One of the biggest mistakes people make when setting up a new corporation is
using a calendar year instead of a different fiscal year. They think it's
easier to do all of their bookkeeping with the same tax year as they use for
their personal taxes. It's also easier to coordinate with 1099s and other
information documents that are received, which are almost always prepared on a
calendar year basis.
There are big tax savings opportunities by shifting income back & forth
between the 1120 with its tax year and the 1040 with its calendar year.
This can mean shifting income back and forth so that it is never subject to
income tax. More frequently, it means shifting income between years in
order to smooth out the effective tax rate and avoid going above the 15%
bracket.
If you already have a December 31 tax year and have already filed an 1120
using that year, IRS will not allow you to switch to a different fiscal year
because they do not want to assist you in saving on your taxes. It is
often more efficient to start a brand new "virgin" corporation that
can use a better fiscal year.
If you haven't yet filed the first 1120 for the corporation, you can still
change the year to any month end you want. This is possible even if you
told IRS that you were planning to end the tax year in December, which many
people accidentally do when they submit their SS-4 to apply for the new ID
number. However, once the first 1120 has been filed with IRS, the fiscal
year is set in stone.
This is not an option for S corporations. They must use a calendar
tax year.
I am often asked what
is the best month to end a tax year. While any month other than December
is a good idea, I have found that using calendar quarters, such as March 31,
June 30 or September 30, is handy for reconciling the corporate numbers with
payroll and sales tax returns, which are often prepared on a quarterly basis.
When properly utilizing
a corporation to minimize taxes, it's important to smooth out and shift income
between the 1120 and the owners' 1040. With a corporate year-end that is
close to the personal year-end, such as February 28 or November 30, that doesn't
allow much time to accomplish the smoothing process. For that reason, I
have found that a June 30 corporate year-end is the ideal one. That gives
us six months on either side to make any necessary changes.
