How to Request a Change of Accounting Period

An accounting period is the annual period used to report income and expenses for federal tax purposes. While most taxpayers use the same period year after year, business needs or other circumstances may make changing this period necessary. A taxpayer who has established an annual accounting period must continue to use it. If a change is desired, approval from the Internal Revenue Service (IRS) is required. This process ensures that the change has a legitimate business purpose and is not primarily for tax avoidance, and an approved change results in a short tax year.

Determining Your Tax Year

The two most common types of tax years are the calendar year and the fiscal year. A calendar year is a 12-consecutive-month period ending on December 31, which many individuals and businesses use by default. A fiscal year is a period of 12 consecutive months ending on the last day of any month except December, established by keeping books and records on that basis. A less common option is the 52-53-week tax year, an annual period that varies from 52 to 53 weeks and always ends on the same day of the week.

Certain business structures face specific rules regarding their tax year. Partnerships, S corporations, and personal service corporations (PSCs) generally have a “required tax year.” This is the tax year they must use unless they can establish a valid business purpose for a different tax year and receive IRS approval. For these entities, the required year is often tied to the tax years of their owners or partners to prevent the deferral of income.

Approval Requirements for the Change

The IRS provides two primary pathways to obtain consent to change an accounting period: an automatic approval procedure and a non-automatic ruling request. The automatic approval process is a streamlined method available to taxpayers who meet specific, predefined conditions. This path is open to taxpayers who have not changed their accounting period within the last 48 months and meet other scope limitations.

If a taxpayer does not qualify for the automatic approval procedure, they must seek permission through a non-automatic ruling request. This more formal process involves filing an application with the IRS National Office. This request requires the taxpayer to establish a substantial business purpose for the change, as the IRS will not approve a change if the primary reason is to gain a tax advantage.

A substantial business purpose is determined by considering all the facts and circumstances, including the tax consequences. A significant non-tax factor is the alignment of the tax year with the taxpayer’s natural business year, such as a retailer changing to a year-end that occurs after its peak selling season. The IRS scrutinizes requests to ensure they do not create a substantial distortion of income.

Required Information and Form Completion

To request a change in an accounting period, taxpayers must file Form 1128, Application to Adopt, Change, or Retain a Tax Year. The application requires the business’s Employer Identification Number (EIN), details of the current and requested tax years, and financial data for the short period that will result from the change.

A primary component of the application is a clear and detailed statement explaining the business purpose for the requested change. If the request is based on a natural business year, supporting financial data demonstrating the business cycle must be included. The form also has a section for taxpayers who qualify for the automatic approval procedures to cite the specific revenue procedure they are following.

The Filing Process

The filing deadline for Form 1128 depends on whether the request is for an automatic or non-automatic change. For an automatic approval request, the application must be filed by the due date of the federal income tax return for the short period, not including extensions. For non-automatic ruling requests, the filing deadline can vary, so the official form instructions must be consulted. The application should be filed at the same address where the taxpayer’s income tax return is filed.

After filing, the process differs based on the type of request. For automatic changes, the taxpayer assumes consent and files their tax return for the short period accordingly. For a non-automatic request, the taxpayer must wait for a formal ruling letter from the IRS National Office. This letter will either approve or deny the request and will provide the terms and conditions under which the change must be made.

Filing the Short Period Tax Return

Approval of a change in accounting period creates a short tax year. This is the period that begins the day after the close of the old tax year and ends on the day before the beginning of the new tax year. A federal income tax return must be filed for this short period, and its due date is generally the same as it would be for a full tax year.

In many cases, the income for the short period must be annualized. This process involves projecting the short period income to a full 12-month period. The tax is calculated on the annualized income and then prorated for the number of months in the short period. The purpose of annualizing income is to prevent a taxpayer from benefiting from lower tax brackets on income earned over a period of less than a full year.

To annualize income, the net income for the short period is multiplied by 12 and then divided by the number of months in the short period. The tax is computed on this annualized amount and then multiplied by a fraction, with the number of months in the short period as the numerator and 12 as the denominator. The specific rules for annualization can be complex, and taxpayers should refer to the instructions for their specific tax form.