Tax year change relief: new election allows four-year spread for bunched income - Federal Tax

California CPA, Dec, 2003 by Stuart R. Josephs

Rev. Proc. 2003-79, IRB 2003-45, Nov. 10, 2003, allows partners and S corporation shareholders to elect a four-year spread for their income from their partnership's or S corp's short year resulting from a change in tax year by the partnership or corporation.

This election is available when the partnership or corporation changes its year under the automatic approval procedures of Rev. Proc. 2002-38 or the prior approval procedures of Rev. Proc. 2002-39.

Rev. Procs. 2002-38 and 2002-39 provide these procedures for a partnership or S corp to change its year if its current year no longer qualifies as a natural business year (or, for certain S corps, an ownership tax year). Rev. Proc. 2003-79 only applies to partners and shareholders within Rev. Proc. 2003-79's scope.

It also only applies if the short year ends after May 9, 2002 and before June 1, 2004 (or, if a taxpayer uses a 52- to 53-week year, with reference to the last day of any month after April 30, 2002 and before June 1, 2004). An initial short year following an S election will not be considered a short year for Rev. Proc. 2003-79 purposes.

Background

Generally, a taxpayer wishing to change its tax year must obtain IRS approval, which is granted only if the taxpayer agrees to the IRS' prescribed terms, conditions and adjustments, including those necessary to neutralize the tax effects of a substantial distortion of income otherwise resulting from the requested year.

Rev. Proc. 2002-38 provides the exclusive procedures for certain partnerships and S corps to obtain automatic approval to change their tax years and contains these pertinent rules:

1. A partnership or S corp may secure IRS approval to adopt or change to its required tax year, a natural business year or an ownership tax year.

2. A permitted tax year includes a required tax year, natural business year or ownership tax year.

3. A natural business year is established by satisfying a 25-percent gross receipts test.

4. Generally, an S corp shareholder that is a tax-exempt entity not subject to tax on such corporation's income is disregarded in determining the corporation's ownership tax year unless the corporation is wholly owned by that entity.

5. If a taxpayer changes to or retains a natural business year or an ownership tax year and that year no longer qualifies as a permitted year, the taxpayer is using an impermissible year and should change to a permitted year.

Rev. Proc. 2002-39 provides the exclusive procedures for taxpayers, that do not qualify under an automatic approval procedure, to obtain IRS prior approval to change their tax year and contains these pertinent rules:

1. A request to change a tax year ordinarily will be approved if the taxpayer establishes a business purpose.

2. A taxpayer requesting a change to its natural business year has a business purpose.

3. A natural business year may be determined under one of these tests: annual business cycle; seasonal business; or 25-percent gross receipts.

4. If a taxpayer changed to or retained a tax year that was its natural business year, and that year no longer qualifies as a permitted year, the taxpayer is using an impermissible year and should change to a permitted year.

If a partnership or S corp changes its tax year to a permitted year, a partner or shareholder may be required to include in gross income in a single year income and expense items from more than one year of the partnership or corporation.

Scope

Rev. Proc. 2003-79 applies to a partner or S corp shareholder if:

1. The partnership or S corp has changed, or will change, its tax year because its current year no longer qualifies as a natural business year or the S corp's current year no longer qualifies as an ownership tax year because a tax-exempt owner is disregarded.

2. As a consequence of such change to a permitted year, income and expense items from more than one year would, but for Rev. Proc. 2003-79, be includible in the partner's or shareholder's income in a single year.

3. The partner's or shareholder's share of income items exceeds its share of expense items attributable to the partnership's or corporation's short year.

Election Procedures

A partner or S corp shareholder makes this election by:

1. Recording one quarter of its share of income (its share of income items exceeding its share of expense items attributable to the partnership's or corporation's short year) on a timely filed original return for the partner's or shareholder's year with, or within, which the partnership's or corporation's short year ends or an amended return filed before April 13, 2004 if the partner or shareholder has timely filed a return before Nov. 24, 2003 for the year with, or within, which the partnership's or corporation's short year ends; and

2. Attaching to that original or amended return and to the returns for every other year of the spread period a completed Form 8082. Notice of Inconsistent Treatment or Administrative Adjustment Request, containing an explanation in Part III similar to the following: Election under Rev. Proc. 2003-79 to apply a ratable four-year spread of the share of income attributable to a change in annual accounting period.