You may want to change your annual accounting period from a calendar year to a fiscal year if you can. Or, for a new business, you may want to adopt a fiscal year as you start the new venture. And for either of two reasons.
First, because a fiscal year may help your business better deal with the severe accountant shortages in the United States. And then, second, because the change will possibly give a business’s owners nearly an extra year of Section 199A deduction. But a bunch of questions need to be asked and answered, thus this FAQ…
In a Nutshell, What’s This About?
The Section 199A deduction expires for most taxpayers at the end of 2025, at least as the law now works. But you can possibly get an extra year of Section 199A tax savings if you use a fiscal year rather than a calendar year.
The reason? Section 199A does not apply to taxable years beginning after December 31, 2025. But it does apply to taxable years beginning before December 31, 2025.
For example, the calendar year that begins on January 1, 2025. As everybody already gets. But other taxable years that begin before the December 31, 2025 cutoff date should work, too. For example, a taxable year that begins on February 1, 2025. Or March 1, 2025. And so on.
Accordingly some existing entities may want to consider changing their fiscal year to get additional Section 199A deductions. (Many existing entities can do this, but some can’t.) And new entities may want to adopt a fiscal year when they start. (Most new partnerships and S corporations do have this choice.)
A wrinkle here though. We’re talking about the way the law works right now, prior to the November election and also Congressional activity in 2025, Section 199A’s termination date might be extended. Or extended for some taxpayers.
How Quickly Do I Need to Move on This?
Pretty quickly if you think the existing law stands and Section 199A ends at the end of 2025.
New partnerships and S corporations complete the fiscal year “adoption” paperwork their very first year and before they file that initial income tax return.
Existing partnerships and S Corporations who want to change their fiscal year need the IRS’s permission. That requires different paperwork which practically needs to be filed shortly after the desired first fiscal year starts.
Can Anyone Use a Non-calendar Fiscal Year?
Most new partnerships and S corporations probably can by making a Section 444 election. A Section 444 election lets a business end its fiscal year September 30, October 31 or November 30. And a November 30 fiscal year end is perfect to maximize an extra year of Section 199A tax savings. But timing and sequencing really matter with a Section 444 election.
You can’t make a Section 444 election for an already established calendar year partnership or S corporation. You can only make the Section 444 election for a new partnership or S corporation between the time the business starts and when it files its first tax return.
For an existing calendar year partnership or S corporation, the only practical method of moving to a fiscal year is the Section 442 natural year which means you consistently have a couple of months each year in which you earn at least 25 percent of your gross receipts.
Another thing to note: Both the Section 444 election and Section 442 natural year require your accounting system to at least generate monthly financial statements. You also need to have conformity between your accounting year and the way you do your books. (That requirement means you need to have some accounting software you use: QuickBooks, Xero, Wave, NetSuite and so forth). Finally, you must use a calendar year if you don’t keep formal books. (Anyone who uses a shoebox full of receipts and invoices, for the record, falls into this category.)
Can I Choose Any Fiscal Tax Year I Want?
No. You are actually very limited. As noted you have essentially two options for getting the Internal Revenue Service to let you use a fiscal year: the Section 442 option and the Section 444 option.
The Section 442 option looks for a natural year. A natural year occurs when you have a two-month interval that represents at least 25 percent of your gross receipts. You can probably change your fiscal year so it ends with those two months.
With the the Section 444 election, you choose when to end your fiscal year when the partnership or S Corporation first starts operating. Your choices include September 30, October 31, or November 30. (You probably get to pick which year-end you want. But it must be one of these three choices.) You can only make this choice when you start your new venture and establish its fiscal year.
What Paperwork is Required to Begin Using a Section 442 Natural Year
Probably not you but more likely your accountants need to timely file and prepare a Form 1128. The form identifies the business, documents your request for permission to use a natural year and includes workpapers that proves a natural year exists. Again, a natural year exists when a firm generates at least 25 percent of its gross receipts in a two month interval. If more than one natural year exists, the workpapers need to show the best natural year is the one you’re asking to use.
The 1128 can be filed as soon as the natural year and fiscal year end date are identified. The 1128 should be filed by the due date (including the extended due date) of the first fiscal year tax return.
What Paperwork is Required to Begin Using a Section 444 Fiscal Year
You file and prepare a Form 8716 as you start your partnership or S corporation. The form identifies the business and the fiscal year selected and officially makes the Section 444 election required to use a, for example, November 30 fiscal year end.
The 8716 should be filed by the earlier of the 15th day of the fifth month of that first fiscal year. The 8716 must be filed before the entity files its first income tax return. A business may file a late election by invoking Regulations section 301.9100-2 as described in the form instructions. In that case, the Form 8716 can be filed late but it still needs to be filed before the first income tax return.
However, really? The right time to file Form 8716 is when the partnership or S corporation begins activity.
One other note: A business may only make one Section 444 election ever.
What is the Section 7519 Tax Deferral Deposit
With a Section 444 election fiscal year, you calculate the tax deferral benefit of the fiscal year and pay that amount to the Treasury. Almost surely your accountant calculates the amount. And then you pay the deposit using a Form 8752.
The deposit essentially equals the tax you owe on the income the fiscal year might let you delay paying taxes on. For example, if a business makes $100,000 a month, using a November 30 year end means December’s $100,000 of profits is always included in the subsequent year’s taxable income.
To remove the tax deferral benefit of the one-year delay, Section 444 requires the business pay a deposit equal to the monthly profit times this percentage: The top marginal tax rate plus one percent.
In 2024, for example, with $100,000 of monthly profit and a top marginal tax rate of 37 percent, the deposit equals $100,000 times (37 percent + 1 percent), so $38,000.
The Section 7519 deposit isn’t really a financial drawback for taxpayers paying the top marginal tax return. The amount deposited and the timing of the deposit roughly match what they would have done otherwise. However, a taxpayer who pays a lower marginal tax rate—like 24 percent—still uses that top marginal tax rate to calculate the deposit. Thus, for those business owners, the deferral may noticeably reduce the benefits of changing the fiscal year to get an additional Section 199A deduction.
How Does the Entity Pay the Section 7519 Deposit
The partnership or S corporation calculates its Section 7519 deposit using a Form 8752. The 8752 should be filed and the payment made by the May 15 of the new fiscal year. For example, if a fiscal year starts December 1, 2025, the 8752 form and the deposit are due May 15, 2026. The business pays the deposit with a check that accompanies the Form 8752 or using the Treasury’s eftps.gov system.
Do Fiscal Years Create Extra Accounting
Yes.
As noted, you need to continue to have a good accounting system. You need to really use the fiscal year as your annual accounting period. This conformity requirement would mean for example that you use the fiscal year to report your profits to creditors or owners.
If you close the books formally, you would need to do that for the fiscal year not the calendar year. If you use accounting software that doesn’t provide for a formal closing (where you zero out income and expense accounts using the retained earnings account) you want to change the fiscal year setting to match your new fiscal year.
If you use a Section 442 natural year, you need to double-check the natural year still exists by double-checking the “25 percent of gross receipts in two months” requirement.
If you use a Section 444 fiscal year, also as noted earlier, you need to annually prepare a Form 8752 to recalculate the appropriate tax deferral deposit amount. You would then need to file that form and pay an additional increment if monthly profits have grown. You would claim a partial refund of your previous deposit if monthly profits for the current year have declined. (Surely your tax account will do this for you as part of your annual tax return.)
Can Fiscal Year Changes Be Reversed in Future
Yes, you can and may even be required to change your fiscal year again in future.
You would be required to change a Section 442 natural year if you lose your eligibility to use a particular year. For example, if your natural year disappears.
You can also change from a Section 442 natural year back to a calendar year after a 48-month waiting period. (You would file another 1128.)
You can terminate a Section 444 election. You can also lose your ability to use the Section 444 election year by not making Section 7519 deposits using that Form 8752.
Can A 52-53-Weeks Year Be Used
A 52-53-weeks year is an annual accounting period that ends on the same day of the week each year. For example, the last Friday of the last month in the accounting year. So, like the last Friday in December.
You can elect to use a 52-53-weeks year by filing Form 1128. However, a 52-53-weeks year alone does not work for obtaining an extra year of Section 199A deduction. The reason is Section 441 (the chunk of law that allows taxpayers to elect to use a 52-53-weeks year) says a firm ignores the 52-53-weeks year for purposes of determining effective dates and just uses the closest month end or month start. Thus a fiscal year that ends on say December 27, 2025 gets treated for tax accounting purposes as if it ends on December 31, 2025. And that time shift eliminates the Section 199A deduction on some of 2026’s income.
Can Tiered Ownership Structures Use Section 444 Fiscal Year
In general, no. And a tiered structure would always be pretty tricky. But Section 444 technically allows tiered structures that contain only partnerships and S Corporations all using the same fiscal year end.
For example, a new partnership of partnerships and a new partnership of S corporations should usually be able to make a Section 444 election and use a Section 444 fiscal year. (Again, any already existing partnerships or S corporations in the tiered structure would have already needed to make Section 444 elections when they first started.)
But a new partnership of S corporations and C corporations should not be able to make a Section 444 election.
Does Section 199A(i) Fiscal Year Change Make Financial Sense
Under current law, and as of October 2024, a new partnership or S corporation that adopts a fiscal year or an existing partnership or S corporation that changes to a fiscal year should get extra months or even nearly an extra year of Section 199A deduction. Typically, a Section 199A deduction allows taxpayers to avoid taxes on the last 20 percent of their business income. Thus, some taxpayers may enjoy very significant savings through a fiscal year adoption or change.
An S corporation or partnership earning $5 million in business income might generate a $1 million Section 199A deduction for its owners. Adding that deduction to the owner’s or owners’ 2026 tax returns might save $396,000 in federal income taxes. That savings amount probably easily justifies the time and costs of making the change.
In comparison, however, the typical successful small business partnership or S corporation often won’t save enough to make adopting a fiscal year or changing to a fiscal year worthwhile purely as a tax savings gambit. A partnership or S corporation earning $100,000 in business income might generate a $20,000 Section 199A for its owners, for example. But that deduction if the marginal federal tax return equals 25 percent saves the taxpayer about $5,000. That amount may not merit the cost of adopting or changing to a fiscal year let alone the annual extra effort of using a fiscal year.
Can Taxpayers Do the Fiscal Year Change Work Themselves
To change the taxable year safely and efficiently, an accountant or taxpayer should understand several relevant sections of the Internal Revenue Code including Sections 441, 442 and 444. (These sections and the companion regulations describe accounting years and changes in accounting years.)
To use a fiscal year to optimize the Section 199A deduction, an accountant or taxpayer should also understand the Section 199A statute and the companion regulations.
Preparers whether accountants or taxpayers would also want to read carefully Revenue Procedure 2006-46 if they’re changing a fiscal year and then also really carefully read the instructions for the 1128, 8716 and 8752 forms.
Can IRS Challenge a Section 199A(i) Fiscal Year Change
The IRS can reject or deny permission if you incompletely prepare the forms used to make the Section 444 election or the forms used to ask permission to use a Section 442 natural year.
The IRS might also theoretically revoke automatic permission granted earlier if a firm fails to follow the rules. For example, if a firm fails to maintain books and financial records in conformity with its fiscal year.
We also think that while Section 199A(i) clearly allows a fiscal year firm to get a Section 199A deduction from income earned in a fiscal year that starts before January 1, 2026, the Treasury or IRS might rule differently on this matter. They might also simply not issue instructions or comment on the tax accounting treatment described here. And that would of course create some risk. (Even if the treatment described here is correct, an IRS auditor might misread the law.)
Why Might IRS Challenge a Section 199A(i) Fiscal Year Change
Some confusion exists about how fiscal years affect the termination of Section 199A. That confusion stems from a mistakenly applied regulation the Treasury wrote in 2018 and 2019 about when taxpayers could begin using the new deduction. (The Section 199A deduction became law starting in 2018.)
These original Treasury regulations for Section 199A said the Section 199A deduction looks at the year the fiscal year ends to determine whether a fiscal year starting in 2017 gets a Section 199A deduction in 2018. Somewhat surprisingly, the regulations gave taxpayers a full Section 199A deduction for these fiscal year partnerships and S corporations if their fiscal years ended in 2018. What was weird about this treatment? This approach gave taxpayers a Section 199A deduction on business income earned before Section 199A even became applicable.
Some commentators, including our firm, initially thought that fiscal years starting in 2025—by the law the last year Section 199A would be applicable—would use the same approach. In other words, that what mattered was when the fiscal year ended. Not when it started. But upon rereading the statute, we now realize that reading was clearly incorrect. (We’ve got a longer, rather technical explanation at our small business blog about this if you’re interested: Section 199A(i) Fiscal Year Change Extends Deduction.)