Fiscal Year Versus Calendar Year: How to Choose

An annual accounting period, or tax year, is the timeframe over which a company or individual calculates income and expenses for tax purposes. While most individual taxpayers use a calendar year, businesses often have the flexibility to choose a tax year that aligns with their operational cycle.

Defining the Tax Year Options

The most common tax year is the calendar year, a 12-month period from January 1 to December 31. For many entities, this is the default option. If a business does not maintain formal records or have a defined annual accounting period, the IRS mandates the use of a calendar year.

A business may instead elect to use a fiscal year, which is a 12-month period that ends on the last day of any month except December. For example, a company could have a tax year that runs from July 1 to June 30. To use a fiscal year, a business must maintain its books and records on the basis of that chosen year.

A more specialized option is the 52-53 week tax year, a type of fiscal year that varies between 52 and 53 weeks. This period does not need to end on the last day of a month. Instead, it always ends on the same day of the week, such as the last Friday in June. This method is useful for businesses that want financial periods of a consistent number of full weeks, simplifying payroll and other weekly reporting.

Factors in Selecting a Tax Year

The decision to use a fiscal year is often driven by the ‘natural business year,’ the 12-month period ending when business activity is lowest. Aligning the tax year-end with this low point allows for a more accurate and less disruptive financial closing process.

For seasonal businesses, this alignment is beneficial. A retail company, for instance, peaks during the holiday season in November and December, followed by returns in January. By selecting a fiscal year-end of January 31, the business can capture the entire holiday sales cycle, including returns, within a single accounting period for a clearer picture of profitability.

This approach also simplifies inventory management. A physical inventory count is easier and more accurate when inventory levels are lowest, which for many businesses occurs right after their peak season. Choosing a fiscal year-end that coincides with this lull leads to a more precise valuation of inventory. Adopting an industry’s common fiscal year-end can also simplify financial comparisons with competitors.

In contrast, simplicity is the primary driver for choosing a calendar year. For sole proprietorships, partnerships, and S corporations, the business’s income flows through to the owners’ personal tax returns. Aligning the business and personal tax years simplifies tax preparation and avoids complications. Most accounting software is also pre-configured for a calendar year, reducing setup friction for new businesses.

Adopting and Changing a Tax Year

A new business formally adopts its tax year on its first federal income tax return, which establishes its official accounting period. Simply filing for an employer identification number or paying estimated taxes does not establish the tax year.

An existing business must receive IRS approval to change its tax year. This process requires filing Form 1128, Application To Adopt, Change, or Retain a Tax Year, and demonstrating a substantial business purpose for the change. This often involves showing that the new fiscal year aligns with the company’s natural business year.

The filing deadline for Form 1128 varies depending on the business’s situation. A change in accounting period results in a ‘short tax year,’ a period of less than 12 months. For instance, if a business switches from a calendar year to a June 30 year-end, it must file a short period return from January 1 to June 30. The tax for this short period is calculated based on IRS rules found in Publication 538, Accounting Periods and Methods.