Applying for a Fiscal Year under Sec. 444 when an S Election Is Made

Editor:
Albert B. Ellentuck, Esq.
Of Counsel
King and Nordlinger, L.L.P.
Arlington, VA

Editor's note: This case study has been adapted from "PPC Tax Planning Guide—S Corporations," 15th Edition, by Andrew R. Biebl and Gregory B. McKeen, published by Practitioners Publishing Company, Fort Worth, Tex., 2001 ((800) 3238241; www.ppcnet.com).

Facts: C Inc., an existing C corporation, has a June 30 fiscal tax-year. On July 1, 2002, the corporation, which manufactures building materials, elects S status. The shareholders, who file on a calendar-year basis, want the S corporation to retain its June 30 year-end. The corporation does not meet the requirements of the 25% test that allows automatic approval of a natural business year. Issue: Can C Inc. elect to continue using a fiscal year ending June 30?

An existing fiscal-tax-year regular C corporation is not automatically entitled to retain its fiscal tax-year on electing S status.

A new S corporation can normally make the Sec. 444 election and use a fiscal year, but it is restricted in the tax years that it can select. (If the corporation makes a Sec. 444 election, it must submit required payments.)

Generally, an S corporation can elect a Sec. 444 fiscal year that results in deferral of income for only three months or less. This restriction limits the corporation to a September 30, October 31 or November 30 year-end. (Certain S corporations may have kept their year beginning in 1986 under grandfather rules.) A C corporation electing S status must use the C year as a reference point, as illustrated by the following examples:

Example 1: C Corp. uses a tax year ending June 30. It elects S status effective July 1, 2002. It has no supportable business purpose for a fiscal year. The S corporation cannot retain the June 30 year-end, but it can make the Sec. 444 election to use a September 30, October 31 or November 30 year-end. The corporation will have an initial short S year that begins on July 1, 2002 and ends on the last day of September, October or November (whichever is applicable).

Example 2: C Corp. uses an October 31 year-end. It elects S status for the year beginning Nov. 1, 2002. It has no supportable business reason for a fiscal year. It can make a Sec. 444 election to retain its October year-end, or to use a November 30 year-end (because the change shortens the deferral period). It cannot, however, make the Sec. 444 election to use a September 30 year-end; that increases the deferral period. If a November year-end is elected, the first S return would be filed for the short period from Nov. 1–Nov. 30, 2002.

Example 3: C Corp. uses a calendar year. It elected S status on Jan. 1, 2002. It does not have a supportable business reason for a fiscal year. It cannot make a Sec. 444 election, because any year-end other than December 31 would increase the deferral period.

If an existing S corporation is changing tax years, it could change to a September 30, October 31 or November 30 year-end, if the new year-end results in a shorter deferral period than the present year.

Partnerships and proprietorships evidently do not have to consider the previous entity's year when choosing an S corporation year-end. A proprietorship, for example, that has been operating on a calendar year can elect S status on incorporation and apparently choose a September, October or November year-end. It must make a Sec. 444 election, and is responsible for submitting required payments.

Given the facts, C Inc. can take one of the following courses of action:

1. Make the Sec. 444 election and use a September 30, October 31 or November 30 year-end.

2. Apply for a June 30 year-end under the facts-and-circumstances business-purpose provisions. If the year is approved by the IRS, the Sec. 444 election will not be necessary.

3. Use a calendar year.

If no supportable reasons exist for a business-purpose fiscal year, C Inc. could elect, for example, an October 31 year-end under Sec. 444, on Form 8716, Election To Have a Tax Year Other Than a Required Tax Year, and submit the form to the IRS Service Center it files it tax returns. C Inc. must file the form by the earlier of:

1. The 15th day of the fifth month following the month that includes the first day of the tax year for which the election is first effective or

2. The due date (without extensions) of the return resulting from the Sec. 444 election.

In this situation, C Inc. files its first S return for the short period beginning July 1, 2002 and ending Oct. 31, 2002. The first Sec. 444 election year begins July 1, 2002 and ends Oct. 31, 2002. The Sec. 444 election on Form 8716 is due by Dec. 15, 2002, which is the earlier of the following two dates:

1. Dec. 15, 2002 (the 15th day of the fifth month following July 2002) or

2. Jan. 15, 2003 (the due date of the return resulting from the Sec. 444 election).

Form 2553, Election by a Small Business Corporation, contains a box (on the reverse side of the form) that a corporation should check to indicate that the it will make the Sec. 444 election. If the box is not checked, the IRS might not accept the Form 8716. Form 2553 also contains a box that states that the corporation will use a calendar year if the Sec. 444 year is not allowed. (The Sec. 444 election might be denied because the Form 8716 is filed late or a deferral period longer than the old deferral period is requested.) If the calendar-year backup box is not checked and the Sec. 444 election year is not allowed, the S election mightl be invalid.

Regs. Sec. 301.9100-2 grants an automatic 12-month extension to make an election on Form 8716. If the form is filed late, but within 12 months of the original due date, the words "Filed Pursuant to Section 301.9100-2" should be written or typed at the top of the properly prepared Form 8716.

Conclusion

C Inc. cannot retain its June 30 year-end unless it has a business reason acceptable to the IRS. The corporation can, however, make the Sec. 444 election to use a September 30, October 31 or November 30 year-end. Another alternative would be for the corporation to change to a calendar year.

The grandfather rules allow certain S corporations to retain fiscal year-ends other than September, October or November. An S corporation that received permission to use a fiscal year can retain its year, as long as the business reason for the year continues to apply. Also, an S corporation can retain its tax year that began in 1986 if made by a Sec. 444 election.