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A partnership's tax year can change
when partners do
By Cora M. Barnhart •
Bankrate.com
Oct. 7, 1999 -- Two heads might be better than
one in business, but they can also make decisions such as choosing
a tax year more complicated. Fortunately, changing a tax
year is easier. This tax tips addresses special considerations for
a partnership when it changes its tax year.
Primer
on tax years
Here's a quick lesson for any partnerships unfamiliar with the
world of tax years. Adopting a calendar year means you must maintain
your books and records and report income and expenses from Jan.
1 through Dec. 31 of each year. Suppose a taxpayer files his first
tax return based on the calendar year. If he later begins a business
as a sole proprietor, becomes a partner in a partnership, or becomes
a shareholder in an S corporation, he must continue to use the calendar
year unless the IRS approves his changing.
On the other hand, if you select an accounting
period of 12 consecutive months ending on the last day of any month
other than December, the tax year you've chosen is a fiscal year.
A 52-53 week tax year is a fiscal year that varies from 52 to 53
weeks. Once a business owner selects a fiscal year, he must maintain
his books and records, and report income and expenses using the
same tax year each time.
Once you select a particular tax year, the IRS
expects you to stick to it. If you do decide to change to another
type, you will need to follow certain rules that often involve filing
a request for approval with the IRS and, in some situations, filing
a return for a short year.
Selecting
the right tax year for a partnership
Given that a partnership's tax year is supposed conform to the
partners' tax years, partnerships may need to change their tax year
for a number of reasons. Partners come and go for a variety of reasons.
Also, partners' shares in the business change over time, which also
could affect the tax year required for a partnership.
The IRS has specific rules to help partnerships
determine their required tax year. If a partnership has a majority
interest tax year, meaning the partnership already has one or more
partners who follow the same tax year and their share of partnership
profits exceeds 50 percent (a majority interest), the partnership
simply uses the tax year of those partners. If there isn't a majority
interest, but there are principal partners (those who have at least
a 5 percent share in the business) who have the same tax year, this
becomes the tax year for the partnership. If neither of these conditions
applies, the partnership has to determine the tax rule that generates
the least
deferral of income.
Changing
a partnership's tax year
When necessary, partnerships can change their required tax year
with the consent of the IRS. They don't have to formally apply for
this change. However, they must notify the IRS by writing at the
top of the first page of the tax return for the first required tax
year, "FILED UNDER SECTION 806 OF THE TAX REFORM ACT OF 1986."
Those who are switching from one tax year to
another may find themselves with a short tax year on their hands
as they make the transition. A short tax year begins on the first
day after the end of the present tax year and ends on the day before
the first day of the new tax year.
When a partnership changes its tax year, it
must file a short period return. The short period return covers
the months between the end of the partnership's prior tax year and
the beginning of its new tax year. For instance, suppose a partnership
currently uses a calendar year and decides to change to a fiscal
year that begins on July 1 and ends on June 30. In this example,
the partnership will have a short tax year for the period from Jan.
1 to June 30.
If a partnership changes to the tax year resulting
in the least aggregate deferral of income, it must attach a statement
to the short period return that shows the computations used to determine
that tax year. The short period return must indicate at the top
of page 1, "FILED UNDER SECTION 1.706-1T."
-- Posted Oct. 7, 1999
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