What Is a Tax Year for Individuals and Businesses?
Learn about the tax year, the defined accounting period for reporting income and expenses, and its relevance for both individual and business taxation.
A tax year is a designated 12-month period for keeping financial records and reporting income and expenses to tax authorities. It forms the foundation for calculating tax liability, ensuring consistency in financial reporting and compliance with tax regulations.
Tax Year for Individuals
For most individual taxpayers, the tax year aligns with the calendar year, running from January 1 to December 31. The calendar year simplifies tax filing for the majority of the population because it corresponds with the common annual cycle. Income earned within this period is typically reported in the following year’s tax return, with a common filing deadline of April 15.
Tax Year for Businesses
Businesses have more flexibility in choosing their tax year compared to individuals. Many businesses, especially sole proprietorships or S corporations, may also use the calendar year (January 1 to December 31) for tax reporting. This choice often simplifies matters as it can align with the owner’s personal tax year.
Alternatively, a business can opt for a fiscal year, which is any 12-consecutive-month period ending on the last day of any month other than December. For example, a fiscal year could run from July 1 to June 30. Businesses often choose a fiscal year to align their tax reporting with their natural business cycle or seasonal fluctuations. This allows for a more accurate financial picture by having a full business cycle within one tax period.
A short tax year refers to a period of less than 12 months. This can occur when a new business starts operations mid-year, changes its accounting period, or ceases to exist. For instance, if a business begins on July 1 and chooses a calendar year, its first tax year would be a short one, covering only July 1 to December 31. Filing a short tax year return is necessary to bridge the gap between accounting periods.
Selecting and Adjusting a Tax Year
A new business generally establishes its tax year when it files its first income tax return. The business entity typically chooses its tax year, though some, like sole proprietorships, must use a calendar year. Once a business adopts a tax year, it must continue to use it unless it obtains permission from the IRS to change.
Changing a tax year usually requires IRS approval and involves demonstrating a valid business purpose beyond tax avoidance. This process often necessitates filing Form 1128. Reasons for a change might include a significant shift in business operations or a desire to align with an affiliated group’s tax year. Filing Form 1128 allows businesses to request either automatic approval or a ruling from the IRS.
A change in tax year often results in a short-period return, which covers the months between the old tax year-end and the new one. This means the business will file two tax returns within a short timeframe. While changing a tax year can align financial reporting with operational cycles, it introduces complexities in tax compliance and may affect various filing deadlines.