SECTION 1. PURPOSE

This revenue procedure provides the general procedures under § 442 of the Internal Revenue Code and § 1.442–1(b) of the Income Tax Regulations for establishing a business purpose and obtaining the approval of the Commissioner of Internal Revenue to adopt, change, or retain an annual accounting period for federal income tax purposes. This revenue procedure also describes the terms,

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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)(4)(B). However, a partnership that has previously established a business purpose to the satisfaction of the Commissioner to use a particular fiscal year is not required to obtain the approval of the Commissioner to retain such fiscal year if its required taxable year changes.

.05 Approval of an Adoption, Change, or Retention .

(1) In general . Section 1.442–1(b) provides that in order to secure the approval of the Commissioner to adopt, change, or retain an annual accounting period, a taxpayer must file an application, generally on Form 1128, Application to Adopt, Change, or Retain a Tax Year, with the Commissioner within such time and in such manner as is provided in administrative procedures published by the Commissioner. 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., §§ 444, 859(b), and § 1.442–1(c) and (d)). 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. 2002–37, 2002–22 I.R.B. 1030 (or any successor) for corporations; Rev. Proc. 2002–38, 2002–22 I.R.B. 1037 (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 .

(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 cir

cumstances 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)(2) 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 required taxable year, ownership taxable year, or natural business year. A taxpayer generally is deemed to have established a natural business year if it satisfies the “25-percent gross receipts test.” See Rev. Proc. 83–25, 1983–1 C.B. 689, superseded by Rev. Proc. 87–32, 1987–2 C.B. 396, superseded by Rev. Proc. 2002–38, 2002–22 I.R.B. 1037. 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 other 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 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

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, 99th Cong., 2d Sess., II–318, 1986–3 (Vol. 4) C.B. 319

.07 Section 444 Elections . A partnership, S corporation, electing S corporation, or PSC generally can elect under § 444 to use a taxable year other than its required taxable year, but only if the deferral period of the taxable year elected is not longer than the shorter of 3 months or the deferral period of the taxable year being changed. A partnership and an S corporation with a § 444 election must make required payments under § 7519 that approximate the amount of the deferral benefit and a PSC with a § 444 election is 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–

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.

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required to use under the Code or regulations thereunder. For example, 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, and § 441(i) in the case of a PSC, without taking into account any taxable year that is allowable by reason of a § 444 election. See generally § 1.441–1(b)(2) (providing examples of other entities with required taxable years).

.05 Permitted Taxable Year . The term “permitted taxable year” means the required taxable year; a natural business year; the ownership taxable year; a taxable year elected under § 444; a 52–53week taxable year that references the required taxable year, natural business year, ownership taxable year, or taxable year elected under § 444; or any other taxable year for which the taxpayer establishes a business purpose to the satisfaction of the Commissioner.

.06 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. The first effective year is also the first taxable year for complying with all the terms and conditions set forth in the letter ruling granting permission to effect the adoption, change, or retention of the taxpayer’s annual accounting period.

.07 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.

.08 Field Office, Area Office, Director . The terms “field office,” “area office,” and “director” have the same meaning as those terms have in Rev. Proc. 2002–1, 2002–1 I.R.B. 1 (or any successor). .09 Under Examination .

(a) Except as provided in section 4.08(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

1T(a)(5) to change to its required taxable year or establish a business purpose for using a different taxable year pursuant to § 442, the regulations thereunder, and Rev. Proc. 2002–38 or this revenue procedure (whichever is applicable).