and which terms, conditions, and adjustments will be required, consideration will be given to all the facts and circumstances relating to the adoption, change, or retention, including the tax consequences resulting therefrom . See also H.R. Rep. No. 99–841, 99th Cong., 2d Sess., II–318, 1986–3 (Vol. 4) C.B. 319. (2) Sufficient business purposes. Section 1.442–1(b) provides that generally the requirement of a business purpose will be satisfied, and adjustments to neutralize any tax consequences will not be required, if the requested annual accounting period coincides with the taxpayer’s natural business year. A taxpayer generally is deemed to have established a natural business year if it satisfies the 25-percent gross receipts test provided in section 5.04 of Rev. Proc. 2001–XX, [insert cite]. In Rev. Rul. 87–57, 1987–2 C.B. 117, the Service determined that a partnership, S corporation, or PSC established, to the satisfaction of the Secretary, a business purpose for adopting, retaining, or changing its taxable year in the following four situations:

(a) the taxpayer established that the taxable year satisfied the 25-percent gross receipts test and resulted in less deferral than its natural business year;

(b) the taxpayer would have established a natural business year under the 25-percent gross receipts test, except that a labor strike closed the taxpayer’s business during a period that included its normal peak season;

(c) the taxpayer, for the past 10 years, had a three-month period of insignificant gross receipts during which, due to weather conditions, its business was not operational; and

(d) the taxpayer, which previously used the cash receipts and disbursements method and changed to an accrual method, would have established a natural business year under the 25-percent gross

.03 Change in taxable year .

(1) In general . Section 1.442–1(a)(1) generally provides that a taxpayer that wants to change its annual accounting period and use a new taxable year must obtain approval from the Commissioner.

(2) Annualization of s hort period re- turn . Section 443(b) and § 1.443–1 (b)(1)(i) generally provide that if a return is made for a short period resulting from a change of an annual accounting period, the taxable income for the short period must be placed on an annual basis by multiplying the income by 12 and dividing the result by the number of months in the short period. Unless § 443(b)(2) and § 1.443–1(b)(2) apply, the tax for the short period is the same part of the tax computed on an annual basis as the number of months in the short period is of 12 months. See § 1.706–1(b)(4)(i) for an exception for partnerships.

(3) No retroactive change in annual accounting period . Unless specifically authorized by the Commissioner, a taxpayer may not request, or otherwise make, a retroactive change in annual ac

(1) In general . Section 1.442–1(b) provides that in order to secure approval to adopt, change, or retain an annual accounting period, a taxpayer must file an application generally on Form 1128, Ap- plication to Adopt, Change, or Retain a Tax Year, with the Commissioner no earlier than the day following the close of the first taxable year in which the taxpayer wants the change to be effective (the first effective year) and no later than the 15th day of the third calendar month following the close of the first effective year. In general, an adoption, change, or retention in annual accounting period will be approved where the taxpayer establishes a business purpose for the requested annual accounting period and agrees to the Commissioner’s prescribed terms, conditions, and adjustments for effecting the adoption, change, or retention.

(2) Automatic approval . Under the Code and regulations, certain taxpayers are allowed to change their annual accounting periods without approval or with automatic approval ( see, e.g., § 859(b), § 1.442–1(c) and (d), and § 1.706–1T(c)). In addition, the Service has issued revenue procedures that enable certain taxpayers to obtain automatic approval to adopt, change, or retain their annual accounting periods. See, for example, Rev. Proc. 2000–11, 2000–3 I.R.B. 309 (or any

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receipts test if it had calculated its gross receipts under an accrual method.

(3) Insufficient business purposes. Section 1.442–1(b) provides that, in the case of a partnership, S corporation, electing S corporation, or PSC, deferral of income to partners, shareholders, or employee-owners will not be treated as a business purpose for using a taxable year other than its required taxable year. In addition, the legislative history to the Tax Reform Act of 1986 provides that the following reasons ordinarily will not be sufficient for a partnership, S corporation, or PSC to establish that the business purpose requirement for a particular taxable year has been met:

(a) the use of a particular year for regulatory or financial accounting purposes;

(b) the hiring patterns of a particular business , e.g., the fact that a firm typically hires staff during certain times of the year;

(c) the use of a particular year for administrative purposes, such as the admission or retirement of partners or shareholders, promotion of staff, and compensation or retirement arrangements with staff, partners, or shareholders; and

(d) the fact that a particular business involves the use of price lists, model years, or other items that change on an annual basis.

Although the above items are not themselves sufficient to establish a business purpose, they may be considered in connection with other items by the Commissioner in determining whether a taxpayer has a business purpose for a particular taxable year. H.R. Rep. No. 99–841, 99 ^th

Cong., 2d Sess., II–318, 1986–3 (Vol. 4) C.B. 319

.07 Section 444 elections . Section 444 generally allows certain partnerships, S corporations, electing S corporations, and PSCs to elect a taxable year other than their required taxable year if the deferral period of the new taxable year is three months or less. Partnerships and S corporations with § 444 elections must make required payments under § 7519 that approximate the amount of the deferral benefit and PSCs with § 444 elections are subject to the minimum distribution requirements of § 280H. A taxpayer may automatically adopt, change to, or retain a taxable year permitted by § 444 by filing

a Form 8716, Election to Have a Taxable Year Other Than a Required Taxable Year . A taxpayer that wants to terminate its § 444 election must follow the automatic procedures under § 1.444–1T(a)(5) to change to its required taxable year or establish a business purpose for its taxable year pursuant to § 442 and this revenue procedure.