SECTION 2. BACKGROUND

.01 Section 442 of the Internal Revenue Code and § 1.442–1(a) of the Income Tax Regulations generally provide that a taxpayer that wants to change its annual accounting period and use a new taxable year must obtain the approval of the Commissioner.

.02 Section 1.442–1(b)(2) provides, in relevant part, that a change in annual accounting period will be approved only where the taxpayer agrees to the Commissioner’s prescribed terms, conditions, and adjustments for effecting the change.

.03 Section 1.442–1(b)(3) provides that such terms, conditions, and adjustments may include adjustments necessary to neutralize the tax effects of a substantial distortion of income that would otherwise result from the requested annual accounting period.

.04 Rev. Proc. 2002–38 provides the exclusive procedures for certain partnerships and S corporations to obtain automatic approval to adopt, change, or retain their annual accounting periods under § 442 and § 1.442–1(b). Among the provisions of Rev. Proc. 2002–38:

(1) Section 4 provides that a partnership or S corporation may secure the Commissioner’s approval to adopt or change to its “required taxable year,” a “natural business year,” or an “ownership taxable year;”

(2) Section 5.04 defines a “permitted taxable year” to include a required taxable year, natural business year, or ownership taxable year;

(3) Section 5.05 provides that a partnership or S corporation establishes a natural business year by satisfying a “25-percent gross receipts test;”

(4) Section 5.06 provides generally that an S corporation shareholder that is a taxexempt entity under § 501(a) and that is not subject to tax on any income attributable to the S corporation is disregarded for purposes of determining an ownership taxable year of the S corporation unless the S corporation is wholly-owned by such tax-exempt entity; and

(5) Sections 6.05 and 6.06 provide that if a taxpayer changes to or retains a natural business year or an ownership taxable year 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 permitted taxable year under Rev. Proc. 2002–38 or Rev. Proc. 2002–39, whichever applies.

.05 Rev. Proc. 2002–39 provides the exclusive procedures for taxpayers, including partnerships and S corporations, that do not qualify under one of the automatic approval procedures, to obtain prior approval of the Commissioner to adopt, change, or retain their annual accounting periods under § 442 and § 1.442–1(b). Among the provisions of Rev. Proc. 2002–39: (1) Section 5.01 provides that a request to adopt, change, or retain an annual accounting period ordinarily will be approved if the taxpayer establishes a business purpose;

(2) Section 5.02 provides that a taxpayer requesting to adopt, change, or retain an annual accounting period that is the taxpayer’s natural business year has established a business purpose to the satisfaction of the Commissioner;

(3) Section 5.03 provides that a natural business year of a taxpayer may be determined under the “annual business cycle test,” the “seasonal business test,” or the “25% gross receipts test;” and

November 10, 2003 1036 2003-45 I.R.B.

Jeffrey S. Marshall of the Office of Associate Chief Counsel (Income Tax and Accounting). For further information regarding this revenue procedure, contact Mr. Hirschhorn or Mr. Marshall at (202) 622–4960 (not a toll-free call).

26 CFR 601.105: Examination of returns and claims for refund, credit, or abatement; determination of correct tax liability. (Also Part I, §§ 62, 162, 267, 274; 1.62–2, 1.162–17, 1.267(a)–1, 1.274–5.)

Rev. Proc. 2003–80