When you start operating your new small business, you have to pick a tax year which is reflected on the very first tax return you file. You make the decision on the tax year you will use at the same time you decide on your form of business organization and your method of accounting.
Proprietorships, Partnerships, and S Corporations
If you set up your business as a sole proprietorship that is unincorporated, you will generally file your taxes using the same tax year as the business owner. This is usually a calendar year -- from January through December.
If you establish your business as an unincorporated partnership, you have to choose a tax year that is consistent with the tax year used by the majority of the partners. A Subchapter S corporation or a personal service corporation must generally use a calendar year as their tax year.
C Corporations and Limited Liability Companies
Generally, it is the C Corporation that establishes its tax year as a fiscal year. A fiscal year is simply a year that a corporation establishes that does not end with December 31. Corporations establish their tax year as a fiscal year in order to more effectively match their income with their expenses, particularly if the corporation is a seasonal business.
Limited Liability Companies usually establish their tax years based on the tax years of most of their members. Usually, the tax year for a LLC is a calendar year. If an LLC is incorporated, then they may use a fiscal year.
Other Types of Businesses
Businesses like universities sometimes establish their tax year as August to July or September to August to match their operating cycles.
Changing your Tax Year
If you decide to make a change to your tax year, you have to notify the Internal Revenue Service (IRS). For example, you may incorporate and want to change to a fiscal year. In this case, you will have to fill out IRS Form 1128. Once you change your tax year, you can't change it again for 10 years, so make your decision wisely.