What Is the Taxable Year? Calendar vs. Fiscal Years

A taxable year represents the annual accounting period used for calculating income tax obligations. This timeframe measures income and expenses for individuals and businesses within the U.S. tax system. Adhering to the correct taxable year is necessary for proper record-keeping and timely tax return filings, impacting compliance and reporting.

Understanding Calendar and Fiscal Years

The two primary types of taxable years are the calendar year and the fiscal year. A calendar year spans 12 consecutive months, beginning on January 1 and concluding on December 31. Most individual taxpayers in the United States operate on a calendar year basis for their tax filings, simplifying preparation as it matches common personal and financial cycles.

Conversely, a fiscal year encompasses any 12-consecutive-month period ending on the last day of any month except December. Businesses often establish a fiscal year based on their natural business cycle. For instance, a retail business heavily reliant on holiday sales might choose a fiscal year ending after the peak season, such as January 31, to capture an entire sales cycle within one tax period. This choice allows businesses to align their tax reporting with their operational flow, reflecting seasonal income and expenses.

How a Taxable Year is Established

Individuals generally must use a calendar year for tax purposes. While it is possible for an individual to obtain IRS approval to use a fiscal year, such instances are rare and typically require a compelling business purpose.

For businesses and other entities, the taxable year is typically chosen when the entity files its first tax return. The chosen taxable year must consistently align with the period used for maintaining the entity’s books and records. Once adopted, changing this elected tax year generally requires IRS approval.

Certain entity types face specific rules regarding their taxable year. S corporations and Personal Service Corporations (PSCs), for example, generally must adopt a calendar year unless they can demonstrate a valid business purpose for using a fiscal year. Partnerships also have specific requirements, needing to use the same taxable year as their partners. These regulations aim to prevent income deferral and ensure consistent reporting across related entities.

Specific Taxable Year Circumstances

A short tax year, also known as a short period, refers to an accounting period of less than 12 months. This circumstance arises when a new business or entity begins operations, or when an entity changes its accounting period, creating a transitional period between the old and new tax years.

A short tax year can also result from the termination of an entity, such as a business dissolving or liquidating. For individual taxpayers, a short tax year may arise due to death. When a short tax year occurs, income for that period often needs to be annualized for specific tax calculations, which helps ensure that tax liability is fairly determined as if the period were a full year.

Once a taxable year is established, obtaining IRS approval is generally required to change it. Entities typically file Form 1128 to request such a change. The IRS requires a valid business purpose to approve a change in the taxable year.