The term fiscal year is one you’ve likely heard but might not know its true meaning. A company’s fiscal year is extremely important because the Internal Revenue Service uses it to determine your business’s tax year and deadlines to submit tax returns. Because it carries tax implications, it is critical that you understand what a fiscal year is and what it means for your company. Read on to find out what a fiscal year is, how it can be used by your business and the IRS, as well as why companies use fiscal years instead of other options such as a calendar year.
What Is a Fiscal Year?
A fiscal year is a business’s financial year, which is a 12-month or 52-week period (and sometimes a 53-week period) that a company uses for accounting purposes. According to the IRS, a fiscal year is one that is 12 consecutive months ending on the last day of any month except December 31. Often, fiscal years are based on the end of quarters and expressed as a year-end date. For example, a company’s fiscal year-end could be September 30, with its fiscal year composed of the 12 months from October 1 to September 30.
Fiscal Year vs. Calendar Year vs. Tax Year
In order to better understand what a fiscal year is, it’s good to identify what it is not. In other words, you should know the differences between a fiscal year and other types of “years” such as a calendar year and tax year.
According to the IRS, a tax year is an annual accounting period for keeping records and reporting income and expenses (for more on both direct and indirect costs and profit go here). A tax year can be in the form of a fiscal year or a calendar year. A calendar year is your classic, traditional year, running from January 1 to December 31. This is why the IRS defines a fiscal year as a 12-month period that does not end on December 31.
A helpful way to understand the difference between your business’s fiscal year and your business’s tax year is to categorize them as internal versus external. For example, your business’s fiscal year is internal, with you reporting on your business financial situation to shareholders or yourself at the end of your fiscal year. Your business tax year is external, it being the 12-month period you report on to the IRS for tax purposes.
Fiscal Year Tax Implications
Since both the use of a calendar year and fiscal year is related to your tax year, there are tax implications to be aware of for your business. There are also some restrictions and suggestions for which type of tax year — calendar year or fiscal year — your business should use. Here’s also a timely reminder that you can ask for legal assistance from some of the best formation services or registered agents, including the likes of Nolo, Rocket Lawyer, ZenBusiness, or IncFile, which we already reviewed.
Parameters for Choosing Your Fiscal Year
Since your business fiscal year is essentially an internal matter, you can have any fiscal year you desire for your business — depending on your company’s business entity type. Thus, the structure of your business is one of the key parameters that can affect whether you can use a calendar year or fiscal year as your tax year.
In general, any company can adopt the calendar year as its tax year. There are circumstances, however, in which a business could have no choice but to use a calendar year. A company that has no books or records, or no annual accounting period must use a calendar year. Also, certain businesses might not qualify for using a fiscal year or must use a calendar year, according to the Internal Revenue Code or Income Tax Regulations.
In terms of business structure, if your company is taxed as a sole proprietor, including single-member LLCs, then you must use December 31 (the calendar year) as your business tax year. If your business is not taxed as a sole proprietorship — such as a partnership, multi-member LLC, S corporation or C corporation — then you may have some more leeway, but not always.
Pass-through business types — such as LLCs, partnerships and S corporations — file their tax returns based on the owners’ individual tax returns, so these entities tend to have their tax year conform with the calendar year starting on January 1 and ending on December 31. There are some exceptions to this rule if you provide a legitimate reason why your business should be allowed to have a fiscal year that is not the calendar year, but in general, it is C corporations that have the most freedom in this regard.
Adopting and Changing Your Fiscal or Tax Year
Your company adopts a tax year when it files its first income tax return using that tax year. If you want to change your company’s tax year, you can do it, but it requires some paperwork. If you file your first tax return for one type of tax year, whether it’s a calendar year or fiscal year, in order to change it you must submit IRS Form 1128, Application to Adopt, Change, or Retain a Tax Year. Without this application, your company will have to stay on whichever tax year used for your first income tax return.
Besides reporting your accounting year on your Employer Identification Number (EIN) application, you don’t actually report your fiscal year to the IRS because it’s essentially an internal matter. The IRS’s main concern in regards to reporting your fiscal year is that you must let them know which type of tax year you are using: a fiscal year or a calendar year.
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Why Use a Fiscal Year for Your Business?
The definition of a fiscal year is fairly straightforward. The real question is, why would a business use a fiscal year instead of, say, an ordinary calendar year? Are there any benefits to using a fiscal year?
If you’re a sole proprietor or taxed like one, then you don’t have a say in the matter — you must operate on the calendar year. But if you’re business is not a sole proprietorship, then you could have the option of choosing to use the fiscal year or calendar year. Again, however, if your company is not organized as a C corporation, you’ll likely have to apply to the IRS to be allowed to be taxed not on a calendar year basis.
Beyond your company’s business structure, the principal motive for using the fiscal year is your company’s business cycle. Typically, businesses will set their fiscal year-end date at the conclusion of their busiest season. This is why, for example, so many businesses will have September 30 as their fiscal year-end because the summer is their busiest season.
Here’s a look at some major companies and their respective fiscal years and fiscal year-ends:
- Microsoft: Uses the fiscal year July 1 to June 30, with June 30 being the end of the fiscal year.
- Apple: Uses the last business day of September, which in 2019 made its fiscal year-end September 28.
- Tesla: Uses the calendar year as its fiscal year, with its latest annual SEC filing reporting the fiscal year ending December 31, 2018.
The Bottom Line
The most basic point to take away about fiscal years is that it is a budgeting and accounting system for your business that is not based on the traditional calendar year. Meaning, if you report your financials based on a year that does not end on December 31, then your business is using the fiscal year and not the calendar year for accounting and tax purposes. The two most important considerations for determining your company’s fiscal year is its business structure and its business cycle. Depending on these two fundamental factors, you may be able to or want to set your company up either on the calendar year or fiscal year of your choosing.