In launching your small business, choosing a fiscal-year calendar or accounting period is a pivotal step that may affect you financially. Most small businesses choose to file tax returns on a calendar-year basis (January 1–December 31) because it's the easiest and most intuitive way to operate. Yet, in some instances, a fiscal-year calendar ending on a date other than December 31 makes more sense for financial reporting or business-specific purposes. To determine the best accounting period for your small business, consider the seasonality of your business and the best way to pair income with expenses.
Reporting by Calendar Year
The calendar-year method of reporting is most frequently used by individuals and small businesses because it aligns with personal tax obligations and is often the easiest choice. Other companies, like those that do not maintain records, are often required by the Internal Revenue Service (IRS) to follow the calendar-year method.
Your first tax return filing determines everything. For many, first tax returns are filed via calendar year, even if the business wasn't fully operational all year. As companies grow and evolve into partnerships or sole proprietorships, they must continue to use the calendar-year model unless granted permission from the IRS to make a change.
The Benefits of an Off-Calendar Fiscal Year
A primary reason for a small business to choose a fiscal year ending in a month other than December is the seasonality of the business. Consider a ski resort that incurs the expenses of training employees and preparing the ski slopes in the fall and early winter, but does not take in most of its revenue until January and February. If a calendar year is used in this situation, most revenue will fall in a different tax year than the related expenses. In short, a calendar year will not capture an accurate picture of the annual performance for a seasonal business.
Choosing an off-calendar fiscal year may also involve potential cost savings. If a business requires a year-end financial statement audit, accountants are more readily available outside their busy season, which coincides with the end of the calendar year. In these lull periods, accounting firms may also give clients a price break on their services. Additionally, fiscal years have benefits regarding industry conventions. When you match up your fiscal years with that of similar companies, financial statements are easier to compare.
Changing Your Accounting Period
Many small businesses begin by reporting by calendar year, but fiscal year reporting may be necessary as your company grows. For example, if you change from a sole proprietorship to a partnership, partnerships must follow the chosen fiscal year of the majority of their partners. If that means moving to a fiscal year, permission must be granted by the IRS prior to change your accounting period. A Form 1128 must be completed and a written explanation documenting the reason for the change must be attached. Automatic approval may be granted in specific instances, so it's best to consult a tax professional before completing the form.
Selecting an accounting period is an important step for any startup company, but isn't always set in stone. Once you've made a decision, the next step is to formalize your financial reporting by integrating a cloud-based accounting system, which will assist with your bookkeeping and accounting needs in any fiscal cycle.