| REG-106917-99 |
June 13, 2001 |
Changes in Accounting Periods
DEPARTMENT OF THE TREASURY
Internal Revenue Service 26 CFR Parts 1, 5c, 5f, 18, and 301
[REG-106917-99] RIN 1545-AX15
TITLE: Changes in Accounting Periods
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking and notice of public hearing.
SUMMARY: This document contains proposed regulations under sections
441, 442, 706, and 1378 of the Internal Revenue Code of 1986 that
relate to certain adoptions, changes, and retentions of annual
accounting periods. The proposed regulations are necessary to
update, clarify, and reorganize the rules and procedures for
adopting, changing, and retaining a taxpayer's annual accounting
period. The proposed regulations primarily affect taxpayers that
want to adopt an annual accounting period under section 441 or that
must receive approval from the Commissioner to adopt, change, or
retain their annual accounting periods under section 442. This
document also contains a notice of public hearing on these proposed
regulations.
DATES: Written and electronic comments and requests to speak (with
outlines of oral comments) at a public hearing scheduled for October
2, 2001, must be received by September 11, 2001.
ADDRESSES: Send submissions to: CC:M&SP:RU (REG-106917-99), room
5226, Internal Revenue Service, POB 7604, Ben Franklin Station,
Washington, DC 20044. Submissions may be hand delivered Monday
through Friday between the hours of 8 a.m. and 5 p.m. to: CC:M&SP:RU
(REG-106917-99), Courier's Desk, Internal Revenue Service, 1111
Constitution Avenue, NW., Washington, DC. Alternatively, taxpayers
may submit comments electronically via the Internet by selecting the
"Tax Regs" option on the IRS Home Page, or by submitting comments
directly to the IRS Internet site at
http://www.irs.ustreas.gov/tax_regs/regslist.html. The public
hearing will be held in the IRS Auditorium, Internal Revenue
Building, 1111 Constitution Avenue, NW., Washington, DC. FOR FURTHER
INFORMATION CONTACT: Concerning the proposed regulations, Roy A.
Hirschhorn and Martin Scully, Jr. (202) 622- 4960; concerning
submissions of comments and the hearing, and/or to be placed on the
building access list to attend the hearing, Treena Garrett (202)
622-7180 (not toll-free numbers).
SUPPLEMENTARY INFORMATION:
Paperwork Reduction Act
The collections of information contained in this notice of proposed
rulemaking have been submitted to the Office of Management and
Budget for review in accordance with the Paperwork Reduction Act of
1995 (44 U.S.C. 3507(d)). Comments on the collections of information
should be sent to the Office of Management and Budget, Attn: Desk
Officer for the DEPARTMENT OF THE TREASURY, Office of Information
and Regulatory Affairs, Washington, DC 20503, with copies to the
Internal Revenue Service, Attn: IRS Reports Clearance Officer,
W:CAR:MP:FP:S:O, Washington, DC 20224. Comments on the collections
of information should be received by August 13, 2001. Comments are
specifically requested concerning: Whether the proposed collections
of information are necessary for the proper performance of the
functions of the Internal Revenue Service, including whether the
information will have practical utility;
The accuracy of the estimated burden associated with the proposed
collections of information (see below);
How the quality, utility, and clarity of the information to be
collected may be enhanced;
How the burden of complying with the proposed collections of
information may be minimized, including through the application of
automated collection techniques or other forms of information
technology; and Estimates of capital or start-up costs and costs of
operation, maintenance, and purchase of services to provide
information.
The collection of information can be found in §§1.441-
2(b)(1), 1.442-1(b)(1) and (b)(4) and (d), and 1.1378-1 of these
regulations.
Section 1.441-2(b)(1) requires certain taxpayers to file statements
on their federal income tax returns to notify the Commissioner of
the taxpayers' election to adopt a 52-53-week taxable year. Section
1.442-1(b)(4) provides that certain taxpayers must establish books
and records that clearly reflect income for the short period
involved when changing their taxable year from their taxable year to
a proposed fiscal taxable year. Section 1.442-1(d) requires a newly
married husband or wife to file a statement with their short period
return when changing to the other spouse's taxable year. This
collection of information is mandatory. The likely respondents are
businesses or other profit entities and individuals.
The estimated average annual burden per respondent and /or
recordkeeper required by §§1.442-1(b)(1) and 1.1378-1 are
reflected in the burdens of Forms 1128 and 2553.
Further, the estimated average burden per respondent and/or
recordkeeper required by §§1.441-2(b)(1), 1.442-1(b)(4)
and 1.442-1(d) is as follows:
Estimated total reporting/recordkeeping burden: 3,500 hours.
Estimated average burden per respondent/recordkeeper: 21 minutes.
Estimated number of respondents/recordkeepers: 10,000.
Estimated annual frequency of responses: On occasion. An agency may
not conduct or sponsor, and a person is not required to respond to,
a collection of information unless the collection of information
displays a valid OMB control number. Books or records relating to a
collection of information must be retained as long as their contents
may become material in the administration of any internal revenue
law. Generally, tax returns and tax return information are
confidential, as required by 26 U.S.C. 6103.
Background and Explanation of Provisions
A. Overview
This document contains proposed amendments to regulations under
section 441 (period for computing taxable income), and sections 442,
706, and 1378 (regarding the requirement to obtain the approval of
the Commissioner to adopt, change, or retain an annual accounting
period).
B. Section 441: Period for computing taxable income
1. Background.
The current temporary regulations under section 441 are primarily
the product of two separate Treasury Decisions, TD 8167, 52 FR
485241 (published with a cross reference to a notice of proposed
rulemaking) and TD 8123, 52 FR 3615 (1988). Prior to the issuance of
TD 8167 and TD 8123 (the temporary regulations), the regulations
under section441 contained provisions relating mostly to the period
for computing taxable income and the election of a 52-53-week
taxable year. The temporary regulations retain these provisions, but
also add new provisions to implement section 806 of the Tax Reform
Act of 1986, Public Law 99-512 (100 Stat. 2362), 1986-3 C.B. (Vol.
1) 1, 279, (the 1986 Act). Enacted with the principal intent of
eliminating the deferral period between certain entities and their
owners, the 1986 Act generally required partnerships, S
corporations, and personal service corporations (PSCs) to conform
their taxable years to the taxable years of their partners,
shareholders, or employee-owners, respectively. H.R. Conf. Rep. No.
99-514, 99th Cong., 2d Sess 318 (1986). In addition to general
implementation provisions, the temporary regulations include
transition and anti-abuse provisions specific to taxpayers in
existence at the time the 1986 Act became effective. For example,
§1.441-3T provides rules intended to prevent taxpayers from
circumventing the effective date of the provisions of the 1986 Act
by adopting or changing to (or from) a 52-53-week taxable year
during the period beginning after September 29, 1986, and ending
before January 5, 1987.
Generally, this document reproposes the temporary regulations under
section 441. However, this document also reorganizes, clarifies,
modifies, and updates the temporary regulations. Many of the
provisions contained in the temporary regulations remain essentially
the same, including the general.Rules for adopting a taxable year,
the provisions relating to electing a 52-53-week taxable year, and
the rules for PSCs. However, provisions that are now obsolete have
been removed, and new rules and definitions have been added, as
described in more detail below. In addition, new cross-references to
section 442 and the proposed regulations thereunder are included to
guide taxpayers, where appropriate, to the rules and procedures for
obtaining approval to adopt, change, or retain their annual
accounting periods.
2. General Rules and Definitions. Most of the substantive provisions
in §1.441-1T of the temporary regulations have been retained,
including the general rules for the period for computing tax,
numerous definitions, and the requirement that partnerships, S
corporations, electing S corporations, and PSCs generally must
demonstrate a business purpose and obtain the Commissioner's
approval to adopt or retain a taxable year other than their required
taxable year. However, §1.441-1T has been reorganized, obsolete
transition rules have been removed, and some rules have been
clarified. For example, the proposed regulations now define the term
required taxable year, identify entities that have such a year (with
appropriate cross-references), and clarify the applicable
exceptions.
In addition, the proposed regulations clarify the meaning of the
requirement to keep books for taxpayers using a fiscal year The
temporary regulations provide that a fiscal year will be recognized
only if the books of the taxpayer are kept in accordance with that
fiscal year. The proposed regulations conform the book keeping
requirement for taxpayers using a fiscal year to that of
§1.446-1(a) (4), which allows for a reconciliation between the
taxpayer's books and return. However, as a term and condition of
obtaining approval to adopt, change to, or retain an annual
accounting period under section 442, certain taxpayers nevertheless
may be required to compute income and keep their books (including
financial statements and reports to creditors) on the basis of the
requested annual accounting period. See, e.g., Rev. Proc. 2000-11
(2000-3 I.R.B. 309).
The proposed regulations also provide that a taxable year is adopted
by filing the first federal income tax return using that taxable
year. Accordingly, filing an application for an employer
identification number, filing an extension, or making estimated tax
payments, indicating a particular taxable year do not constitute an
adoption of that year. Consequently, Rev. Rul. 57- 589 (1957-2 C.B.
298), and Rev. Rul. 69-563 (1969-2 C.B. 104), holding that the
filing of an extension and estimated tax payments establishes a
taxable year, are proposed to be superseded. The IRS will continue
to follow the decision in E.G. Wilson, 267 F.Supp. 89 (East. Dist.
MO, 1967), with respect to the classification of an amended return
as a "first return."
3. 52-53-week Taxable Years. The proposed regulations retain most of
the rules provided in §1.441-2T of the temporary regulations
for taxpayers electing to use a 52-53-week taxable year or changing
to or from a 52-53-week taxable year. However, the procedures for
certain taxpayers to obtain approval (automatic or otherwise) to
change to or from a 52-53-week taxable year have been removed and
are now contained in administrative procedures published by the
Commissioner. See Rev. Proc. 2000-11; and Notice 2001-35 (IRB
2001-23). In addition, although these administrative procedures
continue to provide automatic approval for a change to a 52-53-week
taxable year ending with reference to the same calendar month, the
change will be effected with a Form 1128 (Application to Adopt,
Change or Retain a Tax Year) rather than with a statement,
consistent with most other changes.
The proposed regulations also expand the applicability of the rules
for determining the inclusion of income and deductions from a pass-
through entity where either the entity or its owner uses a 52-53-
week taxable year. In addition to applying to partnerships, S
corporations, and PSCs (as in the temporary regulations), the
proposed regulations apply these inclusion rules to trusts, common
trust funds, controlled foreign corporations, foreign personal
holding companies, and passive foreign investment companies that are
qualified electing funds.
4. Transition Rules. Section 1.441-3T of the temporary regulations
provide transition rules for the 1986 Act that generally were
effective from September 29, 1986, through January 5, 1987.
Moreover, the rules contained in §1.441-3T regarding 52-53-week
taxable years and the definition of a PSC were superseded by similar
rules promulgated under §§1.441-2T and 1.441-4T,
respectively. Because these rules are now obsolete, this section has
been removed from the proposed regulations. 5. Personal Service
Corporations. The rules for PSCs contained in §1.441-4T of the
temporary regulations generally have been retained in the proposed
regulations. However, the proposed regulations reorganize and
clarify the required taxable year of a PSC and the rules for
adopting, changing to, and retaining a year other than the required
taxable year. For example, the proposed regulations make clear that
a PSC may have a year other than a required taxable year by making
an election under section 444. In addition, the provision allowing a
PSC to obtain automatic approval to change to its required taxable
year has been removed and is now contained in Notice 2001-35 (I.R.B.
2001-23). Similarly, the rules regarding establishing a business
purpose and obtaining approval for the use of a fiscal year have
been moved to §1.442-1(b) and Notice 2001-34 (I.R.B. 2001-23).
Comments were received on the notice of proposed rulemaking that is
cross-referenced by the temporary regulations under §1.441-4T.
Most significantly, one commentator suggested that the testing
period for determining whether a taxpayer is a PSC should be the
three preceding taxable years, rather than the preceding taxable
year, to prevent taxpayers from becoming a PSC due to temporary or
aberrational conditions. The proposed regulations retain the one-
year testing period provided in the temporary regulations. However,
the IRS and Treasury Department will reconsider this testing period,
as well as other comments received on the temporary regulations, to
the extent similar comments are received on these proposed
regulations now that taxpayers have significantly more experience
with the provisions in the temporary regulations.
C. Section 442: Changes of annual accounting period
1. Background. Under section 442 and the current regulations, a
taxpayer generally can change its annual accounting period only by
obtaining the approval of the Commissioner. The current regulations
set forth the general rules for obtaining such approval, including:
(1) the manner and time for filing an application to change an
annual accounting period; (2) the requirement that the taxpayer
demonstrate a substantial business purpose for the change; and (3)
the need for agreement between the taxpayer and the Commissioner to
the terms, conditions, and adjustments that are necessary to effect
the change. Under the current regulations, both tax and non-tax
factors are considered in determining whether a taxpayer has
established a substantial business purpose.
2. Manner and Time for Filing. The proposed regulations retain the
general requirement to file a Form 1128 to request approval, but
extend the time for filing the Form 1128. The current regulations
require that the Form 1128 be filed on or before the 15th day of the
second calendar month (generally 45 days) following the close of the
short period. Under the proposed regulations, the Form 1128 must be
filed by the 15th day of the third calendar month (generally 75
days) after the close of the taxable year in which the taxpayer
wants the adoption, change, or retention to be effective (i.e., the
first effective year). However, taxpayers are encouraged to file
their Forms 1128 as soon after the close of the first effective year
as possible to allow the IRS adequate time to process the Form 1128
before the extended due date of the return for the first effective
year. Because the IRS has found that Forms 1128 filed before the
close of the short period often lack complete information and result
in processing delays, the proposed regulation provides that the Form
1128 may not be filed prior to the close of the first effective
year.
3. Business Purpose, Terms, Conditions, and Adjustments. Taxpayers
have expressed concern with the substantial business purpose
requirement set forth in the current regulations. In particular,
taxpayers have complained that the Commissioner's interpretation of
a substantial business purpose as demonstrated in the IRS's ruling
practice has been unclear, inconsistent, and overly restrictive.
As a result, the IRS and Treasury Department published Notice 99-19
(1999-1 C.B. 919) soliciting comments on how the rules for obtaining
approval of an adoption, change, or retention in annual accounting
period could be clarified and simplified. In response, commentators
urged the IRS and Treasury Department to expand the categories of
taxpayers that would be granted automatic approval for an annual
accounting period and to revise the substantial business purpose
requirement to broaden the circumstances in which a taxpayer will be
granted approval to change an annual accounting period.
The IRS and Treasury Department believe that the proposed
regulations, in combination with automatic and prior approval
revenue procedures, will clarify the rules governing accounting
periods, expand the circumstances in which taxpayers will be granted
approval (automatically and otherwise), and result in a more clear,
uniform ruling practice.
The proposed regulations continue to provide the general standards
for obtaining approval for an adoption, change, or retention in
annual accounting period: taxpayers must demonstrate the existence
of a "business purpose" and must agree to the terms, conditions, and
adjustments for the adoption, change, or retention. In modifying the
"substantial business purpose" requirement to "business purpose,"
the IRS and Treasury Department intend merely to conform to the
language of the business purpose requirement found in sections
441(i), 706, and 1378 and not to lower the current standard. In
addition, the proposed regulations contain business purpose
guidelines generally applicable to all taxpayers. For example, the
proposed regulations provide the general rule that deferral of
income will not be treated as a business purpose. They also explain
that a taxpayer will have demonstrated a business purpose by
applying to adopt, change to, or retain a year coinciding with its
required taxable year, ownership taxable year, or natural business
year.
The prior approval revenue procedure is intended to provide more
detailed guidance about how a taxpayer's business purpose will be
evaluated, and the terms, conditions, and adjustments that will
apply to an adoption, change, or retention of annual accounting
period. Notice 2001-34, issued concurrently with these proposed
regulations, proposes a revenue procedure that, when finalized, will
provide the rules and procedures applicable to taxpayers who must
apply to the national office to obtain the Commissioner's prior
approval for an adoption, change, or retention. Under the proposed
revenue procedure, the IRS in its ruling practice would no longer
weigh the merit of the taxpayer's stated business purpose against
the amount of distortion of income or other tax consequences
resulting from an adoption, change, or retention. Taxpayers wanting
to adopt, change to, or retain a natural business year generally
would be granted approval (provided they agree to general terms and
conditions) under the proposed revenue procedure as under the
current IRS ruling practice. Also consistent with the current IRS
ruling practice, establishing a natural business year generally will
be the only circumstance under which a partnership, S corporation,
electing S corporation, or PSC will be granted approval. However,
the IRS ruling practice for other taxpayers generally will be
liberalized. These other taxpayers that do not establish a natural
business year generally would be granted approval under the proposed
revenue procedure if they agree to certain additional terms,
conditions, and adjustments designed to neutralize the tax effects
of substantial distortion of income resulting from the change. Under
the IRS's current ruling practice, these other taxpayers generally
would have been denied approval to change their annual accounting
period if the change would have resulted in more than de minimis
distortion of income.
4. Automatic Approval. Under the current regulations, automatic
approval is granted to a C corporation that satisfies certain
conditions through the filing of a statement with the District
Director. Among the requirements for automatic approval are that the
taxpayer not have changed its annual accounting period at any time
within the preceding ten calendar years, and that a C corporation
not elect S corporation status for the taxable year immediately
following the short period. The rules for C corporations contained
in the current regulations are inconsistent with, and generally more
restrictive than, the automatic approval procedures in Rev. Proc.
2000-11. For example, under Rev. Proc. 2000-11, six years (rather
than ten) is the required period of time between automatic changes
and an S corporation election is allowed for the tax year following
the short period. Consequently, the proposed regulations remove the
automatic approval provision contained in the current regulations.
Further, the proposed regulations provide that the procedures to
obtain automatic approval of the Commissioner for an adoption,
change, or retention of annual accounting period generally are
contained in administrative procedures. The IRS and Treasury
Department believe that this structure will allow for the issuance
of more detailed and useful guidance. See, for example, Rev. Proc.
2000-11 (2000-3 I.R.B. 309), which provides procedures for automatic
approval for corporations; Notice 2001- 35, proposing to update and
supersede Rev. Proc. 87-32 (1987-2 C.B. 396), which provides
procedures for automatic approval for partnerships, S corporations,
electing S corporations, and PSCs; and Rev. Proc. 66-50 (1966-2 C.B.
1260), which provides automatic approval provisions for individuals.
As part of the finalization of these proposed regulations and the
proposed revenue procedures contained in Notices 2001-34 and
2001-35, the IRS and Treasury Department intend to update the
procedures in Rev. Proc. 2000-11 to make conforming changes. For
example, Rev. Proc. 2000-11 may be modified to reduce the time
period between automatic changes from six to four years (as proposed
in Notice 2001-34) and to provide audit protection for taxpayers
making voluntary period changes (as proposed in both notices).
5. Obsolete Provisions. The rules relating to partners and
partnerships contained in the current regulations are proposed to be
removed because they have been superseded by the 1986 Act. Updated
rules for partners and partnerships are provided in new proposed
regulations under §1.706-1 contained in this notice of proposed
rulemaking.
Similarly, the rules relating to certain foreign corporations
contained in the current regulations are proposed to be removed
because they have been superseded by section 898. Updated rules for
these foreign corporations are contained in proposed regulations
under section 898.
Finally, the proposed regulations would remove the following
transitional provisions, which are now obsolete:
§§5c.442-1, 5f.442-1, 1.442-2T, and 1.442-3T.
D. Sections 706: Taxable Years of Partners and Partnerships
1. Partnership taxable year.
The current regulations under §1.706-1 have not been updated to
reflect changes made to section 706(b) by the 1986 Act. These
proposed regulations modify the current regulations to reflect the
required taxable year of a partnership consistent with the 1986 Act
and §1.706-1T (regarding the taxable year that results in the
least aggregate deferral of income). The proposed regulations also
remove the procedural aspects of establishing a business purpose and
requesting approval of the Commissioner to adopt or change a taxable
year and instead refer to the procedures in §1.442-1 (including
the administrative procedures prescribed thereunder).
These regulations also propose to remove §1.706-1T. This
removal is not intended to effect a substantive change because the
provisions of §1.706-1T generally are adopted by the proposed
regulations. The IRS and Treasury recently expressed a commitment to
the finalization of §1.706-1T, as well as other previously
proposed regulations under section 706, LR-183-84 (49 FR 47048) and
LR-53-88 (53 FR 19715). See 66 FR 3920, 3922. However, it is
believed that adopting the substantive provisions of §1.706-1T
in the current proposed regulations will promote clarity and
efficiency.
2. Inclusion rule for distributions, sales, and exchanges. Section
1.706-1(a)(2) of the current regulations provides that any gain or
loss from a partnership distribution or from a sale or exchange of
all or part of a partnership interest is includible in the partner's
gross income for the taxable year in which the payment is made. Gain
or loss from a distribution or a sale or exchange of a partnership
interest generally is includible in gross income in the taxable year
in which payment is made, but not always. For example, a partner who
sells his partnership interest in exchange for an installment note
may be able to defer inclusion of the gain from that sale under the
installment method of accounting. Because the IRS and Treasury
Department believe that other provisions of the Code and regulations
provide adequate guidance on the time for including gain or loss
from a partnership distribution or from a sale or exchange of a
partnership interest, the inclusion rule in §1.706-1(a)(2) is
proposed to be removed.
3. Determination of interest in profits and capital. To apply any of
the three required taxable year tests, a partnership must determine
the partners' interests in partnership profits and capital. The
proposed regulations elaborate on the meaning of a partner's
interest in partnership profits and capital for purposes of these
tests. With respect to profits interests, the regulations clarify
that a partner's profits interest is the partner's share of the
taxable income, rather than the book income, of the partnership. The
regulations also clarify that the partners' profits interests are
determined on an annual basis based on the manner in which the
partnership expects to allocate its income for the year. If the
partnership does not expect to have income in the current year, then
the partnership determines the partner's profits interests based on
the manner in which it expects to allocate its income in the first
taxable year in which the partnership expects to have income.
Generally, a partner's interest in partnership capital is determined
through reference to the assets of the partnership that the partner
would be entitled to upon withdrawal from the partnership or upon
the liquidation of the partnership. See, e.g., §1.704-1(e)(v),
Rev. Proc. 93-27 (1993 C.B. 343). As a practical matter, such a
determination will require a valuation of the partnership's assets.
Because the determination under section 706 must be made on an
annual basis, the burden associated with actual valuations may make
it difficult for partnerships to identify their taxable years
quickly and easily. Therefore, for partnerships that maintain
capital accounts in accordance with §1.704-1(b)(2)(iv), these
proposed regulations provide that in making this determination, it
will be reasonable for the partnership to assume that a partner's
interest in partnership capital is the ratio of the partner's
capital account to all partners' capital accounts. The IRS and
Treasury Department are aware that this method will not always be as
precise as an actual valuation, but believe that any imprecision is
outweighed by the strong interest that partnerships have in being
able to easily determine their taxable year.
This definition of a partner's interest in partnership profits and
capital was designed to be compatible with the provisions of, and
policies underlying, section 706(b). Many other sections of the Code
also contain references to a partner's interest in partnership
profits or capital. As those sections address concerns that differ
substantially from the concerns addressed by section 706(b), this
proposed regulation should not be read to create any implication as
to the meaning of a partner's interest in partnership profits and
capital for purposes of those sections.
E. Section 1378: S Corporations
The current regulations under §18.1378-1 describe the permitted
year of an S corporation and provide procedural rules for an S
corporation or electing S corporation to obtain approval to adopt,
change, or retain its taxable year. However, the automatic change
provision contained in these regulations is more restrictive than
the automatic change proposed in Notice 2001-35. For this reason,
and to be consistent with the policy decision to provide the
procedural aspects of adopting, retaining, or changing a taxable
year under §1.442-1 (including the administrative procedures
prescribed thereunder), these regulations propose to modify
§18.1378-1 to remove these procedural rules and instead refer
to §1.442-1.
F. Proposed Effective Date
These regulations are proposed to be applicable for taxable years
ending on or after the date these regulations are published in the
Federal Register as final regulations.
Effect on Other Documents
Rev. Rul. 57-589 is obsolete. Rev. Rul. 65-316 (1965-2 C.B. 149) is
obsolete. Rev. Rul. 68-125 (1968-1 C.B. 189) is obsolete. Rev. Rul.
69-563 is obsolete. Rev. Rul. 74-326 (1974-2 C.B. 142) is obsolete.
Rev. Rul. 78-179 (1978-1 C.B. 132) is obsolete.
Special Analyses
It has been determined that this notice of proposed rulemaking is
not a significant regulatory action as defined in Executive Order
12866. Therefore, a regulatory assessment is not required. It also
has been determined that section 553(b) of the Administrative
Procedure Act (5 U.S.C. chapter 5) does not apply to these
regulations. It is hereby certified that the collection of
information in these regulations will not have a significant
economic impact on a substantial number of small entities. This
certification is based upon the fact that few small entities are
expected to adopt a 52-53 week taxable year, triggering the
collection of information, and that for those who do, the burden
imposed under §1.441-2(b)(1)(ii) will be minimal. Therefore, a
Regulatory Flexibility Analysis under the Regulatory Flexibility Act
(5 U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of
the Internal Revenue Code, this notice of proposed rulemaking will
be submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small business.
Comments and Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any written comments (a signed
original and eight (8) copies) and electronic comments that are
submitted timely to the IRS. The IRS and Treasury Department
specifically request comments on the clarity of the proposed rules
and how they can be made easier to understand. All comments will be
available for public inspection and copying. A public hearing has
been scheduled for October 2, 2001, at 10 a.m., in the IRS
Auditorium , Internal Revenue Building, 1111 Constitution Avenue,
NW., Washington, DC. Due to building security procedures, visitors
must enter at the 10th Street entrance, located between Constitution
and Pennsylvania Avenues, NW. In addition, all visitors must present
photo identification to enter the building. Because of access
restrictions, visitors will not be admitted beyond the immediate
entrance area more than 15 minutes before the hearing starts. For
information about having your name placed on the building access
list to attend the hearing, see the "FOR FURTHER INFORMATION
CONTACT" section of this preamble.
The rules of 26 CFR 601.601(a)(3) apply to the hearing. Persons who
wish to present oral comments at the hearing must submit timely
written or electronic comments and must submit an outline of the
topics to be discussed and the time to be devoted to each topic
(preferably a signed original and eight (8) copies) by September 11,
2001.
A period of 10 minutes will be allocated to each person for making
comments.
An agenda showing the scheduling of the speakers will be prepared
after the deadline for receiving outlines has passed. Copies of the
agenda will be available free of charge at the hearing.
Drafting Information
The principal authors of these regulations are Roy A. Hirschhorn and
Martin Scully, Jr. of the Office of Associate Chief Counsel (Income
Tax and Accounting). However, other personnel from the IRS and
Treasury Department participated in their development.
List of Subjects
26 CFR Parts 1, 5f, and 18
Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 5c
Accounting, Income taxes, Reporting and recordkeeping requirements.
26 CFR Part 301
Administrative practice and procedure, Income taxes.
Proposed Amendments to the Regulations
Accordingly, 26 CFR parts 1, 5c, 5f, 18, and 301 are proposed to be
amended as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. In the list below, for each section indicated in the left
column, remove the old language in the middle column and add the new
language in the right column.
Affected Section |Remove | Add
-----------------------+-----------------------------+------------
1.46-1(p)(2)(iv) |paragraph (b)(1) of 1.441-2 | §1.441-2
-----------------------+-----------------------------+------------
1.48-3(d)(1)(iii) |paragraph (b)(1) of 1.441-2 | §1.441-2
-----------------------+-----------------------------+------------
1.280H-1T(a), last |§1.441-4T(d) | §1.441-3(c)
sentence | |
-----------------------+-----------------------------+------------
1.443-1(b)(1)(ii) |and paragraph (c)(5) of | and §1.441-
|§1.441-2 | 2(b)(2)(ii)
-----------------------+-----------------------------+------------
1.444-1T(a)(1), first |§1.441-4T(d) | §1.441-3(c)
sentence | |
-----------------------+-----------------------------+------------
1.444-2T(a), last |§1.441-4T(d) |§1.441-3(c)
sentence | |
-----------------------+-----------------------------+------------
1.448-1(h)(2)(ii)(B)(1)|§1.441-2T(b)(1) |§1.441-2(c)
-----------------------+-----------------------------+------------
1.469-1(h)(4)(ii)(D) |§1.441-4T(f) |§1.441-3(e)
-----------------------+-----------------------------+------------
1.469-1T(g)(2)(i) |§1.441-3(c) |§1.441-4T(d)
-----------------------+-----------------------------+------------
1.1561-1(c)(2) |See paragraph (b)(1) of |See §1.441-2
|§1.441-2 |
-----------------------+-----------------------------+------------
1.6654-2(a), concluding|paragraph (b) of |§1.441-2(c)
text |§1.441-2 |
-----------------------+-----------------------------+------------
1.6655-2(a)(4), first |paragraph (b) of 1.441-2 |§1.441-2(c)
sentence | |
-----------------------+-----------------------------+------------
301.7701(b)-6(a), third|§1.441-1(e) |§1.441-1(b)
sentence | |
-----------------------+-----------------------------+------------
Par. 3. Sections 1.441-0, 1.441-1, 1.441-2, 1.441-3, and 1.441-4 are
added to read as follows:
§1.441-0 Table of contents.
This section lists the captions contained in §§1.441-1
through 1.441-4 as follows:
§1.441-1 Period for computation of taxable income.
(a) Computation of taxable income.
(1) In general.
(2) Length of taxable year.
(b) General rules and definitions.
(1) Taxable year.
(2) Required taxable year.
(i) In general.
(ii) Exceptions.
(a) 52-53-week taxable years.
(b) Partnerships, S corporations, and PSCs.
(c) Specified foreign corporations.
(3) Annual accounting period.
(4) Calendar year.
(5) Fiscal year.
(i) Definition.
(ii) Recognition.
(6) Grandfathered fiscal year.
(7) Books.
(c) Adoption of taxable year.
(1) In general.
(2) Approval required.
(i) Taxpayers with required taxable years.
(ii) Taxpayers without books.
(d) Retention of taxable year.
(e) Change of taxable year.
(f) Obtaining approval of the Commissioner or making a section 444
election.
§1.441-2 Election of taxable year consisting of 52-53 weeks.
(a) In general.
(1) Election.
(2) Eligible taxpayer
(3) Example.
(b) Procedures to elect a 52-53-week taxable year.
(1) Adoption of a 52-53-week taxable year.
(i) In general.
(ii) Filing requirement.
(2) Change to (or from) a 52-53-week taxable year.
(i) In general.
(ii) Special rules for short period required to effect the change.
(3) Examples.
(c) Application of effective dates.
(1) In general.
(2) Examples.
(3) Changes in tax rates.
(4) Examples.
(d) Computation of taxable income.
(e) Treatment of taxable years ending with reference to the same
calendar month.
(1) Pass-through entities.
(2) Personal service corporations and employee-owners.
(3) Definitions.
(i) Pass-through entity.
(ii) Owner of a pass-through entity.
(4) Examples.
(5) Transition rule.
§1.441-3 Taxable year of a personal service corporation.
(a) Taxable year.
(1) Required taxable year.
(2) Exceptions.
(b) Adoption, change, or retention of taxable year.
(1) Adoption of taxable year.
(2) Change in taxable year.
(3) Retention of taxable year.
(4) Procedures for obtaining approval or making a section 444
election.
(5) Examples.
(c) Personal service corporation defined.
(1) In general.
(2) Testing period.
(i) In general.
(ii) New corporations.
(3) Examples.
(d) Performance of personal services.
(1) Activities described in section 448(d)(2)(A).
(2) Activities not described in section 448(d)(2)(A).
(e) Principal activity.
(1) General rule.
(2) Compensation cost.
(i) Amounts included.
(ii) Amounts excluded.
(3) Attribution of compensation cost to personal service activity.
(i) Employees involved only in the performance of personal services.
(ii) Employees involved only in activities that are not treated as
the performance of personal services.
(iii)Other employees.
(a) Compensation cost attributable to personal service activity.
(b) Compensation cost not attributable to personal service activity.
(f) Services substantially performed by employee-owners.
(1) General rule.
(2) Compensation cost attributable to personal services.
(3) Examples.
(g) Employee-owner defined.
(1) General rule.
(2) Special rule for independent contractors who are owners.
(h) Special rules for affiliated groups filing consolidated returns.
(1) In general.
(2) Examples.
§1.441-4 Effective date.
§1.441-1 Period for computation of taxable income.
(a) Computation of taxable income--
(1) In general. Taxable income must be computed and a return must be
made for a period known as the "taxable year." For rules relating to
methods of accounting, the taxable year for which items of gross
income are included and deductions are taken, inventories, and
adjustments, see parts II and III (section 446 and following),
subchapter E, chapter 1 of the Internal Revenue Code, and the
regulations thereunder.
(2) Length of taxable year. Except as otherwise provided in the
Internal Revenue Code and the regulations thereunder (e.g.,
§1.441-2 regarding 52-53-week taxable years), a taxable year
may not cover a period of more than 12 calendar months.
(b) General rules and definitions. The general rules and definitions
in this paragraph (b) apply for purposes of sections 441 and 442 and
the regulations thereunder.
(1) Taxable year. Taxable year means--
(i) The period for which a return is made, if a return is made for a
period of less than 12 months (short period). See section 443 and
the regulations thereunder;
(ii) Except as provided in paragraph (b)(1)(i) of this section, the
taxpayer's required taxable year (as defined in paragraph (b)(2) of
this section), if applicable;
(iii) Except as provided in paragraphs (b)(1)(i) and (ii) of this
section, the taxpayer's annual accounting period (as defined in
paragraph (b)(3) of this section), if it is a calendar year or a
fiscal year; or
(iv) Except as provided in paragraphs (b)(1)(i) and (ii) of this
section, the calendar year, if the taxpayer keeps no books, does not
have an annual accounting period, or has an annual accounting period
that does not qualify as a fiscal year.
(2) Required taxable year--
(i) In general. Certain taxpayers must use the particular taxable
year that is required under the Internal Revenue Code and the
regulations thereunder (the required taxable year). For example, the
required taxable year is--
(A) In the case of a foreign sales corporation or domestic
international sales corporation, the taxable year determined under
section 441(h) and §1.921-1T(a)(11), (b)(4), and (b)(6);
(B) In the case of a personal service corporation (PSC), the taxable
year determined under section 441(i) and §1.441-3;
(C) In the case of a nuclear decommissioning fund, the taxable year
determined under §1.468A-4(c)(1);
(D) In the case of a designated settlement fund or a qualified
settlement fund, the taxable year determined under
§1.468B-2(j);
(E) In the case of a common trust fund, the taxable year determined
under section 584(i);
(F) In the case of certain trusts, the taxable year determined under
section 644;
(G) In the case of a partnership, the taxable year determined under
section 706 and §1.706-1;
(H) In the case of an insurance company, the taxable year determined
under section 843 and §1.1502-76(a)(2);
(I) In the case of a real estate investment trust, the taxable year
determined under section 859;
(J) In the case of a real estate mortgage investment conduit, the
taxable year determined under section 860D(a)(5) and
§1.860D-1(b) (6);
(K) In the case of a specified foreign corporation, the taxable year
determined under section 898(c) and §§1.898-1 through
1.898-4;
(L) In the case of an S corporation, the taxable year determined
under section 1378 and §1.1378-1; or
(M) In the case of a member of an affiliated group that makes a
consolidated return, the taxable year determined under §1.1502- 76.
(ii) Exceptions. Notwithstanding paragraph (b)(2)(i) of this
section, the following taxpayers may have a taxable year other than
their required taxable year:
(A) 52-53-week taxable years. Certain taxpayers may elect to use a
52-53-week taxable year that ends with reference to their required
taxable year. See, for example, §§1.441-3 (PSCs), 1.706-1
(partnerships), 1.1378-1 (S corporations), and 1.1502- 76(a)(1)
(members of a consolidated group), and 1.898-4(c)(3) (specified
foreign corporations).
(B) Partnerships, S corporations, and PSCs. A partnership, S
corporation, or PSC may use a taxable year other than its required
taxable year if the taxpayer elects a 52-53-week taxable year that
ends with reference to its required taxable year as provided in
paragraph (b)(2)(ii)(A) of this section, elects to use a taxable
year other than its required taxable year under section 444, or
establishes a business purpose to the satisfaction of the
Commissioner under section 442 (such as a grandfathered fiscal
year).
(c) Specified foreign corporations. A specified foreign corporation
(as defined in section 898(b)) may use a taxable year other than its
required taxable year if it elects a 52-53-week taxable year that
ends with reference to its required taxable year as provided in
paragraph (b)(2)(ii)(A) of this section or makes a one-month
deferral election under section 898(c)(1)(B) and §1.898-3(a)(2).
(3) Annual accounting period. Annual accounting period means the
annual period (calendar year or fiscal year) on the basis of which
the taxpayer regularly computes its income in keeping its books.
(4) Calendar year. Calendar year means a period of 12 consecutive
months ending on December 31. A taxpayer who has not established a
fiscal year must make its return on the basis of a calendar year.
(5) Fiscal year--
(i) Definition. Fiscal year means--
(A) A period of 12 consecutive months ending on the last day of any
month other than December; or
(B) A 52-53-week taxable year, if such period has been elected by
the taxpayer. See §1.441-2.
(ii) Recognition. A fiscal year will be recognized only if the books
of the taxpayer are kept in accordance with such fiscal year.
(6) Grandfathered fiscal year. Grandfathered fiscal year means a
fiscal year (other than a year that resulted in a three month or
less deferral of income) that a partnership or an S corporation
received permission to use on or after July 1, 1974, by a letter
ruling (i.e., not by automatic approval).
(7) Books. Books include the taxpayer's regular books of account and
such other records and data as may be necessary to support the
entries on the taxpayer's books and on the taxpayer's return, as for
example, a reconciliation of any difference between such books and
the taxpayer's return. Records that are sufficient to reflect income
adequately and clearly on the basis of an annual accounting period
will be regarded as the keeping of books. See section 6001 and the
regulations thereunder for rules relating to the keeping of books
and records.
(c) Adoption of taxable year--
(1) In general. Except as provided in paragraph (c)(2) of this
section, a new taxpayer may adopt any taxable year that satisfies
the requirements of section 441 and the regulations thereunder
without the approval of the Commissioner. A taxable year of a new
taxpayer is adopted by filing its first federal income tax return
using that taxable year. The filing of an application for automatic
extension of time to file a federal income tax return (e.g., Form
7004), the filing of an application for an employer identification
number (i.e., Form SS4), or the payment of estimated taxes, for a
particular taxable year do not constitute an adoption of that
taxable year.
(2) Approval required--
(i) Taxpayers with required taxable years. A newly-formed
partnership, electing S corporation, or newly-formed PSC that wants
to adopt a taxable year other than its required taxable year, a
52-53-week taxable year that ends with reference to its required
taxable year, or a taxable year elected under section 444, must
establish a business purpose and obtain the approval of the
Commissioner under section 442.
(ii) Taxpayers without books. A taxpayer that must use a calendar
year under section 441(g) and paragraph (f) of this section may not
adopt a fiscal year without obtaining the approval of the
Commissioner.
(d) Retention of taxable year. In certain cases, a partnership, S
corporation, or PSC will be required to change its taxable year
unless it obtains the approval of the Commissioner under section
442, or makes an election under section 444, to retain its current
taxable year. For example, a corporation using a June 30 fiscal year
that either becomes a PSC or elects to be an S corporation and, as a
result, is required to use the calendar year under sections 441(i)
or 1378, respectively, must obtain the approval of the Commissioner
to retain its current fiscal year. Similarly, a partnership using a
taxable year that corresponds to its required taxable year must
obtain the approval of the Commissioner to retain such taxable year
if its required taxable year changes as a result of a change in
ownership. However, a partnership that previously established a
business purpose to the satisfaction of the Commissioner to use a
taxable year is not required to obtain the approval of the
Commissioner if its required taxable year changes as a result of a
change in ownership.
(e) Change of taxable year. Once a taxpayer has adopted a taxable
year, such taxable year must be used in computing taxable income and
making returns for all subsequent years unless the taxpayer obtains
approval from the Commissioner to make a change or the taxpayer is
otherwise authorized to change without the approval of the
Commissioner under the Internal Revenue Code (e.g., section 444 or
section 859) or the regulations thereunder.
(f) Obtaining approval of the Commissioner or making a section 444
election. See §1.442-1(b) for procedures for obtaining approval of
the Commissioner (automatically or otherwise) to adopt, change, or
retain an annual accounting period. See §§1.444-1T and 1.444-2T for
qualifications, and 1.444-3T for procedures, for making an election
under section 444.
§1.441-2 Election of taxable year consisting of 52-53 weeks.
(a) In general--(1) Election. An eligible taxpayer may elect to
compute its taxable income on the basis of a fiscal year that--
(i) Varies from 52 to 53 weeks;
(ii) Ends always on the same day of the week; and
(iii) Ends always on--
(A) Whatever date this same day of the week last occurs in a
calendar month; or
(B) Whatever date this same day of the week falls that is the
nearest to the last day of the calendar month.
(2) Eligible taxpayer. A taxpayer is eligible to elect a 52-53-week
taxable year if such fiscal year would otherwise satisfy the
requirements of section 441 and the regulations thereunder. For
example, a taxpayer that is required to use a calendar year under
§1.441-1(b)(1)(D) is not an eligible taxpayer.
(3) Example. The provisions of this paragraph (a) are illustrated by
the following example: Example. If the taxpayer elects a taxable
year ending always on the last Saturday in November, then for the
year 2001, the taxable year would end on November 24, 2001. On the
other hand, if the taxpayer had elected a taxable year ending always
on the Saturday nearest to the end of November, then for the year
2001, the taxable year would end on December 1, 2001. Thus, in the
case of a taxable year described in paragraph (a)(1)(iii)(A) of this
section, the year will always end within the month and may end on
the last day of the month, or as many as six days before the end of
the month. In the case of a taxable year described in paragraph (a)
(1)(iii)(B) of this section, the year may end on the last day of the
month, or as many as three days before or three days after the last
day of the month.
(b) Procedures to elect a 52-53-week taxable year--
(1)Adoption of a 52-53 week taxable year--
(i) In general. A new eligible taxpayer elects a 52-53-week taxable
year by adopting such year in accordance with §1.441-1(c). A newly-
formed partnership, electing S corporation, or newly-formed personal
service corporation (PSC) may adopt a 52-53-week taxable year
without the approval of the Commissioner if such year ends with
reference to either the taxpayer's required taxable year (as defined
in §1.441-1(b)(2)) or the taxable year elected under section 444.
See §§1.706-1, 1.1378-1 and 1.441-3. Similarly, a newly-formed
specified foreign corporation (as defined in section 898(b)) may
adopt a 52-53-week taxable year if such year ends with reference to
the taxpayer's required taxable year, or, if the one-month deferral
election under section 898(c)(1)(B) is made, with reference to the
month immediately preceding the required taxable year. See
§1.898-4(c)(3). See also §1.1502- 76(a)(1) for special rules
regarding subsidiaries adopting 52-53- week taxable years.
(ii) Filing requirement. A taxpayer adopting a 52-53-week taxable
year must file with its federal income tax return for its first
taxable year a statement containing the following information--
(A) The calendar month with reference to which the new 52-53- week
taxable year ends;
(B) The day of the week on which the 52-53-week taxable year always
will end; and
(C) Whether the 52-53-week taxable year will always end on the date
on which that day of the week last occurs in the calendar month, or
on the date on which that day of the week falls that is nearest to
the last day of that calendar month.
(2) Change to (or from) a 52-53 week taxable year--
(i) In general. An election of a 52-53-week taxable year by an
existing eligible taxpayer with an established taxable year is
treated as a change in annual accounting period that requires the
approval of the Commissioner in accordance with §1.442-1. Thus, a
taxpayer must obtain approval to change from its current taxable
year to a 52-53-week taxable year. Similarly, a taxpayer must obtain
approval to change from a 52-53-week taxable year, or to change from
one 52-53-week taxable year to another 52-53-week taxable year.
However, if a change to a 52-53-week taxable year ends with
reference to the same calendar month as the existing taxable year,
or if a change from a 52-53-week taxable year ends with reference to
the same calendar month as the proposed taxable year, the taxpayer
may obtain approval for the change automatically pursuant to
administrative procedures published by the Commissioner. See
§1.442-1(b) for procedures for obtaining such approval.
(ii) Special rules for the short period required to effect the
change. If a change to or from a 52-53-week taxable year results in
a short period (within the meaning of §1.443-1(a)) of 359 days or
more, or six days or less, the tax computation under §1.443-1(b)
does not apply. If the short period is 359 days or more, it is
treated as a full taxable year. If the short period is six days or
less, such short period is not a separate taxable year but instead
is added to and deemed a part of the following taxable year. (In the
case of a change to or from a 52-53-week taxable year not involving
a change of the month with reference to which the taxable year ends,
the tax computation under §1.443-1(b) does not apply because the
short period will always be 359 days or more, or six days or less.)
In the case of a short period which is more than six days and less
than 359 days, taxable income for the short period is placed on an
annual basis for purposes of §1.443-1(b) by multiplying such income
by 365 and dividing the result by the number of days in the short
period. In such case, the tax for the short period is the same part
of the tax computed on such income placed on an annual basis as the
number of days in the short period is of 365 days (unless
§1.443-1(b)(2), relating to the alternative tax computation,
applies). For an adjustment in deduction for personal exemption, see
§1.443-1(b)(1)(v).
(3) Examples. The following examples illustrate paragraph (b)(2)(ii)
of this section:
Example 1. A taxpayer having a fiscal year ending April 30, obtains
approval to change to a 52-53-week taxable year ending the last
Saturday in April for taxable years beginning after April 30, 2001.
This change involves a short period of 362 days, from May 1, 2001,
to April 27, 2002, inclusive. Because the change results in a short
period of 359 days or more, it is not placed on an annual basis and
is treated as a full taxable year.
Example 2. Assume the same conditions as Example 1, except that the
taxpayer changes for taxable years beginning after April 30, 2002,
to a taxable year ending on the Thursday nearest to April 30. This
change results in a short period of two days, May 1 to May 2, 2002.
Because the short period is less than seven days, tax is not
separately computed. This short period is added to and deemed part
of the following 52-53-week taxable year, which would otherwise
begin on May 3, 2002, and end on May 1, 2003.
(c) Application of effective dates--
(1) In general. Except as provided in paragraph (c)(3) of this
section, for purposes of determining the effective date (e.g., of
legislative or regulatory changes) or the applicability of any
provision of this title that is expressed in terms of taxable years
beginning, including, or ending with reference to the first or last
day of a specified calendar month, a 52-53-week taxable year is
deemed to begin on the first day of the calendar month nearest to
the first day of the 52-53-week taxable year, and is deemed to end
or close on the last day of the calendar month nearest to the last
day of the 52-53-week taxable year, as the case may be. Examples of
provisions of this title, the applicability of which is expressed in
terms referred to in the preceding sentence, include the provisions
relating to the time for filing returns and other documents, paying
tax, or performing other acts, and the provisions of part II,
subchapter B, chapter 6 (section 1561 and following) relating to
surtax exemptions of certain controlled corporations.
(2) Examples. The provisions of paragraph (c)(1) of this section may
be illustrated by the following examples:
Example 1. Assume that an income tax provision is applicable to
taxable years beginning on or after January 1, 2001. For that
purpose, a 52-53-week taxable year beginning on any day within the
period December 26, 2000, to January 4, 2001, inclusive, is treated
as beginning on January 1, 2001.
Example 2. Assume that an income tax provision requires that a
return must be filed on or before the 15th day of the third month
following the close of the taxable year. For that purpose, a 52-53-
week taxable year ending on any day during the period May 25 to June
3, inclusive, is treated as ending on May 31, the last day of the
month ending nearest to the last day of the taxable year, and the
return, therefore, must be made on or before August 15.
Example 3. X, a corporation created on January 1, 2001,elects a
52-53-week taxable year ending on the Friday nearest the end of
December. Thus, X's first taxable year begins on Monday, January 1,
2001, and ends on Friday, December 28, 2001; its next taxable year
begins on Saturday, December 29, 2001, and ends on Friday, January
3, 2003; and its next taxable year begins on Saturday, January 4,
2003, and ends on Friday, January 2, 2004. For purposes of applying
the provisions of Part II, subchapter B, chapter 6 of the Internal
Revenue Code, X's first taxable year is deemed to end on December
31, 2001; its next taxable year is deemed to begin on January 1,
2002, and end on December 31, 2002, and its next taxable year is
deemed to begin on January 1, 2003, and end on December 31, 2003.
Accordingly, each such taxable year is treated as including one and
only one December 31st.
(3) Changes in tax rates. If a change in the rate of tax is
effective during a 52-53-week taxable year (other than on the first
day of such year as determined under paragraph (c)(1) of this
section), the tax for the 52-53-week taxable year must be computed
in accordance with section 15, relating to effect of changes, and
the regulations thereunder. For the purpose of the computation under
section 15, the determination of the number of days in the period
before the change, and in the period on and after the change, is to
be made without regard to the provisions of paragraph (b)(1) of this
paragraph.
(4) Examples. The provisions of paragraph (c)(3) of this section may
be illustrated by the following examples: Example 1. Assume a change
in the rate of tax is effective for taxable years beginning after
June 30, 2002. For a 52-53- week taxable year beginning on Friday,
November 2, 2001, the tax must be computed on the basis of the old
rates for the actual number of days from November 2, 2001, to June
30, 2002, inclusive, and on the basis of the new rates for the
actual number of days from July 1, 2002, to Thursday, October 31,
2002, inclusive.
Example 2. Assume a change in the rate of tax is effective for
taxable years beginning after June 30, 2001. For this purpose, a
52-53-week taxable year beginning on any of the days from June 25 to
July 4, inclusive, is treated as beginning on July 1. Therefore, no
computation under section 15 will be required for such year because
of the change in rate.
(d) Computation of taxable income. The principles of section 451,
relating to the taxable year for inclusion of items of gross income,
and section 461, relating to the taxable year for taking deductions,
generally are applicable to 52-53-week taxable years. Thus, except
as otherwise provided, all items of income and deduction must be
determined on the basis of a 52-53-week taxable year. However, a
taxpayer may determine particular items as though the 52-53-week
taxable year were a taxable year consisting of 12 calendar months,
provided that practice is consistently followed by the taxpayer and
clearly reflects income. For example, an allowance for depreciation
or amortization may be determined on the basis of a 52-53-week
taxable year, or as though the 52-53-week taxable year is a taxable
year consisting of 12 calendar months, provided the taxpayer
consistently follows that practice with respect to all depreciable
or amortizable items.
(e) Treatment of taxable years ending with reference to the same
calendar month--
(1) Pass-through entities. If a pass-through entity (as defined in
paragraph (e)(3)(i) of this section) or an owner of a pass-through
entity (as defined in paragraph (e)(3)(ii) of this section), or
both, use a 52-53-week taxable year and the taxable year of the
pass-through entity and the owner end with reference to the same
calendar month, then, for purposes of determining the taxable year
in which items of income, gain, loss, deductions, or credits from
the pass-through entity are taken into account by the owner of the
pass-through, the owner's taxable year will be deemed to end on the
last day of the pass-through's taxable year. Thus, if the taxable
year of a partnership and a partner end with reference to the same
calendar month, then for purposes of determining the taxable year in
which that partner takes into account items described in section 702
and items that are deductible by the partnership (including items
described in section 707(c)) and includible in the income of that
partner, that partner's taxable year will be deemed to end on the
last day of the partnership's taxable year. Similarly, if the
taxable year of an S corporation and a shareholder end with
reference to the same calendar month, then for purposes of
determining the taxable year in which that shareholder takes into
account items described in section 1366(a) and items that are
deductible by the S corporation and includible in the income of that
shareholder, that shareholder's taxable year will be deemed to end
on the last day of the S corporation's taxable year.
(2) Personal service corporations and employee-owners. If the
taxable year of a PSC (within the meaning of §1.441-3(c)) and an
employee-owner (within the meaning of §1.441-3(g)) end with
reference to the same calendar month, then for purposes of
determining the taxable year in which an employee-owner takes into
account items that are deductible by the PSC and includible in the
income of the employee-owner, the employee-owner's taxable year will
be deemed to end on the last day of the PSC's taxable year.
(3) Definitions--
(i) Pass-through entity. For purposes of this section, a pass-
through entity means a partnership, S corporation, trust, estate,
common trust fund (within the meaning of section 584(i)), controlled
foreign corporation (within the meaning of section 957), foreign
personal holding company (within the meaning of section 552), or
passive foreign investment company that is a qualified electing fund
(within the meaning of section 1295).
(ii) Owner of a pass-through entity. For purposes of this section,
an owner of a pass-through entity means a taxpayer that owns an
interest in, or stock of, a pass-through entity. For example, an
owner of a pass-through entity includes a partner in a partnership,
a shareholder of an S corporation, a beneficiary of a trust or an
estate, a participant in a common trust fund, a U.S. shareholder (as
defined in section 951(b)) of a controlled foreign corporation, a
U.S. shareholder (as defined in section 551(a)) of a foreign
personal holding company, or a U.S. person that holds stock in a
passive foreign investment company that is a qualified electing
fund.
(4) Examples. The provisions of paragraph (e)(2) of this section may
be illustrated by the following examples:
Example 1. ABC Partnership uses a 52-53-week taxable year that ends
on the Wednesday nearest to December 31, and its partners, A, B, and
C, are individual calendar year taxpayers. Assume that, for ABC's
taxable year ending January 3, 2001, each partner's distributive
share of ABC's taxable income is $10,000. Under section 706(a) and
paragraph (e)(1) of this section, for the taxable year ending
December 31, 2000, A, B, and C each must include $10,000 in income
with respect to the ABC year ending January 3, 2001. Similarly, if
ABC makes a guaranteed payment to A on January 2, 2001, A must
include the payment in income for A's taxable year ending December
31, 2000.
Example 2. X, a PSC, uses a 52-53-week taxable year that ends on the
Wednesday nearest to December 31, and all of the employee- owners of
X are individual calendar year taxpayers. Assume that, for its
taxable year ending January 3, 2001, X pays a bonus of $10,000 to
each employee-owner on January 2, 2001. Under paragraph (e)(2) of
this section, each employee-owner must include its bonus in income
for the taxable year ending December 31, 2000.
(5) Transition rule. In the case of an owner of a pass-through
entity (other than the owner of a partnership or S corporation) that
is required by this paragraph (e) to include in income for its first
taxable year ending on or after the date these regulations are
published in the Federal Register as final regulations amounts
attributable to two taxable years of a pass- through entity, the
amount that otherwise would be required to be included in income for
such first taxable year by reason of this paragraph (e) should be
included in income ratably over the four- taxable- year period
beginning with such first taxable year under principles similar to
§1.702-3T, unless the owner of the pass- through elects to
include all such income in its first taxable year ending on or after
the date these regulations are published in the Federal Register as
final regulations. §1.441-3 Taxable year of a personal service
corporation.
(a) Taxable year--
(1) Required taxable year. Except as provided in paragraph (a)(2) of
this section, the taxable year of a personal service corporation
(PSC) (as defined in paragraph (c) of this section) must be the
calendar year.
(2) Exceptions. A PSC may have a taxable year other than its
required taxable year (i.e., a fiscal year) if elects to use a
52-53-week taxable year that ends with reference to the calendar
year, makes an election under section 444, or establishes a business
purpose for such fiscal year and obtains the approval of the
Commissioner under section 442.
(b) Adoption, change, or retention of taxable year--
(1)Adoption of taxable year. A PSC may adopt, in accordance with
§1.441-1(c), the calendar year, a 52-53-week taxable year
ending with reference to the calendar year, or a taxable year
elected under section 444 without the approval of the Commissioner.
See §1.441-1. A PSC that wants to adopt any other taxable year
must establish a business purpose and obtain the approval of the
Commissioner under section 442.
(2) Change in taxable year. A PSC that wants to change its taxable
year must obtain the approval of the Commissioner under section 442
or make an election under section 444. However, a PSC may obtain
automatic approval for certain changes, including a change to the
calendar year or to a 52-53-week taxable year ending with reference
to the calendar year, pursuant to administrative procedures
published by the Commissioner.
(3) Retention of taxable year. In certain cases, a PSC will be
required to change its taxable year unless it obtains the approval
of the Commissioner under section 442, or makes an election under
section 444, to retain its current taxable year. For example, a
corporation using a June 30 fiscal year that becomes a PSC and, as a
result, is required to use the calendar year must obtain the
approval of the Commissioner to retain its current fiscal year.
(4) Procedures for obtaining approval or making a section 444
election. See §1.442-1(b) for procedures to obtain the approval
of the Commissioner (automatically or otherwise) to adopt, change,
or retain a taxable year. See §§1.444-1T and 1.444-2T for
qualifications, and 1.444-3T for procedures, for making an election
under section 444.
(5) Examples. The provisions of paragraph (b)(4) of this section may
be illustrated by the following examples:
Example 1. X, whose taxable year ends on January 31, 2001, becomes a
PSC for its taxable year beginning February 1, 2001, and does not
obtain the approval of the Commissioner for using a fiscal year.
Thus, for taxable years ending before February 1, 2001, this section
does not apply with respect to X. For its taxable year beginning on
February 1, 2001, however, X will be required to comply with
paragraph (a) of this section. Thus, unless X obtains approval of
the Commissioner to use a January 31 taxable year, or makes a
section 444 election, X will be required to change its taxable year
to the calendar year under paragraph (b) of this section by using a
short taxable year that begins on February 1, 2001, and ends on
December 31, 2001. Under paragraph (b)(1) of this section, X may
obtain automatic approval to change its taxable year to a calendar
year. See §1.442-1(b).
Example 2. Assume the same facts as in Example 1, except that X
desires to change to a 52-53-week taxable year ending with reference
to the month of December. Under paragraph (b)(1) of this section X
may obtain automatic approval to make the change. See
§1.442-1(b).
(c) Personal service corporation defined--
(1) In general. For purposes of this section and section 442, a
taxpayer is a PSC for a taxable year only if--
(i) The taxpayer is a C corporation (as defined in section 1361(a)
(2)) for the taxable year;
(ii) The principal activity of the taxpayer during the testing
period is the performance of personal services;
(iii) During the testing period, those services are substantially
performed by employee-owners (as defined in paragraph (g) of this
section); and
(iv) Employee-owners own (as determined under the attribution rules
of section 318, except that "any" applies instead of "50 percent" in
section 318(a)(2)(C)) more than 10 percent of the fair market value
of the outstanding stock in the taxpayer on the last day of the
testing period.
(2) Testing period--
(i) In general. Except as otherwise provided in paragraph (c)(2)(ii)
of this section, the testing period for any taxable year is the
immediately preceding taxable year.
(ii) New corporations. The testing period for a taxpayer's first
taxable year is the period beginning on the first day of that
taxable year and ending on the earlier of--
(A) The last day of that taxable year; or
(B) The last day of the calendar year in which that taxable year
begins.
(3) Examples. The provisions of paragraph (c)(2)(ii) of this section
may be illustrated by the following examples:
Example 1. Corporation A's first taxable year begins on June 1,
2001, and A desires to use a September 30 taxable year. However, if
A is a personal service corporation, it must obtain the
Commissioner's approval to use a September 30 taxable year. Pursuant
to paragraph (c)(2)(ii) of this section, A's testing period for its
first taxable year beginning June 1, 2001, is the period June 1,
2001 through September 30, 2001. Thus, if, based upon such testing
period, A is a personal service corporation, A must obtain the
Commissioner's permission to use a September 30 taxable year.
Example 2. The facts are the same as in Example 1, except that A
desires to use a March 31 taxable year. Pursuant to paragraph (c)(2)
(ii) of this section, A's testing period for its first taxable year
beginning June 1, 2001, is the period June 1, 2001, through December
31, 2001. Thus, if, based upon such testing period, A is a personal
service corporation, A must obtain the Commissioner's permission to
use a March 31 taxable year.
(d) Performance of personal services--
(1) Activities described in section 448(d)(2)(A). For purposes of
this section, any activity of the taxpayer described in section
448(d)(2)(A) or the regulations thereunder will be treated as the
performance of personal services. Therefore, any activity of the
taxpayer that involves the performance of services in the fields of
health, law, engineering, architecture, accounting, actuarial
science, performing arts, or consulting (as such fields are defined
in §1.448-1T) will be treated as the performance of personal
services for purposes of this section.
(2) Activities not described in section 448(d)(2)(A). For purposes
of this section, any activity of the taxpayer not described in
section 448(d)(2)(A) or the regulations thereunder will not be
treated as the performance of personal services.
(e) Principal activity--
(1) General rule. For purposes of this section, the principal
activity of a corporation for any testing period will be the
performance of personal services if the cost of the corporation's
compensation (the compensation cost) for such testing period that is
attributable to its activities that are treated as the performance
of personal services within the meaning of paragraph (d) of this
section (i.e., the total compensation for personal service
activities) exceeds 50 percent of the corporation's total
compensation cost for such testing period.
(2) Compensation cost--
(i) Amounts included. For purposes of this section, the compensation
cost of a corporation for a taxable year is equal to the sum of the
following amounts allowable as a deduction, allocated to a long-term
contract, or otherwise chargeable to a capital account by the
corporation during such taxable year--
(A) Wages and salaries; and
(B) Any other amounts, attributable to services performed for or on
behalf of the corporation by a person who is an employee of the
corporation (including an owner of the corporation who is treated as
an employee under paragraph (g)(2) of this section) during the
testing period. Such amounts include, but are not limited to,
amounts attributable to deferred compensation, commissions, bonuses,
compensation includible in income under section 83, compensation for
services based on a percentage of profits, and the cost of providing
fringe benefits that are includible in income.
(ii) Amounts excluded. Notwithstanding paragraph (e)(2)(i) of this
section, compensation cost does not include amounts attributable to
a plan qualified under section 401(a) or 403(a), or to a simplified
employee pension plan defined in section 408(k).
(3) Attribution of compensation cost to personal service activity--
(i) Employees involved only in the performance of personal services.
The compensation cost for employees involved only in the performance
of activities that are treated as personal services under paragraph
(d) of this section, or employees involved only in supporting the
work of such employees, are considered to be attributable to the
corporation's personal service activity.
(ii) Employees involved only in activities that are not treated as
the performance of personal services. The compensation cost for
employees involved only in the performance of activities that are
not treated as personal services under paragraph (d) of this
section, or for employees involved only in supporting the work of
such employees, are not considered to be attributable to the
corporation's personal service activity.
(iii) Other employees. The compensation cost for any employee who is
not described in either paragraph (e)(3)(i) or paragraph (e)(3)(ii)
of this section (a mixed-activity employee) is allocated as
follows--
(A) Compensation cost attributable to personal service activity.
That portion of the compensation cost for a mixed activity employee
that is attributable to the corporation's personal service activity
equals the compensation cost for that employee multiplied by the
percentage of the total time worked for the corporation by that
employee during the year that is attributable to activities of the
corporation that are treated as the performance of personal services
under paragraph (d) of this section. That percentage is to be
determined by the taxpayer in any reasonable and consistent manner.
Time logs are not required unless maintained for other purposes;
(B) Compensation cost not attributable to personal service activity.
That portion of the compensation cost for a mixed activity employee
that is not considered to be attributable to the corporation's
personal service activity is the compensation cost for that employee
less the amount determined in paragraph (e)(3)(iii)(A) of this
section.
(f) Services substantially performed by employee-owners--
(1)General rule. Personal services are substantially performed
during the testing period by employee-owners of the corporation if
more than 20 percent of the corporation's compensation cost for that
period attributable to its activities that are treated as the
performance of personal services within the meaning of paragraph (d)
of this section (i.e., the total compensation for personal service
activities) is attributable to personal services performed by
employee-owners.
(2) Compensation cost attributable to personal services. For
purposes of paragraph (f)(1) of this section--
(i) The corporation's compensation cost attributable to its
activities that are treated as the performance of personal services
is determined under paragraph (e)(3) of this section; and
(ii) The portion of the amount determined under paragraph (f)(2)(i)
of this section that is attributable to personal services performed
by employee-owners is to be determined by the taxpayer in any
reasonable and consistent manner.
(3) Examples. The provisions of this paragraph (f) may be
illustrated by the following examples:
Example 1. For its taxable year beginning February 1, 2001, Corp A's
testing period is the taxable year ending January 31, 2000. During
that testing period, A's only activity was the performance of
personal services. The total compensation cost of A (including
compensation cost attributable to employee-owners) for the testing
period was $1,000,000. The total compensation cost attributable to
employee-owners of A for the testing period was $210,000. Pursuant
to paragraph (f)(1) of this section, the employee-owners of A
substantially performed the personal services of A during the
testing period because the compensation cost of A's employee-owners
was more than 20 percent of the total compensation cost for all of
A's employees (including employee- owners).
Example 2. Corp B has the same facts as corporation A in Example 1,
except that during the taxable year ending January 31, 2001, B also
participated in an activity that would not be characterized as the
performance of personal services under this section. The total
compensation cost of B (including compensation cost attributable to
employee-owners) for the testing period was $1,500,000 ($1,000,000
attributable to B's personal service activity and $500,000
attributable to B's other activity). The total compensation cost
attributable to employee-owners of B for the testing period was
$250,000 ($210,000 attributable to B's personal service activity and
$40,000 attributable to B's other activity). Pursuant to paragraph
(f)(1) of this section, the employee-owners of B substantially
performed the personal services of B during the testing period
because more than 20 percent of B's compensation cost during the
testing period attributable to its personal service activities was
attributable to personal services performed by employee-owners
($210,000).
(g) Employee-owner defined--
(1) General rule. For purposes of this section, a person is an
employee-owner of a corporation for a testing period if--
(i) The person is an employee of the corporation on any day of the
testing period; and (ii) The person owns any outstanding stock of
the corporation on any day of the testing period.
(2) Special rule for independent contractors who are owners. Any
person who is an owner of the corporation within the meaning of
paragraph (g)(1)(ii) of this section and who performs personal
services for, or on behalf of, the corporation is treated as an
employee for purposes of this section, even if the legal form of
that person's relationship to the corporation is such that the
person would be considered an independent contractor for other
purposes.
(h) Special rules for affiliated groups filing consolidated
returns--
(1) In general. For purposes of applying this section to the members
of an affiliated group of corporations filing a consolidated return
for the taxable year--
(i) The members of the affiliated group are treated as a single
corporation;
(ii) The employees of the members of the affiliated group are
treated as employees of such single corporation; and
(iii) All of the stock of the members of the affiliated group that
is not owned by any other member of the affiliated group is treated
as the outstanding stock of that corporation.
(2) Examples. The provisions of this paragraph (h) may be
illustrated by the following examples:
Example 1. The affiliated group AB, consisting of corporation A and
its wholly owned subsidiary B, filed a consolidated Federal income
tax return for the taxable year ending January 31, 2001, and AB is
attempting to determine whether it is affected by this section for
its taxable year beginning February 1, 2001. During the testing
period (i.e., the taxable year ending January 31, 2001), A did not
perform personal services. However, B's only activity was the
performance of personal services. On the last day of the testing
period, employees of A did not own any stock in A. However, some of
B's employees own stock in A. In the aggregate, B's employees own 9
percent of A's stock on the last day of the testing period. Pursuant
to paragraph (h)(1) of this section, this section is effectively
applied on a consolidated basis to members of an affiliated group
filing a consolidated federal income tax return. Because the only
employee-owners of AB are the employees of B, and because B's
employees do not own more than 10 percent of AB on the last day of
the testing period, AB is not a PSC subject to the provisions of
this section. Thus, AB is not required to determine on a
consolidated basis whether, during the testing period, its principal
activity is the providing of personal services, or the personal
services are substantially performed by employee-owners.
Example 2. The facts are the same as in Example 1, except that on
the last day of the testing period A owns only 80 percent of B. The
remaining 20 percent of B is owned by employees of B. The fair
market value of A, including its 80 percent interest in B, as of the
last day of the testing period, is $1,000,000. In addition, the fair
market value of the 20 percent interest in B owned by B's employees
is $50,000 as of the last day of the testing period. Pursuant to
paragraphs (c)(1)(iv) and paragraph (h)(1) of this section, AB must
determine whether the employee- owners of A and B (i.e., B's
employees) own more than 10 percent of the fair market value of A
and B as of the last day of the testing period. Because the $140,000
[($1,000,000 x .09) + $50,000] fair market value of the stock held
by B's employees is greater than 10 percent of the aggregate fair
market value of A and B as of the last day of the testing period, or
$105,000 [$1,000,000 + $50,000 x .10], AB may be subject to this
section if, on a consolidated basis during the testing period, the
principal activity of AB is the performance of personal services and
the personal services are substantially performed by employee-
owners.
§1.441-4 Effective date.
Sections 1.441-0 through 1.441-3 are applicable for taxable years
ending on or after the date these regulations are published in the
Federal Register as final regulations.
§§1.441-1T, 1.441-2T, 1.441-3T and 1.441-4T [Removed]
Par. 4. Sections 1.441-1T, 1.441-2T, 1.441-3T and 1.441-4T are
removed.
Par 5. Section 1.442-1 is revised to read as follows: §1.442-1
Change of annual accounting period.
(a) Approval of the Commissioner. A taxpayer that has adopted an
annual accounting period (as defined in §1.441- 1(b)(3)) as its
taxable year generally must continue to use that annual accounting
period in computing its taxable income and for making its federal
income tax returns. If the taxpayer wants to change its annual
accounting period and use a new taxable year, it must obtain the
approval of the Commissioner, unless it is otherwise authorized to
change without the approval of the Commissioner under either the
Internal Revenue Code (e.g., section 444 and section 859) or the
regulations thereunder (e.g., paragraph (c) of this section). In
addition, as described in §1.441-1(c) and (d), a partnership, S
corporation, electing S corporation, or personal service corporation
(PSC) generally is required to secure the approval of the
Commissioner to adopt or retain an annual accounting period other
than its required taxable year. The manner of obtaining approval
from the Commissioner to adopt, change, or retain an annual
accounting period is provided in paragraph (b) of this section.
However, special rules for obtaining approval may be provided in
other sections.
(b) Obtaining approval--(1) Time and manner for requesting approval.
Except as otherwise provided in paragraph (b)(3) of this section, in
order to secure the approval of the Commissioner to adopt, change,
or retain an annual accounting period, a taxpayer must file an
application, generally on Form 1128 (Application To Adopt, Change,
or Retain a Tax Year), with the Commissioner. The Form 1128 must be
filed no earlier than the day following the close of the first
taxable year in which the taxpayer wants the adoption, change, or
retention to be effective (the first effective year) and no later
than the 15th day of the third calendar month following the close of
the first effective year. However, in the case of a change that
results in a short period of six days or less, the Form 1128 must be
filed no later than the 15th day of the third calendar month
following the close of the short period, even though the short
period is not treated as a separate taxable year under
§1.441-2(b) (2).
(2) General requirements for approval. Except as provided in
paragraph (b)(3) of this section, an adoption, change, or retention
in annual accounting period will be approved where the taxpayer
establishes a business purpose for the requested annual accounting
period and agrees to the Commissioner's prescribed terms,
conditions, and adjustments for effecting the adoption, change, or
retention. In determining whether a taxpayer has established a
business purpose and which terms, conditions, and adjustments will
be required, consideration will be given to all the facts and
circumstances relating to the adoption, change, or retention,
including the tax consequences resulting therefrom.
Generally, the requirement of a business purpose will be satisfied,
and adjustments to neutralize any tax consequences will not be
required, if the requested annual accounting period coincides with
the taxpayer's required taxable year (as defined in §1.441-1(b)
(2)), ownership taxable year, or natural business year. In the case
of a partnership, S corporation, electing S corporation, or PSC,
deferral of income to partners, shareholders, or employee-owners
will not be treated as a business purpose.
(3) Administrative procedures. Notwithstanding the provisions of
paragraphs (b)(1) and (2) of this section, the Commissioner may
prescribe administrative procedures under which a taxpayer will be
permitted to adopt, change, or retain an annual accounting period.
These administrative procedures will describe the business purpose
requirements (including an ownership taxable year and a natural
business year) and the terms, conditions, and adjustments necessary
to obtain approval. Such terms, conditions, and adjustments may
include adjustments necessary to neutralize the tax effects of a
substantial distortion of income that would otherwise result from
the requested annual accounting period including: a deferral of a
substantial portion of the taxpayer's income, or shifting of a
substantial portion of deductions, from one taxable year to another;
a similar deferral or shifting in the case of any other person, such
as a beneficiary in an estate; the creation of a short period in
which there is a substantial net operating loss, capital loss, or
credit (including a general business credit); or the creation of a
short period in which there is a substantial amount of income to
offset an expiring net operating loss, capital loss, or credit. See,
for example, Notice 2001-34 (2001- 23 I.R.B. 1302), procedures to
obtain the Commissioner's prior approval of an adoption, change, or
retention in annual accounting period through application to the
national office; Rev. Proc. 2000-11 (2000-3 I.R.B. 309), automatic
approval procedures for certain corporations; Notice 2001-35
(2001-23 I.R.B. 1314), automatic approval procedures for
partnerships, S corporations, electing S corporations, and PSCs; and
Rev. Proc. 66-50 (1966-2 C.B. 1260), automatic approval procedures
for individuals. For availability of Revenue Procedures and Notices,
see §601.601(d)(2) of this chapter.
(4) Taxpayers to whom section 441(g) applies. If section 441(g) and
§1.441-1(b)(1)(iv) apply to a taxpayer, the adoption of a
fiscal year is treated as a change in the taxpayer's annual
accounting period under section 442. Therefore, that fiscal year can
become the taxpayer's taxable year only with the approval of the
Commissioner. In addition to any other terms and conditions that may
apply to such a change, the taxpayer must establish and maintain
books that adequately and clearly reflect income for the short
period involved in the change and for the fiscal year proposed.
(c) Special rule for change of annual accounting period by
subsidiary corporation. A subsidiary corporation that is required to
change its annual accounting period under §1.1502-76, relating
to the taxable year of members of an affiliated group that file a
consolidated return, does not need to obtain the approval of the
Commissioner or file an application on Form 1128 with respect to
that change.
(d) Special rule for newly married couples.
(1) A newly married husband or wife may obtain automatic approval
under this paragraph (d) to change his or her annual accounting
period in order to use the annual accounting period of the other
spouse so that a joint return may be filed for the first or second
taxable year of that spouse ending after the date of marriage. Such
automatic approval will be granted only if the newly married husband
or wife adopting the annual accounting period of the other spouse
files a federal income tax return for the short period required by
that change on or before the 15th day of the 4th month following the
close of the short period. See section 443 and the regulations
thereunder. If the due date for any such short-period return occurs
before the date of marriage, the first taxable year of the other
spouse ending after the date of marriage cannot be adopted under
this paragraph (d). The short- period return must contain a
statement at the top of page one of the return that it is filed
under the authority of this paragraph (d). The newly married husband
or wife need not file Form 1128 with respect to a change described
in this paragraph (d). For a change of annual accounting period by a
husband or wife that does not qualify under this paragraph (d), see
paragraph (b) of this section.
(2) The provisions of this paragraph (d) may be illustrated by the
following example:
Example. H & W marry on September 25, 2001. H is on a fiscal year
ending June 30, and W is on a calendar year. H wishes to change to a
calendar year in order to file joint returns with W. W's first
taxable year after marriage ends on December 31, 2001. H may not
change to a calendar year for 2001 since, under this paragraph (d),
he would have had to file a return for the short period from July 1
to December 31, 2000, by April 16, 2001. Since the date of marriage
occurred subsequent to this due date, the return could not be filed
under this paragraph (d). Therefore, H cannot change to a calendar
year for 2001. However, H may change to a calendar year for 2002 by
filing a return under this paragraph (d) by April 15, 2002, for the
short period from July 1 to December 31, 2001. If H files such a
return, H and W may file a joint return for calendar year 2002
(which is W's second taxable year ending after the date of
marriage).
(e) Effective date. The rules of this section are applicable for
taxable years ending on or after the date these regulations are
published in the Federal Register as final regulations.
§§1.442-2T and 1.442-3T [Removed]
Par. 6. Sections 1.442-2T and 1.442-3T are removed.
Par. 7. Section 1.706-1 is amended by revising paragraphs (a) and
(b) and adding paragraph (d) to read as follows:
§1.706-1 Taxable years of partner and partnership.
(a) Year in which partnership income is includible.
(1) In computing taxable income for a taxable year, a partner is
required to include the partner's distributive share of partnership
items set forth in section 702 and the regulations thereunder for
any partnership taxable year ending within or with the partner's
taxable year. A partner must also include in taxable income for a
taxable year guaranteed payments under section 707(c) that are
deductible by the partnership under its method of accounting in the
partnership taxable year ending within or with the partner's taxable
year.
(2) The rules of this paragraph (a)(1) may be illustrated by the
following example:
Example. Partner A reports his income using a calendar year, while
the partnership of which he is a member reports its income using a
fiscal year ending May 31. The partnership reports its income and
deductions under the cash method of accounting. During the
partnership taxable year ending May 31, 2002, the partnership makes
guaranteed payments of $120,000 to A for services and for the use of
capital. Of this amount, $70,000 was paid to A between June 1 and
December 31, 2001, and the remaining $50,000 was paid to A between
January 1 and May 31, 2002. The entire $120,000 paid to A is
includible in A's taxable income for the calendar year 2002
(together with A's distributive share of partnership items set forth
in section 702 for the partnership taxable year ending May 31,
2002).
(3) If a partner receives distributions under section 731 or sells
or exchanges all or part of a partnership interest, any gain or loss
arising therefrom does not constitute partnership income.
(b) Taxable year--
(1) Partnership treated as a taxpayer. The taxable year of a
partnership must be determined as though the partnership were a
taxpayer.
(2) Partnership's taxable year--
(i) Required taxable year. Except as provided in paragraph (b)(2)
(ii) of this section, the taxable year of a partnership must be--
(A) The majority interest taxable year, as defined in section 706(b)
(4);
(B) If there is no majority interest taxable year, the taxable year
of all of the principal partners of the partnership, as defined in
706(b)(3) (the principal partners' taxable year); or;
(C) If there is no majority interest taxable year or principal
partners' taxable year, the taxable year that produces the least
aggregate deferral of income as determined under §1.706-1(b)(3).
(ii) Exceptions. A partnership may have a taxable year other than
its required taxable year if it elects to use a 52-53-week taxable
year that ends with reference to its required taxable year, makes an
election under section 444, or establishes a business purpose for
such taxable year and obtains approval of the Commissioner under
section 442.
(3) Least aggregate deferral--
(i) Taxable year that results in the least aggregate deferral of
income. The taxable year that results in the least aggregate
deferral of income will be the taxable year of one or more of the
partners in the partnership which will result in the least aggregate
deferral of income to the partners. The aggregate deferral for a
particular year is equal to the sum of the products determined by
multiplying the month(s) of deferral for each partner that would be
generated by that year and each partner's interest in partnership
profits for that year. The partner's taxable year that produces the
lowest sum when compared to the other partner's taxable years is the
taxable year that results in the least aggregate deferral of income
to the partners. If the calculation results in more than one taxable
year qualifying as the taxable year with the least aggregate
deferral, the partnership may select any one of those taxable years
as its taxable year. However, if one of the qualifying taxable years
is also the partnership's existing taxable year, the partnership
must maintain its existing taxable year. The determination of the
taxable year that results in the least aggregate deferral of income
generally must be made as of the beginning of the partnership's
current taxable year. The district director, however, may determine
that the first day of the current taxable year is not the
appropriate testing day and require the use of some other day or
period that will more accurately reflect the ownership of the
partnership and thereby the actual aggregate deferral to the
partners where the partners engage in a transaction that has as its
principal purpose the avoidance of the principles of this section.
Thus, for example the preceding sentence would apply where there is
a transfer of an interest in the partnership that results in a
temporary transfer of that interest principally for purposes of
qualifying for a specific taxable year under the principles of this
section. For purposes of this section, deferral to each partner is
measured in terms of months from the end of the partnership's
taxable year forward to the end of the partner's taxable year.
(ii) Determination of the taxable year of a partner or partnership
that uses a 52-53 week taxable year. For purposes of the calculation
described in paragraph (b)(3)(i) of this section, the taxable year
of a partner or partnership that uses a 52-53 week taxable year must
be the same year determined under the rules of section 441(f) and
the regulations thereunder with respect to the inclusion of income
by the partner or partnership.
(iii) Special de minimis rule. If the taxable year that results in
the least aggregate deferral produces an aggregate deferral that is
less than .5 when compared to the aggregate deferral of the current
taxable year, the partnership's current taxable year will be treated
as the taxable year with the least aggregate deferral. Thus, the
partnership will not be permitted to change its taxable year.
(iv) Examples. The principles of this section may be illustrated by
the following examples:
Example 1. Partnership P is on a fiscal year ending June 30. Partner
A reports income on the fiscal year ending June 30 and Partner B
reports income on the fiscal year ending July 31. A and B each have
a 50 percent interest in partnership profits. For its taxable year
beginning July 1, 1987, the partnership will be required to retain
its taxable year since the fiscal year ending June 30 results in the
least aggregate deferral of income to the partners. This
determination is made as follows:
Test 6/30 Year End Interest in Months of Interest
Partnership Deferral for x Deferral
Profits 6/30 Year
End
Partner A 6/30 .5 0 0
Partner B 7/31 .5 1 .5
----------
Aggregate deferral .5
Test 7/31 Year End Interest in Months of Interest
Partnership Deferral for x Deferral
Profits 7/31 Year
End
Partner A 6/30 .5 11 5.5
Partner B 7/31 .5 0 0
----------
Aggregate deferral 5.5
Example 2. The facts are the same as in Example 1 except that A
reports income on the calendar year and B reports on the fiscal year
ending November 30. For the partnership's taxable year beginning
July 1, 1987, the partnership is required to change its taxable year
to a fiscal year ending November 30 because such year results in the
least aggregate deferral of income to the partners. This
determination is made as follows:
Test 12/31 Year End Interest in Months of Interest
Partnership Deferral for x Deferral
Profits 12/31 Year
End
Partner A 12/31 .5 0 0
Partner B 11/30 .5 11 5.5
----------
Aggregate deferral 5.5
Test 11/30 Year End Interest in Months of Interest
Partnership Deferral for x Deferral
Profits 11/30 Year
End
Partner A 12/31 .5 1 .5
Partner B 11/30 .5 0 0
----------
Aggregate deferral .5
Example 3. The facts are the same as in Example 2 except that B
reports income on the fiscal year ending June 30. For the
partnership's taxable year beginning July 1, 1987, each partner's
taxable year will result in identical aggregate deferral of income.
If the partnership's current taxable year was neither a fiscal year
ending June 30 nor the calendar year, the partnership would select
either the fiscal year ending June 30 or the calendar year as its
taxable year. However, since the partnership's current taxable year
ends June 30, it must retain its current taxable year. The
determination is made as follows:
Test 12/31 Year End Interest in Months of Interest
Partnership Deferral for x Deferral
Profits 12/31 Year
End
Partner A 12/31 .5 0 0
Partner B 6/30 .5 6 3.0
----------
Aggregate deferral 3.0
Test 6/30 Year End Interest in Months of Interest
Partnership Deferral for x Deferral
Profits 6/30 Year
End
Partner A 12/31 .5 6 3.0
Partner B 6/30 .5 0 0
----------
Aggregate deferral 3.0
Example 4. The facts are the same as in Example 1 except that on
December 31, 1987, partner A sells a 4 percent interest in the
partnership to Partner C, who reports income on the fiscal year
ending June 30, and a 40 percent interest in the partnership to
Partner D, who also reports income on the fiscal year ending June
30. The taxable year beginning July 1, 1987, is unaffected by the
sale. However, for the taxable year beginning July 31, 1988, the
partnership must determine the taxable year resulting in the least
aggregate deferral as of July 1, 1988. In this case, the partnership
will be required to retain its taxable year since the fiscal year
ending June 30 continues to be the taxable year that results in the
least aggregate deferral of income to the partners.
Example 5. The facts are the same as in Example 4 except that
Partner D reports income on the fiscal year ending April 30. As in
Example 4, the taxable year during which the sale took place is
unaffected by the shifts in interests. However, for its taxable year
beginning July 1, 1988, the partnership will be required to change
its taxable year to the fiscal year ending April 30. This
determination is made as follows:
Test 7/31 Year End Interest in Months of Interest
Partnership Deferral for x Deferral
Profits 7/31 Year
End
Partner A 6/30 .06 11 .66
Partner B 7/31 .5 0 0
Partner C 6/30 .04 11 .44
Partner D 4/30 .4 9 3.60
-----------
Aggregate deferral 4.70
Test 6/30 Year End Interest in Months of Interest
Partnership Deferral for x Deferral
Profits 6/30 Year
End
Partner A 6/30 .06 0 0
Partner B 7/31 .5 1 .5
Partner C 6/30 .04 0 0
Partner D 4/30 .4 10 4.0
----------
Aggregate deferral 4.5
Test 4/30 Year End Interest in Months of Interest
Partnership Deferral for x Deferral
Profits 4/30 Year
End
Partner A 6/30 .06 2 .12
Partner B 7/31 .5 3 1.50
Partner C 6/30 .04 2 .08
Partner D 4/30 .4 0 0
----------
Aggregate deferral 1.70
§1.706-1(b)(3)
Test: Current taxable year (June 30) 4.5
Less: Taxable year producing the least
aggregate deferral (April 30) 1.7
-------
Additional aggregate deferral (greater than .5) 2.8
Example 6.
(i) Partnership P has two partners, A who reports income on the
fiscal year ending March 31, and B who reports income on the fiscal
year ending July 31. A and B share profits equally. P has determined
its taxable year under §1.706- 1(b)(3) to be the fiscal year ending
March 31 as follows:
Test 3/31 Year End Interest in Deferral for Interest
Partnership 3/31 Year x Deferral
Profits End
Partner A 3/31 .5 0 0
Partner B 7/31 .5 4 2
--------
Aggregate deferral 2
Test 7/31 Year End Interest in Deferral for Interest
Partnership 7/31 Year x Deferral
Profits End
Partner A 3/31 .5 8 4
Partner B 7/31 .5 0 0
---------
Aggregate deferral 4
(ii) In May 1988, Partner A sells a 45 percent interest in the
partnership to C, who reports income on the fiscal year ending April
30. For the taxable period beginning April 1, 1989, the fiscal year
ending April 30 is the taxable year that produces the least
aggregate deferral of income to the partners. However, under
paragraph (b)(3)(iii) of this section the partnership is required to
retain its fiscal year ending March 31. This determination is made
as follows:
Test 3/31 Year End Interest in Deferral for Interest
Partnership 3/31 Year x Deferral
Profits End
Partner A 3/31 .05 0 0
Partner B 7/31 .5 4 2.0
Partner C 4/30 .45 1 .45
----------
Aggregate deferral 2.45
Test 7/31 Year End Interest in Deferral for Interest
Partnership 7/31 Year x Deferral
Profits End
Partner A 3/31 .05 8 .40
Partner B 7/31 .5 0 0
Partner C 4/30 .45 9 4.05
---------
Aggregate deferral 4.45
Test 4/30 Year End Interest in Deferral for Interest
Partnership 4/30 Year x Deferral
Profits End
Partner A 3/31 .05 11 .55
Partner B 7/31 .5 3 1.50
Partner C 4/30 .45 0 0
---------
Aggregate deferral 2.05
§1.706-1(b)(3) Test:
Current taxable year (3/31) 2.45
Less: Taxable year producing the least
aggregate deferral (4/30). 2.05
---------
Additional aggregate deferral (less than .5) .40
(4) Measurement of partner's profits and capital interest--
(i) In general. The rules of this paragraph (b)(4) apply in
determining the majority interest taxable year, the principal
partners' taxable year, and the least aggregate deferral taxable
year.
(ii) Profits interest--
(A) In general. For purposes of section 706(b), a partner's interest
in partnership profits is generally the partner's percentage share
of partnership profits for the current partnership taxable year. If
the partnership does not expect to have net income for the current
partnership taxable year, then a partner's interest in partnership
profits instead must be the partner's percentage share of
partnership net income for the first taxable year in which the
partnership expects to have net income.
(B) Percentage share of partnership net income. The partner's
percentage share of partnership net income for a partnership taxable
year is the ratio of: the partner's distributive share of
partnership net income for the taxable year, to the partnership's
net income for the year. If a partner's percentage share of
partnership net income for the taxable year depends on the amount or
nature of partnership income for that year (due to, for example,
preferred returns or special allocations of specific partnership
items), then the partnership must make a reasonable estimate of the
amount and nature of its income for the taxable year. This estimate
must be based on all facts and circumstances known to the
partnership as of the first day of the current partnership taxable
year. The partnership must then use this estimate in determining the
partners' interests in partnership profits for the taxable year.
(C) Distributive share. For purposes of this paragraph (b)(4)(ii), a
partner's distributive share of partnership net income is determined
by taking into account all rules and regulations affecting that
determination, including, without limitation, section 704(b), (c),
and (e), section 736, and section 743.
(iii) Capital interest. Generally, a partner's interest in
partnership capital is determined by reference to the assets of the
partnership that the partner would be entitled to upon withdrawal
from the partnership or upon liquidation of the partnership. If the
partnership maintains capital accounts in accordance with
§1.704-1(b)(2)(iv), then for purposes of section 706(b), the
partnership may assume that a partner's interest in partnership
capital is the ratio of the partner's capital account to all
partners' capital accounts as of the first day of the partnership
taxable year.
(5) Certain tax-exempt partners disregarded. [Reserved]
(6) Foreign partners. [Reserved]
(7) Adoption of taxable year. A newly-formed partnership may adopt,
in accordance with §1.441-1(c), its required taxable year, a 52-53-
week taxable year ending with reference to its required taxable
year, or a taxable year elected under section 444 without securing
the approval of the Commissioner. If a newly-formed partnership
wants to adopt any other taxable year, it must establish a business
purpose and secure the approval of the Commissioner under section
442.
(8) Change in taxable year--
(i) Partnerships--
(A) Approval required. An existing partnership may change its
taxable year only by securing the approval of the Commissioner under
section 442 or making an election under section 444. However, a
partnership may obtain automatic approval for certain changes,
including a change to its required taxable year, pursuant to
administrative procedures published by the Commissioner.
(B) Short period tax return. A partnership that changes its taxable
year must make its return for a short period in accordance with
section 443, but must not annualize the partnership taxable income.
(C) Change in required taxable year. If a partnership is required to
change to its majority interest taxable year, then no further change
in the partnership's required taxable year is required for either of
the two years following the year of the change. This limitation
against a second change within a three-year period applies only if
the first change was to the majority interest taxable year and does
not apply following a change in the partnership's taxable year to
the principal partners' taxable year or the least aggregate deferral
taxable year.
(ii) Partners. Except as otherwise provided in the Internal Revenue
Code or the regulations thereunder (e.g., section 859 regarding real
estate investment trusts or §1.442-2(c) regarding a subsidiary
changing to its consolidated parent's taxable year), a partner may
not change its taxable year without securing the approval of the
Commissioner under section 442. However, certain partners may be
eligible to obtain automatic approval to change their taxable years
pursuant to the regulations or administrative procedures published
by the Commissioner. A partner that changes its taxable year must
make its return for a short period in accordance with section 443.
(9) Retention of taxable year. In certain cases, a partnership will
be required to change its taxable year unless it obtains the
approval of the Commissioner under section 442, or makes an election
under section 444, to retain its current taxable year. For example,
a partnership using a taxable year that corresponds to its required
taxable year must obtain the approval of the Commissioner to retain
such taxable year if its required taxable year changes as a result
of a change in ownership, unless the partnership previously obtained
approval for its current taxable year or, if appropriate, makes an
election under section 444.
(10) Procedures for obtaining approval or making a section 444
election. See §1.442-1(b) for procedures to obtain the approval of
the Commissioner (automatically or otherwise) to adopt, change, or
retain a taxable year. See §§1.444-1T and 1.444-2T for
qualifications, and §1.444-3T for procedures, for making an election
under section 444.
* * * * *
(d) Effective date. The rules of this section are applicable for
taxable years ending on or after the date these regulations are
published in the Federal Register as final regulations, except for
paragraph (c) which applies for taxable years beginning after
December 31, 1953.
§1.706-1T [Removed]
Par. 8. Section 1.706-1T is removed.
Par. 9. Section 1.898-4, as proposed to be added at 58 FR 297,
January 5, 1993, is amended by adding paragraph (c)(3)(iv) to read
as follows:
§1.898-4 Special rules.
*****
(c) ***
(3) ***
(iv) Recognition of income and deductions. See §1.441-2(e) for
rules regarding the recognition of income and deductions (e.g.,
amounts includible in gross income pursuant to sections 951(a) or
553) if either the majority United States shareholder, or the
specified foreign corporation, or both, elect to use a 52- 53-week
taxable year under this paragraph (c)(3).
* * * * *
Par. 10. Section 1.1378-1 is added under the undesignated
centerheading "Small Business Corporations and Their Shareholders"
to read as follows:
§1.1378-1 Taxable year of S corporation.
(a) In general. The taxable year of an S corporation must be a
permitted year or a taxable year elected under section 444. No
corporation may make an election to be an S corporation for any
taxable year unless the taxable year is a permitted year or a
taxable year elected under section 444. In addition, an S
corporation may not change its taxable year to any taxable year
other than a permitted year or a taxable year elected under section
444. A permitted year is the required taxable year (i.e., a taxable
year ending on December 31), a 52-53-week taxable year ending with
reference to the required taxable year, or any other taxable year
for which the corporation establishes a business purpose to the
satisfaction of the Commissioner under section 442.
(b) Adoption of taxable year. An electing S corporation may adopt,
in accordance with §1.441-1(c), its required taxable year, a
52-53- week taxable year ending with reference to its required
taxable year, or a taxable year elected under section 444 without
the approval of the Commissioner. See §1.441-1. An electing S
corporation that wants to adopt any other taxable year, must
establish a business purpose and obtain the approval of the
Commissioner under section 442.
(c) Change in taxable year. An S corporation or electing S
corporation that wants to change its taxable year must obtain the
approval of the Commissioner under section 442 or make an election
under section 444. However, an S corporation or electing S
corporation may obtain automatic approval for certain changes,
including a change to its required taxable year, pursuant to
administrative procedures published by the Commissioner.
(d) Retention of taxable year. In certain cases, an S corporation or
electing S corporation will be required to change its taxable year
unless it obtains the approval of the Commissioner under section
442, or makes an election under section 444, to retain its current
taxable year. For example, a corporation using a June 30 fiscal year
that elects to be an S corporation and, as a result, is required to
use the calendar year must obtain the approval of the Commissioner
to retain its current fiscal year.
(e) Procedures for obtaining approval or making a section 444
election--
(1) In general. See §1.442-1(b) for procedures to obtain the
approval of the Commissioner (automatically or otherwise) to adopt,
change, or retain a taxable year. See §§1.444-1T and
1.444-2T for qualifications, and 1.444-3T for procedures, for making
an election under section 444.
(2) Special rules for electing S corporations. An electing S
corporation that wants to adopt, change to, or retain a taxable year
other than its required taxable year must request approval of the
Commissioner on Form 2553 (Election by a Small Business Corporation)
when the election to be an S corporation is filed pursuant to
section 1362(b) and §1.1362-6. See §1.1362- 6(a)(2)(i) for
the manner of making an election to be an S corporation. If such
corporation receives permission to adopt, change to, or retain a
taxable year other than its required taxable year, the election to
be an S corporation will be effective. Denial of the request renders
the election ineffective unless the corporation agrees that, in the
event the request to adopt, change to, or retain a taxable year
other than its required taxable year is denied, it will adopt,
change to, or retain its required taxable year or, if applicable,
make an election under section 444.
(f) Effective date. The rules of this section are applicable for
taxable years ending on or after the date these regulations are
published in the Federal Register as final regulations.
PART 5c--TEMPORARY INCOME TAX REGULATIONS UNDER THE ECONOMIC
RECOVERY TAX ACT OF 1981
Par. 11. The authority citation for part 5c continues to read as
follows:
Authority 26 U.S.C. 168(f)(8)(G) and 7805.
§5c.442-1 [Removed]
Par. 12. Section 5c.442-1 is removed.
PART 5f--TEMPORARY INCOME TAX REGULATIONS UNDER THE TAX EQUITY AND
FISCAL RESPONSIBILITY ACT OF 1982
Par. 13. The authority citation for part 5f continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
§5f.442-1 [Removed]
Par. 15. Section 5f.442-1 is removed.
PART 18--TEMPORARY INCOME TAX REGULATIONS UNDER THE SUBCHAPTER S
REVISION ACT OF 1982
Par. 16. The authority citation for part 18 continues to read as
follows:
Authority 26 U.S.C. 7805.
§18.1378-1 [Removed]
Par. 15. Section 18.1378-1 is removed.
Robert E. Wenzel
Deputy Commissioner of Internal Revenue.
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