Changing a financial year end is occasionally the right commercial decision: a seasonal business closing at its busiest point, or a subsidiary that has to align with a parent.
The request itself is not the hard part. What businesses underestimate is everything keyed to the old year end, from payroll reporting periods to covenants measured on a financial year, and the short period return that bridges the two.
This covers who files, which years are permitted, when approval is automatic and when a business purpose has to be shown, and what the short period involves.
Most businesses must get IRS permission before changing their tax year. Form 1128, Application to Adopt, Change, or Retain a Tax Year, is the form used to make that request. Some changes qualify for automatic approval; others require a ruling based on business purpose. This guide explains the process for both paths.
Who Files Form 1128?
- Corporations seeking to change their tax year
- S-corporations seeking to change to or from a permitted tax year
- Partnerships seeking to change their tax year
- Tax-exempt organizations changing their accounting period
Newly formed entities generally adopt a tax year on their first timely filed return, no Form 1128 required to adopt. Form 1128 is for changes after the initial year has been established.
The filing is the easy part. What businesses underestimate is everything keyed to the old year end: payroll periods, state filings, comparatives, and any covenant measured on a financial year. Map those before you request the change rather than discovering them afterwards.
Ankit Sarawagi, CPA, CA, MBA · LinkedInRequired Tax Years
Many entities are required to use a specific tax year by the tax code:
| Entity Type | Required Tax Year |
|---|---|
| S-corporation | Calendar year (December 31) unless a valid business-purpose fiscal year or grandfathered year |
| Partnership | Tax year of majority partners, or tax year of all principal partners, or calendar year |
| Personal service corporations | Calendar year (December 31) unless business purpose shown |
| C-corporations | Any fiscal year, no restriction |
Automatic Approval Procedures
Revenue Procedure 2006-45 (and related guidance) provides automatic approval for certain changes. Automatic approval is available when:
- An S-corporation is changing to a permitted year (calendar year, natural business year with 25%+ test, or ownership tax year)
- A partnership is changing to conform to the required tax year
- A corporation with no net operating loss for any year in the change period is adopting a fiscal year that is a natural business year
Automatic approval requires completing Part I of Form 1128 and attaching the required calculations. No user fee is charged for automatic changes.
Non-Automatic Approval: The Business Purpose Test
When automatic approval is not available, the entity must demonstrate a business purpose for the requested tax year. Acceptable business purposes include:
- Natural business year, at least 25% of gross receipts in the last 2 months of the requested fiscal year (three consecutive years of history required)
- Ownership tax year, the requested year results in least aggregate deferral for owners
- Special business purpose approved by IRS (seasonal businesses, industry norms, etc.)
The Short Tax Year
When you change your tax year, you must file a return for the short period (less than 12 months) that bridges the old and new tax years. This short-period return covers January 1 through the last day of your new tax year-end. Taxable income for the short period is annualized for tax rate purposes, then reduced back to the actual short-period amount.
How to Complete Form 1128
- Part I: Identify the entity (name, EIN, tax year being requested) and check the applicable box (adopt, change, or retain).
- Part II: For automatic approval, complete the relevant section for your entity type and attach required computations.
- Part III: For non-automatic, attach a detailed statement of business purpose, income data supporting the natural business year (if applicable), and owner information for the ownership tax year test.
- Pay the user fee (non-automatic changes only) and mail to the IRS address specified in the instructions.
Filing Deadline for Form 1128
| Approval Type | When to File |
|---|---|
| Automatic approval | By the due date (including extensions) of the first return for the new tax year |
| Non-automatic approval | Before the 15th day of the 4th month of the short year (must get IRS ruling before filing the short-year return) |
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Frequently Asked Questions
Can an LLC taxed as a partnership change its tax year?
Yes, using the same rules as partnerships. The LLC must change to or from the required tax year (majority partners' year, principal partners' year, or least aggregate deferral year) unless it can demonstrate a business purpose for a different year.
What if the IRS denies the request?
If the IRS denies a non-automatic change request, the entity must continue using its current tax year. You can reapply in a future year if circumstances change.
Is there a filing fee?
Automatic approval: no user fee. Non-automatic approval: a user fee applies, currently several hundred dollars per application. Confirm the current fee from the IRS fee schedule in Rev. Proc. for the applicable year.
What are the practical consequences of changing the year end?
A short period return, and a good deal of administration around it. Everything keyed to the year moves: payroll reporting periods may not align, state filings have their own rules, comparatives in the accounts cover different lengths, and any covenant or agreement measured on a financial year has to be checked. The tax filing is usually the simplest part of the exercise.
When is a change genuinely worth making?
When the current year end works against the business rather than merely being inconvenient. A seasonal business closing at its busiest point, a subsidiary that has to align with a parent, or a year end that puts a stock count at the worst possible time are real reasons. Preference is not, and where the change needs approval rather than being automatic, a business purpose has to be shown.
Written by
Ankit Sarawagi, CPA, CA, MBA
Ankit leads the finance team at Profitjets, where he has worked with 500+ businesses across the US on bookkeeping, tax and CFO-level strategy. He writes about the habits that keep small business books accurate all year. Connect on LinkedIn
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