J.K. Lasser's Small Business Taxes 2018. Barbara Weltman
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be a separate state tax identification number.
If you are just starting your business and do not have an EIN, you can obtain one instantaneously online using an interview-style application at www.irs.gov (search “EIN online”) or by filing Form SS-4, Application for Employer Identification Number, with the IRS service center in the area in which your business is located. Application by mail takes several weeks. An SS-4 can be obtained from the IRS website at www.irs.gov or by calling a special business phone number (800-829-4933) or the special Tele-TIN phone number. The number for your service center is listed in the instructions to Form SS-4. If you call for a number, it is assigned immediately, after which you must send or fax a signed SS-4 within 24 hours.
If you change your business entity (e.g., from a sole proprietorship to an S corporation), you usually need to obtain a new EIN. You can determine whether you need a new EIN at www.irs.gov (search “do you need a new EIN?”).
SPECIAL RULES FOR SOLE PROPRIETORS
Because sole proprietors report their business income and expenses on their personal returns, they may not be required to use an EIN. Instead, they simply use their Social Security number for federal income tax reporting.
A sole proprietor must use an EIN if the business has any employees or maintains a qualified retirement plan. A sole proprietor may need an EIN to open a business bank account (it depends on the institution). An EIN can also be used in place of a Social Security number by an independent contractor for purposes of Form 1099-MISC reporting (a consideration today with concerns about identity theft). A sole proprietor should use an EIN as a way in which to build a business credit profile in order to qualify for credit without relying entirely on the owner's credit history and personal guarantee.
A single-member limited liability company, which is a disregarded entity taxed as a sole proprietorship (unless an election is made to be taxed as a corporation) for income tax purposes, must obtain an employer identification number and use the number issued to the entity (and not the EIN issued to the owner's name).
CHAPTER 2
Tax Year and Accounting Methods
Alert
At the time this book was completed, Congress was considering important tax changes that could affect 2017 tax returns and planning for 2018. Check the online Supplement in February 2018 at www.jklasser.com or www.barbaraweltman.com to see what changes have been enacted and when they are effective.
Once you select your form of business organization, you must decide how you will report your income. There are 2 key decisions you must make: What is the time frame for calculating your income and deductions (called the tax year or accounting period), and what are the rules that you will follow to calculate your income and deductions (called the accounting method). In some cases, as you will see, your form of business organization restricts you to an accounting period or accounting method. In other cases, however, you can choose which method is best for your business. Depending upon circumstances, you may want to need to change your accounting method. Sometimes making a change is easy, with automatic procedures; other situations require IRS consent, as you will see later in this chapter.
For a further discussion on tax years and accounting methods, see IRS Publication 538, Accounting Periods and Methods. Inventory rules are discussed in Chapter 4.
Accounting Periods
You account for your income and expenses on an annual basis. This period is called your tax year. There are 2 methods for fixing your tax year: calendar and fiscal. Under the calendar year, you use a 12-month period ending on December 31. Under the fiscal year, you use a 12-month period ending at the end of any month other than December.
You select your tax year when you begin your business. You do not need IRS approval for your tax year; you simply use it to govern when you must file your first return. You use the same tax year thereafter. If you commence your business in the middle of the tax year you have selected, your first tax year will be short.
Example
You start your S corporation in May 2017. It uses a calendar year to report expenses. The corporation will have a short tax year ending December 31, 2017, for its first tax year. Then, for 2018, it will have a full 12-month tax year.
A short tax year may occur in the first or final year of business. For example, if you closed the doors to your business on May 1, 2017, even though you operated on a calendar year. Your final tax year is a short year because it is only 4 months. You do not have to apportion or prorate deductions for this short year merely because the business was not in existence for the entire year. Different rules apply if a short year results from a change in accounting period.
Seasonal businesses should use special care when selecting their tax year. It is often advisable to select a tax year that will include both the period in which most of the expenses as well as most of the income is realized. For example, if a business expects to sell its products primarily in the spring and incurs most of its expenses for these sales in the preceding fall, it may be best to select a fiscal year ending just after the selling season, such as July or August. In this way, the expenses and the income that are related to each other will be reported on the same return.
C corporations, other than personal service corporations (PSCs), can choose a calendar year or a fiscal year, whichever is more advantageous. Other entities, however, cannot simply choose a fiscal year, even though it offers tax advantages to its owners. In general, partnerships, limited liability companies (LLCs), S corporations, and PSCs must use a required year. Since individuals typically use a calendar year, their partnership or LLC must also use a calendar year.
Required year For S corporations, this is a calendar year; for partnerships and LLCs, it is the same year as the tax year of the entity's owners. When owners have different tax years, special rules determine which owner's tax year governs.
The entity can use a fiscal year even though its owners use a calendar year if it can be established to the satisfaction of the IRS that there is a business purpose for the fiscal year. The fact that the use of a fiscal year defers income for its owners is not considered to be a valid business purpose warranting a tax year other than a required tax year.
Business purpose This is shown if the fiscal year is the natural business year of the entity. For a PSC, for example, a fiscal year is treated as a natural business year if 25 % or more of its gross receipts for the 12-month period ending on the last month of the requested tax year are received within the last 2 months of that year.
While the vast majority of small businesses use a calendar year, some companies may use a fiscal year because it is the natural year of the type of business they are in. The end of the fiscal year coincides with the close of the business cycle. For example, a ski shop may close out its year on June 30 after running end-of-season sales. They do not have to use this fiscal year, however, and many such businesses use a calendar year.
If an entity wants to use a fiscal year that is not its natural business year, it can do so by making a Section 444 election. The only acceptable tax years under this election are those ending September 30, October 31, and November 30. Use of these fiscal years means that at most there can be a 3-month deferral for the owners. The election is made by filing Form 8716, Election to Have a Tax Year Other Than a Required Tax Year, by the earlier of the due date of the return for the new tax year (without regard to extensions) or the fifteenth day of the sixth month of the tax year for which the election will be effective.
If the election is made, then partnerships, LLCs, and S corporations must make