Why I Like Using September 30 Fiscal Year End for S Corporations and Partnerships
If you are considering an election to be an S Corporation or forming a new partnership, you may already know that S corporations and partnerships generally do not pay federal income tax at the corporate or partnership level. The income of such entities is allocated to their owners who report and pay tax on the income on their individual return for the year that includes the ending date of the business’s tax year. For example, a September 30, 2017 fiscal year-end pass through entity would be reported on the owners’ 2017 individual return.
S corporations and partnerships must file on a calendar year basis unless one of three exceptions applies:
- It has a natural business year. This is defined as a year-end where 25% of the gross receipts occur in the last two months of the fiscal year. Many accounting firms (including mine) qualify for an April or May year-end for their S corporation.
- It can establish a business purpose for using a fiscal year-end and request a Letter Ruling from the IRS. Permission to use a business purpose fiscal year based on the facts and circumstances will be granted only in rare and unusual circumstances.
- It can make a Section 444 election to select year-ends of September 30, October 31 or November 30.
Making a Section 444 election is only available when timely filed to the first year S corporation or newly formed partnership. It involves checking some boxes on the Form 2553 Election by a Small Business Corporation and/or completing a filing Form 8716 Election to Have a Tax Year Other Than a Required Year. Why would you want to do this?
By selecting a fiscal year-end of September 30, the S corporation or partnership tax return can be completed by the due date of December 15. When the return is done, owners of the S corporation or partnership will know the exact amount of income that they must report on their individual returns which will be due four months later. For many small business owners, most of the income they report on their individual returns is the income from their small business. Therefore, by December 15, the owners of the S corporation and partnerships can anticipate the taxes they will owe when they file their individual returns reporting the fiscal year-end business income and know the tax estimates they would need to pay for the following year.
The price to be paid for this knowledge is that a tax deposit is required for businesses that elect that fiscal year-end. It is basically calculated based on 39.6% of the amount of income that is assumed to be deferred.
For example, if the S corporation makes $100,000 net income in the first full year of operating with a September 30 year-end (and assuming wages and rents paid to a shareholder are equally paid throughout the year), the tax deposit required would be $9,900 ($100,000 times ¼ times 39.6%). This deposit would be due May 15 following the September 30 year-end.
This tax deposit would increase the following year if the total S corporation net income increased.
For example. If the S corporation income in the second year increases to $120,000 in the second full year (and continues to pay shareholder wages and rents equally throughout the year), the tax deposit would be $1,980 ($120,000 times ¼ times 39.6% less the $9,900 already paid).
If the S corporation net income decreases, the tax deposit calculation would likewise result in a tax refund. The tax deposit is reflected on the company books as an asset since it is fully refundable when the company goes out of business, changes their year-end back to a calendar year or loses money. Think of the tax deposit as an interest free loan to the IRS.
An added bonus is that most CPAs and tax professionals are typically less busy in November and December so that the S corporation return can be prepared and filed by the due date of December 15. Calendar year-end S corporations and partnerships are due March 15 and sometimes you might find your tax accountant may put that return on extension which can further delay the knowledge of the taxes you will need to pay.
The rules for making the fiscal year S corporation or partnership election and calculating the tax deposits can be complex for a non-tax professional and I have simplified the rules for purposes of illustration. However, with proper guidance and the right circumstances for a profitable business, the shareholders can project their cash flow requirements for their individual taxes up to one year in advance.
For example, when your fiscal year entity is completed December 15, 2017, you can anticipate the taxes you would owe April 15, 2018 for the owners’ individual tax return, the tax deposit that is due May 15, 2018 and he tax estimates the owners’ 2018 tax estimates that would be due April 15, 2018, June 15, 2018, September 15, 2018 and January 15, 2019.
Bottom line: No more last minute tax surprises! This is why I like using September 30 fiscal year-ends for S corporations and partnerships.
Any accounting, business or tax advice contained in this communication, including attachments and enclosures, is not intended as a thorough, in-depth analysis of specific issues, nor a substitute for a formal opinion, nor is it sufficient to avoid tax-related penalties. If desired, Yorke & Associates CPA’s, Inc. would be pleased to perform the requisite research and provide you with a detailed written analysis. Such an engagement may be the subject of a separate engagement letter that would define the scope and limits of the desired consultation services.
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