[Federal Register Volume 67, Number 96 (Friday, May 17, 2002)]
[Rules and Regulations]
[Pages 35009-35025]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-12169]



[[Page 35009]]

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 5c, 5f, 18, and 602

[TD 8996]
RIN 1545-AX15


Changes in Accounting Periods

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations and removal of temporary regulations.

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SUMMARY: This document contains final regulations relating to certain 
adoptions, changes, and retentions of annual accounting periods. The 
final regulations are necessary to update, clarify, and reorganize the 
rules and procedures for adopting, changing, and retaining a taxpayer's 
annual accounting period. The final regulations primarily affect 
taxpayers that want to adopt an annual accounting period under section 
441 or that must receive approval from the Commissioner to adopt, 
change, or retain their annual accounting periods under section 442.

DATES: Effective Date: These regulations are effective May 17, 2002.
    Applicability Date: These regulations are applicable for taxable 
years ending on or after May 17, 2002.

FOR FURTHER INFORMATION CONTACT: Michael Schmit or Roy Hirschhorn at 
(202) 622-4960 (not a toll-free number).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collections of information contained in these final regulations 
have been reviewed and approved by the Office of Management and Budget 
in accordance with the Paperwork Reduction Act of 1995 (44 U.S.C. 
3507(d)) under control number 1545-1748. Responses to these collections 
of information are required for certain taxpayers to adopt, change, or 
retain an annual accounting period.
    An agency may not conduct or sponsor, and a person is not required 
to respond to, a collection of information unless the collection of 
information displays a valid control number assigned by the Office of 
Management and Budget.
    The estimated annual burden per respondent varies from 20 minutes 
to one hour, depending on individual circumstances, with an estimated 
average of 30 minutes.
    Comments concerning the accuracy of this burden estimate and 
suggestions for reducing this burden should be sent to the Internal 
Revenue Service, Attn: IRS Reports Clearance Officer, W:CAR:MP:FP:S, 
Washington, DC 20224, and to the Office of Management and Budget, Attn: 
Desk Officer for the Department of the Treasury, Office of Information 
and Regulatory Affairs, Washington, DC 20503.
    Books or records relating to this collection of information must be 
retained as long as their contents may become material in the 
administration of any internal revenue law. Generally, tax returns and 
tax return information are confidential, as required by 26 U.S.C. 6103.

Background

    On June 12, 2001, the IRS and Treasury Department published in the 
Federal Register proposed amendments to regulations under section 441 
(period for computing taxable income), and sections 442, 706, 898, and 
1378 (regarding the requirement to obtain the approval of the 
Commissioner to adopt, change, or retain an annual accounting period) 
[REG-106917-99 (66 FR 31850)]. Written and electronic comments were 
solicited, and a public hearing was scheduled for October 2, 2001. 
Several comments were received, and are discussed below. Because no 
requests to speak were received, the public hearing was cancelled. 
After consideration of all comments, the proposed regulations under 
sections 441, 442, 706, and 1378 are adopted as revised by this 
Treasury decision.

Summary of Comments and Explanation of Revisions

1. Comments and Changes Relating to Sec. 1.441 of the Proposed 
Regulations

A. Definition of 52-53-Week Taxable Year
    The proposed regulations both define the term taxable year 
consisting of 52-53-weeks and provide an Example illustrating a 52-53-
week taxable year that ends on a particular day of the week that last 
occurs in a calendar month or that is nearest to the last day of that 
calendar month. A commentator observed that many taxpayers have 
difficulty correctly applying the rules for 52-53-week taxable years, 
and suggested that certain explanatory text contained in the Example be 
moved to the regulations text itself where it would be more apparent 
and helpful. This suggestion has been adopted in the final regulations.
B. Changes to or From a 52-53-Week Taxable Year
    The proposed regulations generally provide that changes to or from 
a 52-53-week taxable year are treated as changes in annual accounting 
periods that require the approval of the Commissioner, and describe 
some specific instances in which such approval may be obtained 
automatically under administrative procedures to be published by the 
Commissioner. Consistent with the general framework of the regulations, 
the descriptions of these specific changes have been removed from the 
final regulations. Taxpayers should see Rev. Proc. 2002-37 and Rev. 
Proc. 2002-38, 2002-22 I.R.B., for situations in which automatic 
approval for changes to or from a 52-53-week taxable year will be 
granted. The final regulations clarify that a taxpayer will not be 
granted automatic approval for a change from one 52-53-week taxable 
year to another 52-53-week taxable year, even if both years reference 
the same calendar month.
C. Short Periods of 6 Days or Less
    The proposed regulations provide special rules for certain short 
periods required to effect a change in annual accounting period to (or 
from) a 52-53-week taxable year. The proposed regulations provide that 
if the short period is 6 days or less, such short period is not a 
separate taxable year but is instead added to and deemed a part of the 
following taxable year.
    One commentator suggested that taxpayers be permitted the option of 
adding such a short period to either: (1) the following taxable year 
(as the proposed regulations would require); or (2) the prior taxable 
year, whichever convention is used by the taxpayer for financial 
accounting purposes.
    The IRS and Treasury Department believe that adopting the 
commentator's suggestion in this case would present certain 
administrative difficulties, complicate tax administration, and 
possibly encourage the use of hindsight in tax reporting. After careful 
consideration, the IRS and Treasury have concluded that it is in the 
best interests of sound tax administration to have a uniform and 
certain rule applicable in all such situations. Thus, the final 
regulations do not adopt this suggestion.
D. Application of Effective Date Rules to 52-53-Week-Taxable Years
    The proposed regulations provide a general rule concerning the 
application of certain effective dates as they apply to taxpayers 
employing 52-53-week taxable years. In response to comments, the final 
regulations clarify that this rule also applies to administrative 
guidance published by the Commissioner.
    A comment was received suggesting that additional Examples be 
provided

[[Page 35010]]

illustrating how particular terms other than those ``expressed in terms 
of taxable years beginning, including, or ending with reference to the 
first or last day of a specified calendar month,'' apply to 52-53-week 
fiscal-year taxpayers. In response to this comment, clarifying language 
and an additional Example have been provided in the final regulations.
E. Definitions of ``Pass-Through Entity'' and ``Owner of a Pass-Through 
Entity''
    The proposed regulations provide rules for certain pass-through 
entities and owners of pass-through entities relating to the treatment 
of certain taxable years ending with reference to the same calendar 
month. These rules are designed to prevent substantial deferral and 
distortion of income reporting.
    The IRS and Treasury have become aware of a potentially abusive 
situation involving the deferral of income reporting in the case of 
closely-held Real Estate Investment Trusts (REITs) (within the meaning 
of section 6655(e)(5)(B)) and certain owners of interests in closely-
held REITs (within the meaning of section 6655(e)(5)(A)).
    For estimated tax purposes, certain owners of interests in closely-
held REITs are required to recognize income from the REIT in a manner 
similar to partners in a partnership. Unlike a partnership, however, 
REITs are not required to use a taxable year that conforms to the 
taxable year of their owners but rather are required to use a taxable 
year ending December 31 pursuant to section 859. Thus, the potential 
for deferral of estimated taxes exists with respect to certain owners 
of interests in closely-held REITs, including owners with 52-53-week 
taxable years that reference December 31, as well as fiscal-year 
owners.
    In an attempt to reduce the potential for deferral of estimated 
taxes in the case of certain owners of interests in closely-held REITs, 
the final regulations have been modified to add: (1) a closely-held 
REIT (within the meaning of section 6655(e)(5)(B)) to the definition of 
a pass-through entity; and (2) an owner of an interest (within the 
meaning of section 6655(e)(5)(A)) in a closely-held REIT to the 
definition of an owner of a pass-through entity. Thus, these owners of 
interests in a closely-held REIT with 52-53-week taxable years that 
reference December 31 will be required under the final regulations to 
recognize income from the closely-held REIT as if their taxable year 
ends on December 31.
F. Accrual of Foreign Taxes
    The IRS recognizes that changes to the taxable year of a taxpayer 
may shift the taxable year in which foreign taxes are treated as 
accruing for U.S. purposes. The IRS also recognizes that similar 
results may occur in the case of taxpayers that use a 52-53-week 
taxable year, which will not always include the last day of the 
taxpayer's taxable year in a foreign jurisdiction. The IRS is working 
on guidance that it expects will be issued this year to ensure that 
changes in U.S. taxable years, or the use of a 52-53-week taxable year, 
do not result in unintended and inappropriate consequences for foreign 
tax credit purposes. Comments are requested on the changes necessary 
and appropriate to address the accrual of foreign taxes in these 
situations.

2. Comments and Changes Relating to Sec. 1.442 of the Proposed 
Regulations

A. Time and Manner for Filing an Application
    The proposed regulations provide specific rules for the time and 
manner of filing an application to adopt, change, or retain an annual 
accounting period. Consistent with the general framework of the 
regulations, the IRS and Treasury have concluded that it is more 
appropriate to remove the specific time and manner requirements for 
filing applications for adoptions, changes, and retentions in annual 
accounting period from the final regulations, and provide them instead 
in administrative procedures published by the Commissioner. See Rev. 
Proc. 2002-37, Rev. Proc. 2002-38, and Rev. Proc. 2002-39. The IRS and 
Treasury believe that providing these rules in administrative guidance, 
rather than in regulations, allows the IRS more flexibility to respond 
in the future to the changing needs of taxpayers and the IRS.
    The proposed regulations provide that an application for non-
automatic approval of an annual accounting period change may be filed 
no earlier than the day following the close of the first effective year 
and no later than the 15th day of the third calendar month following 
the close of the first effective year. One commentator suggested that 
such applications be permitted to be filed no earlier than the later 
of: (1) The first day of the short period resulting from the proposed 
tax year change; or (2) 60 days prior to the end of the short period.
    The IRS currently allows taxpayers to file applications with the 
national office within the referenced 60-day period and believes that 
many taxpayers take advantage of early filing, even knowing that their 
applications lack adequate information, in an effort to obtain priority 
over other applications processed by the national office. However, the 
lack of adequate financial and other required information common to 
such early applications requires that the IRS devote additional 
resources to properly develop and process the applications. Ultimately, 
this causes a delay in processing both the early applications, and 
other applications as well. For this reason, the administrative 
guidance issued concurrently with these final regulations do not adopt 
this suggestion. However, the IRS and Treasury Department intend to 
study filing patterns under the new rules, and will consider expanding 
or modifying the time frame for filing applications with the national 
office if circumstances warrant.
    One commentator recommended that instead of requiring all taxpayers 
to file the application by the 15th day of the third calendar month 
following the close of the first taxable year in which the taxpayer 
wants the adoption, change, or retention to be effective (the first 
effective year), as the proposed regulations provide, the due date for 
the application should be the due date of the taxpayer's return for the 
short period, without extensions. The IRS and Treasury believe that 
such a rule will be simpler for taxpayers (such as individuals and 
partnerships) and the IRS. Accordingly, this change is adopted in the 
administrative guidance issued concurrently with these final 
regulations.
B. Changes to Required Taxable Years by Pass-Through Entities
    One commentator suggested that the proposed regulations be modified 
to waive the Form 1128, ``Application to Adopt, Change, or Retain a Tax 
Year,'' filing requirement in the case of partnerships, S corporations, 
and personal service corporations (PSCs) changing to a ``required 
taxable year'' for the first taxable year for which such change is 
required. Alternatively, the commentator recommended use of an 
``automatic consent'' procedure similar to the procedure outlined in 
the proposed regulations for subsidiaries changing tax years to conform 
to the periods of their affiliated groups. The commentator reasoned 
that changes to statutorily required taxable years should not require 
the Commissioner's prior approval through any filing or application 
process.
    Except in very limited circumstances (e.g., adoptions of required 
years, certain section 444 terminations, and

[[Page 35011]]

certain section 859 changes) applications historically have been 
required for changes to a required taxable year by a pass-through 
entity. The IRS and Treasury Department believe that the statutes that 
require such entities to use or change to a particular taxable year 
must be read in conjunction with the general requirement under section 
442 to obtain the prior approval of the Commissioner to change an 
existing taxable year. Moreover, the applications serve to provide the 
IRS with necessary information about the entity's annual accounting 
period. Accordingly, this comment was not adopted in the final 
regulations or the administrative guidance issued concurrently with 
these regulations.
C. Book Conformity Requirements
    The proposed regulations conform the record keeping requirement for 
taxpayers using a fiscal year to that of Sec. 1.446-1(a)(4), which 
allows for a reconciliation between the taxpayer's books and return. 
However, the preamble to the proposed regulations noted that, as a term 
and condition of obtaining approval to adopt, change to, or retain an 
annual accounting period under section 442, certain taxpayers 
nevertheless may be required, under administrative procedures published 
by the Commissioner, to compute income and keep their books (including 
financial statements and reports to creditors) on the basis of the 
requested annual accounting period. In fact, strict book conformity is 
a general requirement in the administrative procedures for approval to 
make many changes. See, e.g., Rev. Proc. 2002-37.
    One commentator objected to the proposed elimination of procedures 
contained in the existing regulations under section 442 under which 
certain corporations are granted automatic approval to change their 
taxable year without a strict book conformity requirement (i.e., by 
satisfying the general book conformity rules of section 446). The 
commentator recommended that either the final regulations retain these 
automatic consent rules or, alternatively, that the administrative 
procedures eliminate the strict book conformity requirement.
    The IRS and Treasury Department believe it is appropriate to apply 
the more lenient book conformity rule of section 446 in the case of a 
taxpayer adopting, changing to, or retaining a required or ownership 
taxable year and in the case of a foreign corporation that is required 
by foreign law to use a particular year for financial accounting 
purposes. See, e.g., Rev. Proc. 2002-39. However, for all other changes 
under the administrative procedures, the IRS and Treasury Department 
continue to believe that strict book conformity is an appropriate term 
and condition of a voluntary change in annual accounting period, as it 
provides assurance that the change is motivated by business, as opposed 
to tax, considerations. In addition, the IRS and Treasury believe, for 
reasons stated in the preamble to the proposed regulations, that tax 
administration and taxpayers are better served by providing the 
specific rules for adoptions, changes, and retentions of annual 
accounting periods in administrative pronouncements, rather than 
regulations. Accordingly, the comment has not been adopted.

3. Comments and Changes Relating to Partnerships, S Corporations, and 
Personal Service Corporations (PSCs)

    A comment was received recommending that the limitation on 
additional required taxable year changes in the proposed regulations 
for partnerships using a majority-interest taxable years, be extended 
to partnerships using other required taxable years (e.g., to principal 
partners' taxable years and to least-aggregate-deferral taxable years). 
The limitation for changes to a majority interest taxable year is 
specifically provided in section 706(b)(4)(B). No such statutory 
authority exists for providing similar limitations in the case of other 
required taxable year changes by partnerships. Accordingly, this 
comment was not adopted in the final regulations. However, the Treasury 
Department is considering this comment in connection with a legislative 
simplification study.
    The proposed regulations (consistent with the existing temporary 
regulations) generally provide for a 1-year testing period for 
determining whether a taxpayer is a PSC. In the preamble to the 
proposed regulations, the IRS and Treasury Department responded to a 
comment received in connection with the original notice of proposed 
rulemaking cross-referenced by the temporary regulations. The original 
commentator suggested that the testing period be expanded to the three 
preceding taxable years in order to minimize instances in which 
taxpayers become PSCs due to temporary or aberrational conditions. In 
response, the IRS and Treasury Department indicated that they would 
consider alternatives to the current 1-year period if similar requests 
were received in comments to the proposed regulations now that 
taxpayers have significantly more experience with the 1-year rule.
    Although some comments were received recommending a general 3-year 
testing period for both PSCs and S corporations, the suggestions were 
not directed to particular taxpayer burdens stemming from the 1-year 
testing period for a PSC or the original concern about taxpayers 
becoming a PSC because of temporary or aberrational conditions. Rather, 
commentators suggested that a general 3-year testing period rule would 
reduce repetitive ``required tax year'' changes, and promote tax-year 
certainty.
    The IRS and Treasury Department believe that these reasons do not 
warrant extending the 1-year testing period for PSCs and S corporations 
because the current required taxable year framework for PSCs and S 
corporations should not result in repetitive required taxable year 
changes. Once a PSC or S corporation has changed to its required 
taxable year (i.e., a calendar year), any further changes would be 
voluntary rather than required. Accordingly, this suggestion has not 
been adopted in the final regulations.

Effect on Other Documents

    Rev. Rul. 57-589 is obsolete.
    Rev. Rul. 65-316 (1965-2 C.B. 149) is obsolete.
    Rev. Rul. 68-125 (1968-1 C.B. 189) is obsolete.
    Rev. Rul. 69-563 is obsolete.
    Rev. Rul. 74-326 (1974-2 C.B. 142) is obsolete.
    Rev. Rul. 78-179 (1978-1 C.B. 132) is obsolete.

Special Analyses

    It has been determined that this Treasury decision is not a 
significant regulatory action as defined in Executive Order 12866. 
Therefore, a regulatory assessment is not required. It also has been 
determined that section 553(b) of the Administrative Procedure Act (5 
U.S.C. chapter 5) does not apply to these regulations. It is hereby 
certified that the collections of information in these regulations will 
not have a significant economic impact on a substantial number of small 
entities. This certification is based upon the fact that few small 
entities are expected to adopt a 52-53-week taxable year, triggering 
the collection of information, and that for those who do, the burden 
imposed under Sec. 1.441-2(b)(1)(ii) will be minimal. Therefore, a 
Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 
U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the 
Internal Revenue Code, the notice of proposed rulemaking preceding 
these regulations was submitted to the Chief Counsel for

[[Page 35012]]

Advocacy of the Small Business Administration for comment on its impact 
on small business.

Drafting Information

    The principal authors of these regulations are Roy A. Hirschhorn 
and Michael F. Schmit of the Office of Associate Chief Counsel (Income 
Tax and Accounting). However, other personnel from the IRS and Treasury 
Department participated in their development.

List of Subjects

26 CFR Parts 1, 5f, and 18

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 5c

    Accounting, Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 602

    Reporting and recordkeeping requirements.

Adoption of Amendments to the Regulations

    Accordingly, 26 CFR parts 1, 5c, 5f, 18, and 602 are amended as 
follows:

PART 1--INCOME TAXES

    Paragraph 1. The authority citation for part 1 continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *


    Par. 2. In the list below, for each section indicated in the left 
column, remove the old language in the middle column and add the new 
language in the right column.

------------------------------------------------------------------------
       Affected section                Remove                 Add
------------------------------------------------------------------------
1.46-1(p)(2)(iv).............  paragraph (b)(1) of    Sec. 1.441-2
                                Sec. 1.441-2.
1.48-3(d)(1)(iii)............  paragraph (b)(1) of    Sec. 1.441-2
                                Sec. 1.441-2.
1.280H-1T(a), last sentence..  Sec. 1.441-4T(d).....  Sec. 1.441-3(c)
1.443-1(b)(1)(ii)............  and paragraph (c)(5)   and Sec. 1.441-
                                of Sec. 1.441-2.       2(b)(2)(ii)
1.444-1T(a)(1), first          Sec. 1.441-4T(d).....  Sec. 1.441-3(c)
 sentence.
1.444-2T(a), last sentence...  Sec. 1.441-4T(d).....  Sec. 1.441-3(c)
1.448-1(h)(2)(ii)(B)(1)......  Sec. 1.441-2T(b)(1)..  Sec. 1.441-2(c)
1.469-1(h)(4)(ii)(D).........  Sec. 1.441-4T(f).....  Sec. 1.441-3(e)
1.469-1T(g)(2)(i)............  Sec. 1.441-4T(d).....  Sec. 1.441-3(c)
1.1561-1(c)(2)...............  See paragraph (b)(1)   See Sec. 1.441-2
                                of Sec. 1.441-2.
1.6654-2(a), concluding text.  paragraph (b) of Sec.  Sec. 1.441-2(c)
                                1.441-2.
1.6655-2(a)(4), first          paragraph (b) of Sec.  Sec. 1.441-2(c)
 sentence.                      1.441-2.
301.7701(b)-6(a), third        Sec. 1.441-1(e)......  Sec. 1.441-1(b)
 sentence.
------------------------------------------------------------------------



    Par. 3. Sections 1.441-0, 1.441-1, 1.441-2, 1.441-3, and 1.441-4 
are added to read as follows:


Sec. 1.441-0  Table of contents.

    This section lists the captions contained in Sec. 1.441-1 through 
1.441-4 as follows:

Sec. 1.441-1  Period for computation of taxable income.

(a) Computation of taxable income.
(1) In general.
(2) Length of taxable year.
(b) General rules and definitions.
(1) Taxable year.
(1) Required taxable year.
(i) In general.
(ii) Exceptions.
(A) 52-53-week taxable years.
(B) Partnerships, S corporations, and PSCs.
(C) Specified foreign corporations.
(3) Annual accounting period.
(4) Calendar year.
(5) Fiscal year.
(i) Definition.
(ii) Recognition.
(6) Grandfathered fiscal year.
(7) Books.
(8) Taxpayer.
(c) Adoption of taxable year.
(1) In general.
(2) Approval required.
(i) Taxpayers with required taxable years.
(ii) Taxpayers without books.
(d) Retention of taxable year.
(e) Change of taxable year.
(f) Obtaining approval of the Commissioner or making a section 444 
election.

Sec. 1.441-2  Election of taxable year consisting of 52-53 weeks

(a) In general.
(1) Election.
(2) Effect.
(3) Eligible taxpayer.
(4) Example.
(b) Procedures to elect a 52-53-week taxable year.
(1) Adoption of a 52-53-week taxable year.
(i) In general.
(ii) Filing requirement.
(2) Change to (or from) a 52-53-week taxable year.
(i) In general.
(ii) Special rules for short period required to effect the change.
(3) Examples.
(c) Application of effective dates.
(1) In general.
(2) Examples.
(3) Changes in tax rates.
(4) Examples.
(d) Computation of taxable income.
(e) Treatment of taxable years ending with reference to the same 
calendar month.
(1) Pass-through entities.
(2) Personal service corporations and employee-owners.
(3) Definitions.
(i) Pass-through entity.
(ii) Owner of a pass-through entity.
(4) Examples.
(5) Transition rule.

Sec. 1.441-3  Taxable year of a personal service corporation

(a) Taxable year.
(1) Required taxable year.
(2) Exceptions.
(b) Adoption, change, or retention of taxable year.
(1) Adoption of taxable year.
(2) Change in taxable year.
(3) Retention of taxable year.
(4) Procedures for obtaining approval or making a section 444 
election.
(5) Examples.
(c) Personal service corporation defined.
(1) In general.
(2) Testing period.
(i) In general.
(ii) New corporations.
(3) Examples.
(d) Performance of personal services.
(1) Activities described in section 448(d)(2)(A).
(2) Activities not described in section 448(d)(2)(A).
(e) Principal activity.
(1) General rule.
(2) Compensation cost.
(i) Amounts included.
(ii) Amounts excluded.
(3) Attribution of compensation cost to personal service activity.
(i) Employees involved only in the performance of personal services.
(ii) Employees involved only in activities that are not treated as 
the performance of personal services.
(iii) Other employees.

[[Page 35013]]

(A) Compensation cost attributable to personal service activity.
(B) Compensation cost not attributable to personal service activity.
(f) Services substantially performed by employee-owners.
(1) General rule.
(2) Compensation cost attributable to personal services.
(3) Examples.
(g) Employee-owner defined.
(1) General rule.
(2) Special rule for independent contractors who are owners.
(h) Special rules for affiliated groups filing consolidated returns.
(1) In general.
(2) Examples.

Sec. 1.441-4  Effective date


Sec. 1.441-1  Period for computation of taxable income.

    (a) Computation of taxable income--(1) In general. Taxable income 
must be computed and a return must be made for a period known as the 
taxable year. For rules relating to methods of accounting, the taxable 
year for which items of gross income are included and deductions are 
taken, inventories, and adjustments, see parts II and III (section 446 
and following), subchapter E, chapter 1 of the Internal Revenue Code, 
and the regulations thereunder.
    (2) Length of taxable year. Except as otherwise provided in the 
Internal Revenue Code and the regulations thereunder (e.g., Sec. 1.441-
2 regarding 52-53-week taxable years), a taxable year may not cover a 
period of more than 12 calendar months.
    (b) General rules and definitions. The general rules and 
definitions in this paragraph (b) apply for purposes of sections 441 
and 442 and the regulations thereunder.
    (1) Taxable year. Taxable year means--
    (i) The period for which a return is made, if a return is made for 
a period of less than 12 months (short period). See section 443 and the 
regulations thereunder;
    (ii) Except as provided in paragraph (b)(1)(i) of this section, the 
taxpayer's required taxable year (as defined in paragraph (b)(2) of 
this section), if applicable;
    (iii) Except as provided in paragraphs (b)(1)(i) and (ii) of this 
section, the taxpayer's annual accounting period (as defined in 
paragraph (b)(3) of this section), if it is a calendar year or a fiscal 
year; or
    (iv) Except as provided in paragraphs (b)(1)(i) and (ii) of this 
section, the calendar year, if the taxpayer keeps no books, does not 
have an annual accounting period, or has an annual accounting period 
that does not qualify as a fiscal year.
    (2) Required taxable year--(i) In general. Certain taxpayers must 
use the particular taxable year that is required under the Internal 
Revenue Code and the regulations thereunder (the required taxable 
year). For example, the required taxable year is--
    (A) In the case of a foreign sales corporation or domestic 
international sales corporation, the taxable year determined under 
section 441(h) and Sec. 1.921-1T(a)(11), (b)(4), and (b)(6);
    (B) In the case of a personal service corporation (PSC), the 
taxable year determined under section 441(i) and Sec. 1.441-3;
    (C) In the case of a nuclear decommissioning fund, the taxable year 
determined under Sec. 1.468A-4(c)(1);
    (D) In the case of a designated settlement fund or a qualified 
settlement fund, the taxable year determined under Sec. 1.468B-2(j);
    (E) In the case of a common trust fund, the taxable year determined 
under section 584(i);
    (F) In the case of certain trusts, the taxable year determined 
under section 644;
    (G) In the case of a partnership, the taxable year determined under 
section 706 and Sec. 1.706-1;
    (H) In the case of an insurance company, the taxable year 
determined under section 843 and Sec. 1.1502-76(a)(2);
    (I) In the case of a real estate investment trust, the taxable year 
determined under section 859;
    (J) In the case of a real estate mortgage investment conduit, the 
taxable year determined under section 860D(a)(5) and Sec. 1.860D-
1(b)(6);
    (K) In the case of a specified foreign corporation, the taxable 
year determined under section 898(c)(1)(A);
    (L) In the case of an S corporation, the taxable year determined 
under section 1378 and Sec. 1.1378-1; or
    (M) In the case of a member of an affiliated group that makes a 
consolidated return, the taxable year determined under Sec. 1.1502-76.
    (ii) Exceptions. Notwithstanding paragraph (b)(2)(i) of this 
section, the following taxpayers may have a taxable year other than 
their required taxable year:
    (A) 52-53-week taxable years. Certain taxpayers may elect to use a 
52-53-week taxable year that ends with reference to their required 
taxable year. See, for example, Sec. 1.441-3 (PSCs), 1.706-1 
(partnerships), 1.1378-1 (S corporations), and 1.1502-76(a)(1) (members 
of a consolidated group).
    (B) Partnerships, S corporations, and PSCs. A partnership, S 
corporation, or PSC may use a taxable year other than its required 
taxable year if the taxpayer elects to use a taxable year other than 
its required taxable year under section 444, elects a 52-53-week 
taxable year that ends with reference to its required taxable year as 
provided in paragraph (b)(2)(ii)(A) of this section or to a taxable 
year elected under section 444, or establishes a business purpose to 
the satisfaction of the Commissioner under section 442 (such as a 
grandfathered fiscal year).
    (C) Specified foreign corporations. A specified foreign corporation 
(as defined in section 898(b)) may use a taxable year other than its 
required taxable year if it elects a 52-53-week taxable year that ends 
with reference to its required taxable year as provided in paragraph 
(b)(2)(ii)(A) of this section or makes a one-month deferral election 
under section 898(c)(1)(B).
    (3) Annual accounting period. Annual accounting period means the 
annual period (calendar year or fiscal year) on the basis of which the 
taxpayer regularly computes its income in keeping its books.
    (4) Calendar year. Calendar year means a period of 12 consecutive 
months ending on December 31. A taxpayer who has not established a 
fiscal year must make its return on the basis of a calendar year.
    (5) Fiscal year--(i) Definition. Fiscal year means--
    (A) A period of 12 consecutive months ending on the last day of any 
month other than December; or
    (B) A 52-53-week taxable year, if such period has been elected by 
the taxpayer. See Sec. 1.441-2.
    (ii) Recognition. A fiscal year will be recognized only if the 
books of the taxpayer are kept in accordance with such fiscal year.
    (6) Grandfathered fiscal year. Grandfathered fiscal year means a 
fiscal year (other than a year that resulted in a three month or less 
deferral of income) that a partnership or an S corporation received 
permission to use on or after July 1, 1974, by a letter ruling (i.e., 
not by automatic approval).
    (7) Books. Books include the taxpayer's regular books of account 
and such other records and data as may be necessary to support the 
entries on the taxpayer's books and on the taxpayer's return, as for 
example, a reconciliation of any difference between such books and the 
taxpayer's return. Records that are sufficient to reflect income 
adequately and clearly on the basis of an annual accounting period will 
be regarded as the keeping of books. See section 6001 and the 
regulations thereunder for rules relating to the keeping of books and 
records.

[[Page 35014]]

    (8) Taxpayer. Taxpayer has the same meaning as the term person as 
defined in section 7701(a)(1) (e.g., an individual, trust, estate, 
partnership, association, or corporation) rather than the meaning of 
the term taxpayer as defined in section 7701(a)(14) (any person subject 
to tax).
    (c) Adoption of taxable year--(1) In general. Except as provided in 
paragraph (c)(2) of this section, a new taxpayer may adopt any taxable 
year that satisfies the requirements of section 441 and the regulations 
thereunder without the approval of the Commissioner. A taxable year of 
a new taxpayer is adopted by filing its first Federal income tax return 
using that taxable year. The filing of an application for automatic 
extension of time to file a Federal income tax return (e.g., Form 7004, 
``Application for Automatic Extension of Time to File Corporation 
Income Tax Return''), the filing of an application for an employer 
identification number (i.e., Form SS-4, ``Application for Employer 
Identification Number''), or the payment of estimated taxes, for a 
particular taxable year do not constitute an adoption of that taxable 
year.
    (2) Approval required--(i) Taxpayers with required taxable years. A 
newly-formed partnership, S corporation, or PSC that wants to adopt a 
taxable year other than its required taxable year, a taxable year 
elected under section 444, or a 52-53-week taxable year that ends with 
reference to its required taxable year or a taxable year elected under 
section 444 must establish a business purpose and obtain the approval 
of the Commissioner under section 442.
    (ii) Taxpayers without books. A taxpayer that must use a calendar 
year under section 441(g) and paragraph (f) of this section may not 
adopt a fiscal year without obtaining the approval of the Commissioner.
    (d) Retention of taxable year. In certain cases, a partnership, S 
corporation, electing S corporation, or PSC will be required to change 
its taxable year unless it obtains the approval of the Commissioner 
under section 442, or makes an election under section 444, to retain 
its current taxable year. For example, a corporation using a June 30 
fiscal year that either becomes a PSC or elects to be an S corporation 
and, as a result, is required to use the calendar year under section 
441(i) or 1378, respectively, must obtain the approval of the 
Commissioner to retain its current fiscal year. Similarly, a 
partnership using a taxable year that corresponds to its required 
taxable year must obtain the approval of the Commissioner to retain 
such taxable year if its required taxable year changes as a result of a 
change in ownership. However, a partnership that previously established 
a business purpose to the satisfaction of the Commissioner to use a 
taxable year is not required to obtain the approval of the Commissioner 
if its required taxable year changes as a result of a change in 
ownership.
    (e) Change of taxable year. Once a taxpayer has adopted a taxable 
year, such taxable year must be used in computing taxable income and 
making returns for all subsequent years unless the taxpayer obtains 
approval from the Commissioner to make a change or the taxpayer is 
otherwise authorized to change without the approval of the Commissioner 
under the Internal Revenue Code (e.g., section 444 or 859) or the 
regulations thereunder.
    (f) Obtaining approval of the Commissioner or making a section 444 
election. See Sec. 1.442-1(b) for procedures for obtaining approval of 
the Commissioner (automatically or otherwise) to adopt, change, or 
retain an annual accounting period. See Sec. 1.444-1T and 1.444-2T for 
qualifications, and 1.444-3T for procedures, for making an election 
under section 444.


Sec. 1.441-2  Election of taxable year consisting of 52-53 weeks.

    (a) In general--(1) Election. An eligible taxpayer may elect to 
compute its taxable income on the basis of a fiscal year that--
    (i) Varies from 52 to 53 weeks;
    (ii) Ends always on the same day of the week; and
    (iii) Ends always on--
    (A) Whatever date this same day of the week last occurs in a 
calendar month; or
    (B) Whatever date this same day of the week falls that is the 
nearest to the last day of the calendar month.
    (2) Effect. In the case of a taxable year described in paragraph 
(a)(1)(iii)(A) of this section, the year will always end within the 
month and may end on the last day of the month, or as many as six days 
before the end of the month. In the case of a taxable year described in 
paragraph (a)(1)(iii)(B) of this section, the year may end on the last 
day of the month, or as many as three days before or three days after 
the last day of the month.
    (3) Eligible taxpayer. A taxpayer is eligible to elect a 52-53-week 
taxable year if such fiscal year would otherwise satisfy the 
requirements of section 441 and the regulations thereunder. For 
example, a taxpayer that is required to use a calendar year under 
Sec. 1.441-1(b)(2)(i)(D) is not an eligible taxpayer.
    (4) Example. The provisions of this paragraph (a) are illustrated 
by the following example:

    Example. If the taxpayer elects a taxable year ending always on 
the last Saturday in November, then for the year 2001, the taxable 
year would end on November 24, 2001. On the other hand, if the 
taxpayer had elected a taxable year ending always on the Saturday 
nearest to the end of November, then for the year 2001, the taxable 
year would end on December 1, 2001.

    (b) Procedures to elect a 52-53-week taxable year--(1) Adoption of 
a 52-53-week taxable year--(i) In general. A new eligible taxpayer 
elects a 52-53-week taxable year by adopting such year in accordance 
with Sec. 1.441-1(c). A newly-formed partnership, S corporation or 
personal service corporation (PSC) may adopt a 52-53-week taxable year 
without the approval of the Commissioner if such year ends with 
reference to either the taxpayer's required taxable year (as defined in 
Sec. 1.441-1(b)(2)) or the taxable year elected under section 444. See 
Sec. 1.441-3, 1.706-1, and 1.1378-1. Similarly, a newly-formed 
specified foreign corporation (as defined in section 898(b)) may adopt 
a 52-53-week taxable year if such year ends with reference to the 
taxpayer's required taxable year, or, if the one-month deferral 
election under section 898(c)(1)(B) is made, with reference to the 
month immediately preceding the required taxable year. See Sec. 1.1502-
76(a)(1) for special rules regarding subsidiaries adopting 52-53-week 
taxable years.
    (ii) Filing requirement. A taxpayer adopting a 52-53-week taxable 
year must file with its Federal income tax return for its first taxable 
year a statement containing the following information--
    (A) The calendar month with reference to which the 52-53-week 
taxable year ends;
    (B) The day of the week on which the 52-53-week taxable year always 
will end; and
    (C) Whether the 52-53-week taxable year will always end on the date 
on which that day of the week last occurs in the calendar month, or on 
the date on which that day of the week falls that is nearest to the 
last day of that calendar month.
    (2) Change to (or from) a 52-53-week taxable year--(i) In general. 
An election of a 52-53-week taxable year by an existing eligible 
taxpayer with an established taxable year is treated as a change in 
annual accounting period that requires the approval of the Commissioner 
in accordance with Sec. 1.442-1. Thus, a taxpayer must obtain approval 
to change from its current

[[Page 35015]]

taxable year to a 52-53-week taxable year, even if such 52-53-week 
taxable year ends with reference to the same calendar month. Similarly, 
a taxpayer must obtain approval to change from a 52-53-week taxable 
year, or to change from one 52-53-week taxable year to another 52-53-
week taxable year. However, a taxpayer may obtain approval for 52-53-
week taxable year changes automatically to the extent provided in 
administrative procedures published by the Commissioner. See 
Sec. 1.442-1(b) for procedures for obtaining such approval.
    (ii) Special rules for the short period required to effect the 
change. If a change to or from a 52-53-week taxable year results in a 
short period (within the meaning of Sec. 1.443-1(a)) of 359 days or 
more, or six days or less, the tax computation under Sec. 1.443-1(b) 
does not apply. If the short period is 359 days or more, it is treated 
as a full taxable year. If the short period is six days or less, such 
short period is not a separate taxable year but instead is added to and 
deemed a part of the following taxable year. (In the case of a change 
to or from a 52-53-week taxable year not involving a change of the 
month with reference to which the taxable year ends, the tax 
computation under Sec. 1.443-1(b) does not apply because the short 
period will always be 359 days or more, or six days or less.) In the 
case of a short period which is more than six days and less than 359 
days, taxable income for the short period is placed on an annual basis 
for purposes of Sec. 1.443-1(b) by multiplying such income by 365 and 
dividing the result by the number of days in the short period. In such 
case, the tax for the short period is the same part of the tax computed 
on such income placed on an annual basis as the number of days in the 
short period is of 365 days (unless Sec. 1.443-1(b)(2), relating to the 
alternative tax computation, applies). For an adjustment in deduction 
for personal exemption, see Sec. 1.443-1(b)(1)(v).
    (3) Examples. The following examples illustrate paragraph 
(b)(2)(ii) of this section:

    Example 1. A taxpayer having a fiscal year ending April 30, 
obtains approval to change to a 52-53-week taxable year ending the 
last Saturday in April for taxable years beginning after April 30, 
2001. This change involves a short period of 362 days, from May 1, 
2001, to April 27, 2002, inclusive. Because the change results in a 
short period of 359 days or more, it is not placed on an annual 
basis and is treated as a full taxable year.
    Example 2. Assume the same conditions as Example 1, except that 
the taxpayer changes for taxable years beginning after April 30, 
2002, to a taxable year ending on the Thursday nearest to April 30. 
This change results in a short period of two days, May 1 to May 2, 
2002. Because the short period is less than seven days, tax is not 
separately computed. This short period is added to and deemed part 
of the following 52-53-week taxable year, which would otherwise 
begin on May 3, 2002, and end on May 1, 2003.

    (c) Application of effective dates--(1) In general. Except as 
provided in paragraph (c)(3) of this section, for purposes of 
determining the effective date (e.g., of legislative, regulatory, or 
administrative changes) or the applicability of any provision of the 
internal revenue laws that is expressed in terms of taxable years 
beginning, including, or ending with reference to the first or last day 
of a specified calendar month, a 52-53-week taxable year is deemed to 
begin on the first day of the calendar month nearest to the first day 
of the 52-53-week taxable year, and is deemed to end or close on the 
last day of the calendar month nearest to the last day of the 52-53-
week taxable year, as the case may be. Examples of provisions of this 
title, the applicability of which is expressed in terms referred to in 
the preceding sentence, include the provisions relating to the time for 
filing returns and other documents, paying tax, or performing other 
acts, and the provisions of part II, subchapter B, chapter 6 (section 
1561 and following) relating to surtax exemptions of certain controlled 
corporations.
    (2) Examples. The provisions of paragraph (c)(1) of this section 
may be illustrated by the following examples:

    Example 1. Assume that an income tax provision is applicable to 
taxable years beginning on or after January 1, 2001. For that 
purpose, a 52-53-week taxable year beginning on any day within the 
period December 26, 2000, to January 4, 2001, inclusive, is treated 
as beginning on January 1, 2001.
    Example 2. Assume that an income tax provision requires that a 
return must be filed on or before the 15th day of the third month 
following the close of the taxable year. For that purpose, a 52-53-
week taxable year ending on any day during the period May 25 to June 
3, inclusive, is treated as ending on May 31, the last day of the 
month ending nearest to the last day of the taxable year, and the 
return, therefore, must be made on or before August 15.
    Example 3. Assume that a revenue procedure requires the 
performance of an act by the taxpayer within ``the first 90 days of 
the taxable year,'' by ``the 75th day of the taxable year,'' or, 
alternately, by ``the last day of the taxable year.'' The taxpayer 
employs a 52-53-week taxable year that ends always on the Saturday 
closest to the last day of December. These requirements are not 
expressed in terms of taxable years beginning, including, or ending 
with reference to the first or last day of a specified calendar 
month, and are accordingly outside the scope of the rule stated in 
Sec. 1.441-2(c)(1). Accordingly, the taxpayer must perform the 
required act by the 90th, 75th, or last day, respectively, of its 
taxable year.
    Example 4. X, a corporation created on January 1, 2001, elects a 
52-53-week taxable year ending on the Friday nearest the end of 
December. Thus, X's first taxable year begins on Monday, January 1, 
2001, and ends on Friday, December 28, 2001; its next taxable year 
begins on Saturday, December 29, 2001, and ends on Friday, January 
3, 2003; and its next taxable year begins on Saturday, January 4, 
2003, and ends on Friday, January 2, 2004. For purposes of applying 
the provisions of Part II, subchapter B, chapter 6 of the Internal 
Revenue Code, X's first taxable year is deemed to end on December 
31, 2001; its next taxable year is deemed to begin on January 1, 
2002, and end on December 31, 2002, and its next taxable year is 
deemed to begin on January 1, 2003, and end on December 31, 2003. 
Accordingly, each such taxable year is treated as including one and 
only one December 31st.

    (3) Changes in tax rates. If a change in the rate of tax is 
effective during a 52-53-week taxable year (other than on the first day 
of such year as determined under paragraph (c)(1) of this section), the 
tax for the 52-53-week taxable year must be computed in accordance with 
section 15, relating to effect of changes, and the regulations 
thereunder. For the purpose of the computation under section 15, the 
determination of the number of days in the period before the change, 
and in the period on and after the change, is to be made without regard 
to the provisions of paragraph (b)(1) of this paragraph.
    (4) Examples. The provisions of paragraph (c)(3) of this section 
may be illustrated by the following examples:

    Example 1. Assume a change in the rate of tax is effective for 
taxable years beginning after June 30, 2002. For a 52-53-week 
taxable year beginning on Friday, November 2, 2001, the tax must be 
computed on the basis of the old rates for the actual number of days 
from November 2, 2001, to June 30, 2002, inclusive, and on the basis 
of the new rates for the actual number of days from July 1, 2002, to 
Thursday, October 31, 2002, inclusive.
    Example 2. Assume a change in the rate of tax is effective for 
taxable years beginning after June 30, 2001. For this purpose, a 52-
53-week taxable year beginning on any of the days from June 25 to 
July 4, inclusive, is treated as beginning on July 1. Therefore, no 
computation under section 15 will be required for such year because 
of the change in rate.

    (d) Computation of taxable income. The principles of section 451, 
relating to the taxable year for inclusion of items of gross income, 
and section 461, relating to the taxable year for taking deductions, 
generally are applicable to 52-53-week taxable years. Thus, except as 
otherwise provided, all items of income and deduction must be

[[Page 35016]]

determined on the basis of a 52-53-week taxable year. However, a 
taxpayer may determine particular items as though the 52-53-week 
taxable year were a taxable year consisting of 12 calendar months, 
provided that practice is consistently followed by the taxpayer and 
clearly reflects income. For example, an allowance for depreciation or 
amortization may be determined on the basis of a 52-53-week taxable 
year, or as though the 52-53-week taxable year is a taxable year 
consisting of 12 calendar months, provided the taxpayer consistently 
follows that practice with respect to all depreciable or amortizable 
items.
    (e) Treatment of taxable years ending with reference to the same 
calendar month--(1) Pass-through entities. If a pass-through entity (as 
defined in paragraph (e)(3)(i) of this section) or an owner of a pass-
through entity (as defined in paragraph (e)(3)(ii) of this section), or 
both, use a 52-53-week taxable year and the taxable year of the pass-
through entity and the owner end with reference to the same calendar 
month, then, for purposes of determining the taxable year in which 
items of income, gain, loss, deductions, or credits from the pass-
through entity are taken into account by the owner of the pass-through, 
the owner's taxable year will be deemed to end on the last day of the 
pass-through's taxable year. Thus, if the taxable year of a partnership 
and a partner end with reference to the same calendar month, then for 
purposes of determining the taxable year in which that partner takes 
into account items described in section 702 and items that are 
deductible by the partnership (including items described in section 
707(c)) and includible in the income of that partner, that partner's 
taxable year will be deemed to end on the last day of the partnership's 
taxable year. Similarly, if the taxable year of an S corporation and a 
shareholder end with reference to the same calendar month, then for 
purposes of determining the taxable year in which that shareholder 
takes into account items described in section 1366(a) and items that 
are deductible by the S corporation and includible in the income of 
that shareholder, that shareholder's taxable year will be deemed to end 
on the last day of the S corporation's taxable year.
    (2) Personal service corporations and employee-owners. If the 
taxable year of a PSC (within the meaning of Sec. 1.441-3(c)) and an 
employee-owner (within the meaning of Sec. 1.441-3(g)) end with 
reference to the same calendar month, then for purposes of determining 
the taxable year in which an employee-owner takes into account items 
that are deductible by the PSC and includible in the income of the 
employee-owner, the employee-owner's taxable year will be deemed to end 
on the last day of the PSC's taxable year.
    (3) Definitions--(i) Pass-through entity. For purposes of this 
section, a pass-through entity means a partnership, S corporation, 
trust, estate, closely-held real estate investment trust (within the 
meaning of section 6655(e)(5)(B)), common trust fund (within the 
meaning of section 584(i)), controlled foreign corporation (within the 
meaning of section 957), foreign personal holding company (within the 
meaning of section 552), or passive foreign investment company that is 
a qualified electing fund (within the meaning of section 1295).
    (ii) Owner of a pass-through entity. For purposes of this section, 
an owner of a pass-through entity generally means a taxpayer that owns 
an interest in, or stock of, a pass-through entity. For example, an 
owner of a pass-through entity includes a partner in a partnership, a 
shareholder of an S corporation, a beneficiary of a trust or an estate, 
an owner of a closely-held real estate investment trust (within the 
meaning of section 6655(e)(5)(A)), a participant in a common trust 
fund, a U.S. shareholder (as defined in section 951(b)) of a controlled 
foreign corporation, a U.S. shareholder (as defined in section 551(a)) 
of a foreign personal holding company, or a U.S. person that holds 
stock in a passive foreign investment company that is a qualified 
electing fund with respect to that shareholder.
    (4) Examples. The provisions of paragraph (e)(2) of this section 
may be illustrated by the following examples:

    Example 1. ABC Partnership uses a 52-53-week taxable year that 
ends on the Wednesday nearest to December 31, and its partners, A, 
B, and C, are individual calendar year taxpayers. Assume that, for 
ABC's taxable year ending January 3, 2001, each partner's 
distributive share of ABC's taxable income is $10,000. Under section 
706(a) and paragraph (e)(1) of this section, for the taxable year 
ending December 31, 2000, A, B, and C each must include $10,000 in 
income with respect to the ABC year ending January 3, 2001. 
Similarly, if ABC makes a guaranteed payment to A on January 2, 
2001, A must include the payment in income for A's taxable year 
ending December 31, 2000.
    Example 2. X, a PSC, uses a 52-53-week taxable year that ends on 
the Wednesday nearest to December 31, and all of the employee-owners 
of X are individual calendar year taxpayers. Assume that, for its 
taxable year ending January 3, 2001, X pays a bonus of $10,000 to 
each employee-owner on January 2, 2001. Under paragraph (e)(2) of 
this section, each employee-owner must include its bonus in income 
for the taxable year ending December 31, 2000.

    (5) Transition rule. In the case of an owner of a pass-through 
entity (other than the owner of a partnership or S corporation) that is 
required by this paragraph (e) to include in income for its first 
taxable year ending on or after May 17, 2002 amounts attributable to 
two taxable years of a pass-through entity, the amount that otherwise 
would be required to be included in income for such first taxable year 
by reason of this paragraph (e) should be included in income ratably 
over the four-taxable-year period beginning with such first taxable 
year under principles similar to Sec. 1.702-3T, unless the owner of the 
pass-through entity elects to include all such income in its first 
taxable year ending on or after May 17, 2002.


Sec. 1.441-3  Taxable year of a personal service corporation.

    (a) Taxable year--(1) Required taxable year. Except as provided in 
paragraph (a)(2) of this section, the taxable year of a personal 
service corporation (PSC) (as defined in paragraph (c) of this section) 
must be the calendar year.
    (2) Exceptions. A PSC may have a taxable year other than its 
required taxable year (i.e., a fiscal year) if it makes an election 
under section 444, elects to use a 52-53-week taxable year that ends 
with reference to the calendar year or a taxable year elected under 
section 444, or establishes a business purpose for such fiscal year and 
obtains the approval of the Commissioner under section 442.
    (b) Adoption, change, or retention of taxable year--(1) Adoption of 
taxable year. A PSC may adopt, in accordance with Sec. 1.441-1(c), the 
calendar year, a taxable year elected under section 444, or a 52-53-
week taxable year ending with reference to the calendar year or a 
taxable year elected under section 444 without the approval of the 
Commissioner. See Sec. 1.441-1. A PSC that wants to adopt any other 
taxable year must establish a business purpose and obtain the approval 
of the Commissioner under section 442.
    (2) Change in taxable year. A PSC that wants to change its taxable 
year must obtain the approval of the Commissioner under section 442 or 
make an election under section 444. However, a PSC may obtain automatic 
approval for certain changes, including a change to the calendar year 
or to a 52-53-week taxable year ending with reference to the calendar 
year, pursuant to administrative procedures published by the 
Commissioner.
    (3) Retention of taxable year. In certain cases, a PSC will be 
required to

[[Page 35017]]

change its taxable year unless it obtains the approval of the 
Commissioner under section 442, or makes an election under section 444, 
to retain its current taxable year. For example, a corporation using a 
June 30 fiscal year that becomes a PSC and, as a result, is required to 
use the calendar year must obtain the approval of the Commissioner to 
retain its current fiscal year.
    (4) Procedures for obtaining approval or making a section 444 
election. See Sec. 1.442-1(b) for procedures to obtain the approval of 
the Commissioner (automatically or otherwise) to adopt, change, or 
retain a taxable year. See Sec. 1.444-1T and 1.444-2T for 
qualifications, and 1.444-3T for procedures, for making an election 
under section 444.
    (5) Examples. The provisions of paragraph (b)(4) of this section 
may be illustrated by the following examples:

    Example 1. X, whose taxable year ends on January 31, 2001, 
becomes a PSC for its taxable year beginning February 1, 2001, and 
does not obtain the approval of the Commissioner for using a fiscal 
year. Thus, for taxable years ending before February 1, 2001, this 
section does not apply with respect to X. For its taxable year 
beginning on February 1, 2001, however, X will be required to comply 
with paragraph (a) of this section. Thus, unless X obtains approval 
of the Commissioner to use a January 31 taxable year, or makes a 
section 444 election, X will be required to change its taxable year 
to the calendar year under paragraph (b) of this section by using a 
short taxable year that begins on February 1, 2001, and ends on 
December 31, 2001. Under paragraph (b)(1) of this section, X may 
obtain automatic approval to change its taxable year to a calendar 
year. See Sec. 1.442-1(b).
    Example 2. Assume the same facts as in Example 1, except that X 
desires to change to a 52-53-week taxable year ending with reference 
to the month of December. Under paragraph (b)(1) of this section X 
may obtain automatic approval to make the change. See Sec. 1.442-
1(b).

    (c) Personal service corporation defined--(1) In general. For 
purposes of this section and section 442, a taxpayer is a PSC for a 
taxable year only if--
    (i) The taxpayer is a C corporation (as defined in section 
1361(a)(2)) for the taxable year;
    (ii) The principal activity of the taxpayer during the testing 
period is the performance of personal services;
    (iii) During the testing period, those services are substantially 
performed by employee-owners (as defined in paragraph (g) of this 
section); and
    (iv) Employee-owners own (as determined under the attribution rules 
of section 318, except that the language ``any'' applies instead of 
``50 percent'' in section 318(a)(2)(C)) more than 10 percent of the 
fair market value of the outstanding stock in the taxpayer on the last 
day of the testing period.
    (2) Testing period--(i) In general. Except as otherwise provided in 
paragraph (c)(2)(ii) of this section, the testing period for any 
taxable year is the immediately preceding taxable year.
    (ii) New corporations. The testing period for a taxpayer's first 
taxable year is the period beginning on the first day of that taxable 
year and ending on the earlier of--
    (A) The last day of that taxable year; or
    (B) The last day of the calendar year in which that taxable year 
begins.
    (3) Examples. The provisions of paragraph (c)(2)(ii) of this 
section may be illustrated by the following examples:

    Example 1. Corporation A's first taxable year begins on June 1, 
2001, and A desires to use a September 30 taxable year. However, if 
A is a personal service corporation, it must obtain the 
Commissioner's approval to use a September 30 taxable year. Pursuant 
to paragraph (c)(2)(ii) of this section, A's testing period for its 
first taxable year beginning June 1, 2001, is the period June 1, 
2001 through September 30, 2001. Thus, if, based upon such testing 
period, A is a personal service corporation, A must obtain the 
Commissioner's permission to use a September 30 taxable year.
    Example 2. The facts are the same as in Example 1, except that A 
desires to use a March 31 taxable year. Pursuant to paragraph 
(c)(2)(ii) of this section, A's testing period for its first taxable 
year beginning June 1, 2001, is the period June 1, 2001, through 
December 31, 2001. Thus, if, based upon such testing period, A is a 
personal service corporation, A must obtain the Commissioner's 
permission to use a March 31 taxable year.

    (d) Performance of personal services--(1) Activities described in 
section 448(d)(2)(A). For purposes of this section, any activity of the 
taxpayer described in section 448(d)(2)(A) or the regulations 
thereunder will be treated as the performance of personal services. 
Therefore, any activity of the taxpayer that involves the performance 
of services in the fields of health, law, engineering, architecture, 
accounting, actuarial science, performing arts, or consulting (as such 
fields are defined in Sec. 1.448-1T) will be treated as the performance 
of personal services for purposes of this section.
    (2) Activities not described in section 448(d)(2)(A). For purposes 
of this section, any activity of the taxpayer not described in section 
448(d)(2)(A) or the regulations thereunder will not be treated as the 
performance of personal services.
    (e) Principal activity--(1) General rule. For purposes of this 
section, the principal activity of a corporation for any testing period 
will be the performance of personal services if the cost of the 
corporation's compensation (the compensation cost) for such testing 
period that is attributable to its activities that are treated as the 
performance of personal services within the meaning of paragraph (d) of 
this section (i.e., the total compensation for personal service 
activities) exceeds 50 percent of the corporation's total compensation 
cost for such testing period.
    (2) Compensation cost--(i) Amounts included. For purposes of this 
section, the compensation cost of a corporation for a taxable year is 
equal to the sum of the following amounts allowable as a deduction, 
allocated to a long-term contract, or otherwise chargeable to a capital 
account by the corporation during such taxable year--
    (A) Wages and salaries; and
    (B) Any other amounts, attributable to services performed for or on 
behalf of the corporation by a person who is an employee of the 
corporation (including an owner of the corporation who is treated as an 
employee under paragraph (g)(2) of this section) during the testing 
period. Such amounts include, but are not limited to, amounts 
attributable to deferred compensation, commissions, bonuses, 
compensation includible in income under section 83, compensation for 
services based on a percentage of profits, and the cost of providing 
fringe benefits that are includible in income.
    (ii) Amounts excluded. Notwithstanding paragraph (e)(2)(i) of this 
section, compensation cost does not include amounts attributable to a 
plan qualified under section 401(a) or 403(a), or to a simplified 
employee pension plan defined in section 408(k).
    (3) Attribution of compensation cost to personal service activity--
(i) Employees involved only in the performance of personal services. 
The compensation cost for employees involved only in the performance of 
activities that are treated as personal services under paragraph (d) of 
this section, or employees involved only in supporting the work of such 
employees, are considered to be attributable to the corporation's 
personal service activity.
    (ii) Employees involved only in activities that are not treated as 
the performance of personal services. The compensation cost for 
employees involved only in the performance of activities that are not 
treated as personal services under paragraph (d) of this section, or 
for employees involved only in supporting the work of such employees, 
are not considered to be attributable to the corporation's personal 
service activity.

[[Page 35018]]

    (iii) Other employees. The compensation cost for any employee who 
is not described in either paragraph (e)(3)(i) or (ii) of this section 
(a mixed-activity employee) is allocated as follows--
    (A) Compensation cost attributable to personal service activity. 
That portion of the compensation cost for a mixed activity employee 
that is attributable to the corporation's personal service activity 
equals the compensation cost for that employee multiplied by the 
percentage of the total time worked for the corporation by that 
employee during the year that is attributable to activities of the 
corporation that are treated as the performance of personal services 
under paragraph (d) of this section. That percentage is to be 
determined by the taxpayer in any reasonable and consistent manner. 
Time logs are not required unless maintained for other purposes;
    (B) Compensation cost not attributable to personal service 
activity. That portion of the compensation cost for a mixed activity 
employee that is not considered to be attributable to the corporation's 
personal service activity is the compensation cost for that employee 
less the amount determined in paragraph (e)(3)(iii)(A) of this section.
    (f) Services substantially performed by employee-owners--(1) 
General rule. Personal services are substantially performed during the 
testing period by employee-owners of the corporation if more than 20 
percent of the corporation's compensation cost for that period 
attributable to its activities that are treated as the performance of 
personal services within the meaning of paragraph (d) of this section 
(i.e., the total compensation for personal service activities) is 
attributable to personal services performed by employee-owners.
    (2) Compensation cost attributable to personal services. For 
purposes of paragraph (f)(1) of this section--
    (i) The corporation's compensation cost attributable to its 
activities that are treated as the performance of personal services is 
determined under paragraph (e)(3) of this section; and
    (ii) The portion of the amount determined under paragraph (f)(2)(i) 
of this section that is attributable to personal services performed by 
employee-owners is to be determined by the taxpayer in any reasonable 
and consistent manner.
    (3) Examples. The provisions of this paragraph (f) may be 
illustrated by the following examples:

    Example 1. For its taxable year beginning February 1, 2001, Corp 
A's testing period is the taxable year ending January 31, 2000. 
During that testing period, A's only activity was the performance of 
personal services. The total compensation cost of A (including 
compensation cost attributable to employee-owners) for the testing 
period was $1,000,000. The total compensation cost attributable to 
employee-owners of A for the testing period was $210,000. Pursuant 
to paragraph (f)(1) of this section, the employee-owners of A 
substantially performed the personal services of A during the 
testing period because the compensation cost of A's employee-owners 
was more than 20 percent of the total compensation cost for all of 
A's employees (including employee-owners).
    Example 2. Corp B has the same facts as corporation A in Example 
1, except that during the taxable year ending January 31, 2001, B 
also participated in an activity that would not be characterized as 
the performance of personal services under this section. The total 
compensation cost of B (including compensation cost attributable to 
employee-owners) for the testing period was $1,500,000 ($1,000,000 
attributable to B's personal service activity and $500,000 
attributable to B's other activity). The total compensation cost 
attributable to employee-owners of B for the testing period was 
$250,000 ($210,000 attributable to B's personal service activity and 
$40,000 attributable to B's other activity). Pursuant to paragraph 
(f)(1) of this section, the employee-owners of B substantially 
performed the personal services of B during the testing period 
because more than 20 percent of B's compensation cost during the 
testing period attributable to its personal service activities was 
attributable to personal services performed by employee-owners 
($210,000).

    (g) Employee-owner defined--(1) General rule. For purposes of this 
section, a person is an employee-owner of a corporation for a testing 
period if--
    (i) The person is an employee of the corporation on any day of the 
testing period; and
    (ii) The person owns any outstanding stock of the corporation on 
any day of the testing period.
    (2) Special rule for independent contractors who are owners. Any 
person who is an owner of the corporation within the meaning of 
paragraph (g)(1)(ii) of this section and who performs personal services 
for, or on behalf of, the corporation is treated as an employee for 
purposes of this section, even if the legal form of that person's 
relationship to the corporation is such that the person would be 
considered an independent contractor for other purposes.
    (h) Special rules for affiliated groups filing consolidated 
returns--(1) In general. For purposes of applying this section to the 
members of an affiliated group of corporations filing a consolidated 
return for the taxable year--
    (i) The members of the affiliated group are treated as a single 
corporation;
    (ii) The employees of the members of the affiliated group are 
treated as employees of such single corporation; and
    (iii) All of the stock of the members of the affiliated group that 
is not owned by any other member of the affiliated group is treated as 
the outstanding stock of that corporation.
    (2) Examples. The provisions of this paragraph (h) may be 
illustrated by the following examples:

    Example 1. The affiliated group AB, consisting of corporation A 
and its wholly owned subsidiary B, filed a consolidated Federal 
income tax return for the taxable year ending January 31, 2001, and 
AB is attempting to determine whether it is affected by this section 
for its taxable year beginning February 1, 2001. During the testing 
period (i.e., the taxable year ending January 31, 2001), A did not 
perform personal services. However, B's only activity was the 
performance of personal services. On the last day of the testing 
period, employees of A did not own any stock in A. However, some of 
B's employees own stock in A. In the aggregate, B's employees own 9 
percent of A's stock on the last day of the testing period. Pursuant 
to paragraph (h)(1) of this section, this section is effectively 
applied on a consolidated basis to members of an affiliated group 
filing a consolidated Federal income tax return. Because the only 
employee-owners of AB are the employees of B, and because B's 
employees do not own more than 10 percent of AB on the last day of 
the testing period, AB is not a PSC subject to the provisions of 
this section. Thus, AB is not required to determine on a 
consolidated basis whether, during the testing period, its principal 
activity is the providing of personal services, or the personal 
services are substantially performed by employee-owners.
    Example 2. The facts are the same as in Example 1, except that 
on the last day of the testing period A owns only 80 percent of B. 
The remaining 20 percent of B is owned by employees of B. The fair 
market value of A, including its 80 percent interest in B, as of the 
last day of the testing period, is $1,000,000. In addition, the fair 
market value of the 20 percent interest in B owned by B's employees 
is $50,000 as of the last day of the testing period. Pursuant to 
paragraphs (c)(1)(iv) and (h)(1) of this section, AB must determine 
whether the employee-owners of A and B (i.e., B's employees) own 
more than 10 percent of the fair market value of A and B as of the 
last day of the testing period. Because the $140,000 [($1,000,000 x 
.09) + $50,000] fair market value of the stock held by B's employees 
is greater than 10 percent of the aggregate fair market value of A 
and B as of the last day of the testing period, or $105,000 
[$1,000,000 + $50,000 x .10], AB may be subject to this section if, 
on a consolidated basis during the testing period, the principal 
activity of AB is the performance of personal services and the 
personal services are substantially performed by employee-owners.

[[Page 35019]]

Sec. 1.441-4  Effective date.

    Sections 1.441-0 through 1.441-3 are applicable for taxable years 
ending on or after May 17, 2002.


Sec. 1.441-1T, 1.441-2T, 1.441-3T and 1.441-4T  [Removed]

    Par. 4. Sections 1.441-1T, 1.441-2T, 1.441-3T and 1.441-4T are 
removed.

    Par 5. Section 1.442-1 is revised to read as follows:


Sec. 1.442-1  Change of annual accounting period.

    (a) Approval of the Commissioner. A taxpayer that has adopted an 
annual accounting period (as defined in Sec. 1.441-1(b)(3)) as its 
taxable year generally must continue to use that annual accounting 
period in computing its taxable income and for making its Federal 
income tax returns. If the taxpayer wants to change its annual 
accounting period and use a new taxable year, it must obtain the 
approval of the Commissioner, unless it is otherwise authorized to 
change without the approval of the Commissioner under either the 
Internal Revenue Code (e.g., section 444 and section 859) or the 
regulations thereunder (e.g., paragraph (c) of this section). In 
addition, as described in Sec. 1.441-1(c) and (d), a partnership, S 
corporation, electing S corporation, or personal service corporation 
(PSC) generally is required to secure the approval of the Commissioner 
to adopt or retain an annual accounting period other than its required 
taxable year. The manner of obtaining approval from the Commissioner to 
adopt, change, or retain an annual accounting period is provided in 
paragraph (b) of this section. However, special rules for obtaining 
approval may be provided in other sections.
    (b) Obtaining approval--(1) Time and manner for requesting 
approval. In order to secure the approval of the Commissioner to adopt, 
change, or retain an annual accounting period, a taxpayer must file an 
application, generally on Form 1128, ``Application To Adopt, Change, or 
Retain a Tax Year,'' with the Commissioner within such time and in such 
manner as is provided in administrative procedures published by the 
Commissioner.
    (2) General requirements for approval. An adoption, change, or 
retention in annual accounting period will be approved where the 
taxpayer establishes a business purpose for the requested annual 
accounting period and agrees to the Commissioner's prescribed terms, 
conditions, and adjustments for effecting the adoption, change, or 
retention. In determining whether a taxpayer has established a business 
purpose and which terms, conditions, and adjustments will be required, 
consideration will be given to all the facts and circumstances relating 
to the adoption, change, or retention, including the tax consequences 
resulting therefrom. Generally, the requirement of a business purpose 
will be satisfied, and adjustments to neutralize any tax consequences 
will not be required, if the requested annual accounting period 
coincides with the taxpayer's required taxable year (as defined in 
Sec. 1.441-1(b)(2)), ownership taxable year, or natural business year. 
In the case of a partnership, S corporation, electing S corporation, or 
PSC, deferral of income to partners, shareholders, or employee-owners 
will not be treated as a business purpose.
    (3) Administrative procedures. The Commissioner will prescribe 
administrative procedures under which a taxpayer may be permitted to 
adopt, change, or retain an annual accounting period. These 
administrative procedures will describe the business purpose 
requirements (including an ownership taxable year and a natural 
business year) and the terms, conditions, and adjustments necessary to 
obtain approval. Such terms, conditions, and adjustments may include 
adjustments necessary to neutralize the tax effects of a substantial 
distortion of income that would otherwise result from the requested 
annual accounting period including: a deferral of a substantial portion 
of the taxpayer's income, or shifting of a substantial portion of 
deductions, from one taxable year to another; a similar deferral or 
shifting in the case of any other person, such as a beneficiary in an 
estate; the creation of a short period in which there is a substantial 
net operating loss, capital loss, or credit (including a general 
business credit); or the creation of a short period in which there is a 
substantial amount of income to offset an expiring net operating loss, 
capital loss, or credit. See, for example, Rev. Proc. 2002-39, 2002-22 
I.R.B., procedures for obtaining the Commissioner's prior approval of 
an adoption, change, or retention in annual accounting period through 
application to the national office; Rev. Proc. 2002-37, 2002-22 I.R.B., 
automatic approval procedures for certain corporations; Rev. Proc. 
2002-38, 2002-22 I.R.B., automatic approval procedures for 
partnerships, S corporations, electing S corporations, and PSCs; and 
Rev. Proc. 66-50, 1966-2 C.B. 1260, automatic approval procedures for 
individuals. For availability of Revenue Procedures and Notices, see 
Sec. 601.601(d)(2) of this chapter.
    (4) Taxpayers to whom section 441(g) applies. If section 441(g) and 
Sec. 1.441-1(b)(1)(iv) apply to a taxpayer, the adoption of a fiscal 
year is treated as a change in the taxpayer's annual accounting period 
under section 442. Therefore, that fiscal year can become the 
taxpayer's taxable year only with the approval of the Commissioner. In 
addition to any other terms and conditions that may apply to such a 
change, the taxpayer must establish and maintain books that adequately 
and clearly reflect income for the short period involved in the change 
and for the fiscal year proposed.
    (c) Special rule for change of annual accounting period by 
subsidiary corporation. A subsidiary corporation that is required to 
change its annual accounting period under Sec. 1.1502-76, relating to 
the taxable year of members of an affiliated group that file a 
consolidated return, does not need to obtain the approval of the 
Commissioner or file an application on Form 1128 with respect to that 
change.
    (d) Special rule for newly married couples. (1) A newly married 
husband or wife may obtain automatic approval under this paragraph (d) 
to change his or her annual accounting period in order to use the 
annual accounting period of the other spouse so that a joint return may 
be filed for the first or second taxable year of that spouse ending 
after the date of marriage. Such automatic approval will be granted 
only if the newly married husband or wife adopting the annual 
accounting period of the other spouse files a Federal income tax return 
for the short period required by that change on or before the 15th day 
of the 4th month following the close of the short period. See section 
443 and the regulations thereunder. If the due date for any such short-
period return occurs before the date of marriage, the first taxable 
year of the other spouse ending after the date of marriage cannot be 
adopted under this paragraph (d). The short-period return must contain 
a statement at the top of page one of the return that it is filed under 
the authority of this paragraph (d). The newly married husband or wife 
need not file Form 1128 with respect to a change described in this 
paragraph (d). For a change of annual accounting period by a husband or 
wife that does not qualify under this paragraph (d), see paragraph (b) 
of this section.
    (2) The provisions of this paragraph (d) may be illustrated by the 
following example:


[[Page 35020]]


    Example. H & W marry on September 25, 2001. H is on a fiscal 
year ending June 30, and W is on a calendar year. H wishes to change 
to a calendar year in order to file joint returns with W. W's first 
taxable year after marriage ends on December 31, 2001. H may not 
change to a calendar year for 2001 since, under this paragraph (d), 
he would have had to file a return for the short period from July 1 
to December 31, 2000, by April 16, 2001. Since the date of marriage 
occurred subsequent to this due date, the return could not be filed 
under this paragraph (d). Therefore, H cannot change to a calendar 
year for 2001. However, H may change to a calendar year for 2002 by 
filing a return under this paragraph (d) by April 15, 2002, for the 
short period from July 1 to December 31, 2001. If H files such a 
return, H and W may file a joint return for calendar year 2002 
(which is W's second taxable year ending after the date of 
marriage).

    (e) Effective date. The rules of this section are applicable for 
taxable years ending on or after May 17, 2002.


Sec. 1.442-2T and 1.442-3T  [Removed]

    Par. 6. Sections 1.442-2T and 1.442-3T are removed.

    Par. 7. Section 1.706-1 is amended by revising paragraphs (a) and 
(b) and adding paragraph (d) to read as follows:


Sec. 1.706-1  Taxable years of partner and partnership.

    (a) Year in which partnership income is includible. (1) In 
computing taxable income for a taxable year, a partner is required to 
include the partner's distributive share of partnership items set forth 
in section 702 and the regulations thereunder for any partnership 
taxable year ending within or with the partner's taxable year. A 
partner must also include in taxable income for a taxable year 
guaranteed payments under section 707(c) that are deductible by the 
partnership under its method of accounting in the partnership taxable 
year ending within or with the partner's taxable year.
    (2) The rules of this paragraph (a)(1) may be illustrated by the 
following example:

    Example. Partner A reports income using a calendar year, while 
the partnership of which A is a member reports its income using a 
fiscal year ending May 31. The partnership reports its income and 
deductions under the cash method of accounting. During the 
partnership taxable year ending May 31, 2002, the partnership makes 
guaranteed payments of $120,000 to A for services and for the use of 
capital. Of this amount, $70,000 was paid to A between June 1 and 
December 31, 2001, and the remaining $50,000 was paid to A between 
January 1 and May 31, 2002. The entire $120,000 paid to A is 
includible in A's taxable income for the calendar year 2002 
(together with A's distributive share of partnership items set forth 
in section 702 for the partnership taxable year ending May 31, 
2002).

    (3) If a partner receives distributions under section 731 or sells 
or exchanges all or part of a partnership interest, any gain or loss 
arising therefrom does not constitute partnership income.
    (b) Taxable year--(1) Partnership treated as a taxpayer. The 
taxable year of a partnership must be determined as though the 
partnership were a taxpayer.
    (2) Partnership's taxable year--(i) Required taxable year. Except 
as provided in paragraph (b)(2)(ii) of this section, the taxable year 
of a partnership must be--
    (A) The majority interest taxable year, as defined in section 
706(b)(4);
    (B) If there is no majority interest taxable year, the taxable year 
of all of the principal partners of the partnership, as defined in 
706(b)(3) (the principal partners' taxable year); or
    (C) If there is no majority interest taxable year or principal 
partners' taxable year, the taxable year that produces the least 
aggregate deferral of income as determined under paragraph (b)(3) of 
this section.
    (ii) Exceptions. A partnership may have a taxable year other than 
its required taxable year if it makes an election under section 444, 
elects to use a 52-53-week taxable year that ends with reference to its 
required taxable year or a taxable year elected under section 444, or 
establishes a business purpose for such taxable year and obtains 
approval of the Commissioner under section 442.
    (3) Least aggregate deferral--(i) Taxable year that results in the 
least aggregate deferral of income. The taxable year that results in 
the least aggregate deferral of income will be the taxable year of one 
or more of the partners in the partnership which will result in the 
least aggregate deferral of income to the partners. The aggregate 
deferral for a particular year is equal to the sum of the products 
determined by multiplying the month(s) of deferral for each partner 
that would be generated by that year and each partner's interest in 
partnership profits for that year. The partner's taxable year that 
produces the lowest sum when compared to the other partner's taxable 
years is the taxable year that results in the least aggregate deferral 
of income to the partners. If the calculation results in more than one 
taxable year qualifying as the taxable year with the least aggregate 
deferral, the partnership may select any one of those taxable years as 
its taxable year. However, if one of the qualifying taxable years is 
also the partnership's existing taxable year, the partnership must 
maintain its existing taxable year. The determination of the taxable 
year that results in the least aggregate deferral of income generally 
must be made as of the beginning of the partnership's current taxable 
year. The director, however, may determine that the first day of the 
current taxable year is not the appropriate testing day and require the 
use of some other day or period that will more accurately reflect the 
ownership of the partnership and thereby the actual aggregate deferral 
to the partners where the partners engage in a transaction that has as 
its principal purpose the avoidance of the principles of this section. 
Thus, for example the preceding sentence would apply where there is a 
transfer of an interest in the partnership that results in a temporary 
transfer of that interest principally for purposes of qualifying for a 
specific taxable year under the principles of this section. For 
purposes of this section, deferral to each partner is measured in terms 
of months from the end of the partnership's taxable year forward to the 
end of the partner's taxable year.
    (ii) Determination of the taxable year of a partner or partnership 
that uses a 52-53-week taxable year. For purposes of the calculation 
described in paragraph (b)(3)(i) of this section, the taxable year of a 
partner or partnership that uses a 52-53-week taxable year must be the 
same year determined under the rules of section 441(f) and the 
regulations thereunder with respect to the inclusion of income by the 
partner or partnership.
    (iii) Special de minimis rule. If the taxable year that results in 
the least aggregate deferral produces an aggregate deferral that is 
less than .5 when compared to the aggregate deferral of the current 
taxable year, the partnership's current taxable year will be treated as 
the taxable year with the least aggregate deferral. Thus, the 
partnership will not be permitted to change its taxable year.
    (iv) Examples. The principles of this section may be illustrated by 
the following examples:

    Example 1. Partnership P is on a fiscal year ending June 30. 
Partner A reports income on the fiscal year ending June 30 and 
Partner B reports income on the fiscal year ending July 31. A and B 
each have a 50 percent interest in partnership profits. For its 
taxable year beginning July 1, 1987, the partnership will be 
required to retain its taxable year since the fiscal year ending 
June 30 results in the least aggregate deferral of income to the 
partners. This determination is made as follows:

[[Page 35021]]



----------------------------------------------------------------------------------------------------------------
                                                                    Interest in      Months of
                    Test 6/30                        Year end       partnership   deferral for 6/   Interest x
                                                                      profits       30 year end      deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            6/30             .5                0            0
Partner B.......................................            7/31             .5                1             .5
                                                                                                 ---------------
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                    Interest in      Months of
                    Test 7/31                        Year end       partnership   deferral for 7/   Interest x;
                                                                      profits       31 year end      deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            6/30             .5               11            5.5
Partner B.......................................            7/31             .5                0            0
                                                                                                 ---------------
----------------------------------------------------------------------------------------------------------------

    Example 2. The facts are the same as in Example 1 except that A 
reports income on the calendar year and B reports on the fiscal year 
ending November 30. For the partnership's taxable year beginning 
July 1, 1987, the partnership is required to change its taxable year 
to a fiscal year ending November 30 because such year results in the 
least aggregate deferral of income to the partners. This 
determination is made as follows:

----------------------------------------------------------------------------------------------------------------
                                                                    Interest in      Months of
                   Test 12/31                        Year end       partnership    deferral for     Interest x
                                                                      profits     12/31 year end     deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................           12/31             .5                0            0
Partner B.......................................           11/30             .5               11            5.5
                                                                                                 ---------------
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                    Interest in      Months of
                   Test 11/30                        Year end       partnership    deferral for     Interest x
                                                                      profits     11/30 year end     deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................           12/31             .5                1             .5
Partner B.......................................           11/30             .5                0            0
                                                                                                 ---------------
----------------------------------------------------------------------------------------------------------------

    Example 3. The facts are the same as in Example 2 except that B 
reports income on the fiscal year ending June 30. For the 
partnership's taxable year beginning July 1, 1987, each partner's 
taxable year will result in identical aggregate deferral of income. 
If the partnership's current taxable year was neither a fiscal year 
ending June 30 nor the calendar year, the partnership would select 
either the fiscal year ending June 30 or the calendar year as its 
taxable year. However, since the partnership's current taxable year 
ends June 30, it must retain its current taxable year. The 
determination is made as follows:

----------------------------------------------------------------------------------------------------------------
                                                                    Interest in      Months of
                   Test 12/31                        Year end       partnership    deferral for     Interest x
                                                                      profits     12/31 year end     deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................           12/31             .5                0            0
Partner B.......................................            6/30             .5                6            3.0
                                                                                                 ---------------
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                    Interest in      Months of
                    Test 6/30                        Year end       partnership   deferral for 6/   Interest x
                                                                      profits       30 year end      deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................           12/31             .5                6            3.0
Partner B.......................................            6/30             .5                0            0
                                                                                                 ---------------
----------------------------------------------------------------------------------------------------------------

    Example 4. The facts are the same as in Example 1 except that on 
December 31, 1987, partner A sells a 4 percent interest in the 
partnership to Partner C, who reports income on the fiscal year 
ending June 30, and a 40 percent interest in the partnership to 
Partner D, who also reports income on the fiscal year ending June 
30. The taxable year beginning July 1, 1987, is unaffected by the 
sale. However, for the taxable year beginning July 31, 1988, the 
partnership must determine the taxable year resulting in the least 
aggregate deferral as of July 1, 1988. In this case, the partnership 
will be required to retain its taxable year since the fiscal year 
ending June

[[Page 35022]]

30 continues to be the taxable year that results in the least 
aggregate deferral of income to the partners.
    Example 5. The facts are the same as in Example 4 except that 
Partner D reports income on the fiscal year ending April 30. As in 
Example 4, the taxable year during which the sale took place is 
unaffected by the shifts in interests. However, for its taxable year 
beginning July 1, 1988, the partnership will be required to change 
its taxable year to the fiscal year ending April 30. This 
determination is made as follows:

----------------------------------------------------------------------------------------------------------------
                                                                    Interest in      Months of
                    Test 7/31                        Year end       partnership   deferral for 7/   Interest x
                                                                      profits       31 year end      deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            6/30             .06              11             .66
Partner B.......................................            7/31             .5                0            0
Partner C.......................................            6/30             .04              11             .44
Partner D.......................................            4/30             .4                9            3.60
                                                                                                 ---------------
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                    Interest in      Months of
                    Test 6/30                        Year end       partnership   deferral for 6/   Interest x
                                                                      profits       30 year end      deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            6/30             .06               0            0
Partner B.......................................            7/31             .5                1             .5
Partner C.......................................            6/30             .04               0            0
Partner D.......................................            4/30             .4               10            4.0
                                                                                                 ---------------
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                    Interest in      Months of
                    Test 4/30                        Year end       partnership   deferral for 4/   Interest x
                                                                      profits       30 year end      deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            6/30             .06               2             .12
Partner B.......................................            7/31             .5                3            1.50
Partner C.......................................            6/30             .04               2             .08
Partner D.......................................            4/30             .4                0            0
                                                                                                 ---------------
----------------------------------------------------------------------------------------------------------------


                         Sec. 1.706-1(b)(3) Test
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Current taxable year (June 30)..........................             4.5
Less: Taxable year producing the least aggregate                     1.7
 deferral (April 30)....................................
 
------------------------------------------------------------------------

    Example 6. (i) Partnership P has two partners, A who reports income 
on the fiscal year ending March 31, and B who reports income on the 
fiscal year ending July 31. A and B share profits equally. P has 
determined its taxable year under paragraph (b)(3) of this section to 
be the fiscal year ending March 31 as follows:

----------------------------------------------------------------------------------------------------------------
                                                                    Interest in
                    Test 3/31                        Year end       partnership    Deferral for     Interest x
                                                                      profits      3/31 year end     deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            3/31             .5                0            0
Partner B.......................................            7/31             .5                4            2
                                                                                                 ---------------
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                    Interest in
                    Test 7/31                        Year end       partnership    Deferral for     Interest x
                                                                      profits      7/31 year end     deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            3/31             .5                8            4
Partner B.......................................            7/31             .5                0            0
                                                                                                 ---------------
----------------------------------------------------------------------------------------------------------------

    (ii) In May 1988, Partner A sells a 45 percent interest in the 
partnership to C, who reports income on the fiscal year ending April 
30. For the taxable period beginning April 1, 1989, the fiscal year 
ending April 30 is the taxable year that produces the least 
aggregate deferral of income to the partners. However, under 
paragraph (b)(3)(iii) of this section the partnership is required to 
retain its fiscal year ending March 31. This determination is made 
as follows:

[[Page 35023]]



----------------------------------------------------------------------------------------------------------------
                                                                    Interest in
                    Test 3/31                        Year end       partnership    Deferral for     Interest x
                                                                      profits      3/31 year end     deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            3/31             .05               0            0
Partner B.......................................            7/31             .5                4            2.0
Partner C.......................................            4/30             .45               1             .45
                                                                                                 ---------------
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                    Interest in
                    Test 7/31                        Year end       partnership    Deferral for     Interest x
                                                                      profits      7/31 year end     deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            3/31             .05               8             .40
Partner B.......................................            7/31             .5                0            0
Partner C.......................................            4/30             .45               9            4.05
                                                                                                 ---------------
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                    Interest in
                    Test 4/30                        Year end       partnership    Deferral for     Interest x
                                                                      profits      4/30 year end     deferral
----------------------------------------------------------------------------------------------------------------
Partner A.......................................            3/31             .05              11             .55
Partner B.......................................            7/31             .5                3            1.50
Partner C.......................................            4/30             .45               0            0
                                                                                                 ---------------
----------------------------------------------------------------------------------------------------------------


                         Sec. 1.706-1(b)(3) Test
------------------------------------------------------------------------
 
------------------------------------------------------------------------
Current taxable year (3/31).............................            2.45
Less: Taxable year producing the least aggregate                    2.05
 deferral (4/30)........................................
 
------------------------------------------------------------------------

    (4) Measurement of partner's profits and capital interest--
    (i) In general. The rules of this paragraph (b)(4) apply in 
determining the majority interest taxable year, the principal partners' 
taxable year, and the least aggregate deferral taxable year.
    (ii) Profits interest--(A) In general. For purposes of section 
706(b), a partner's interest in partnership profits is generally the 
partner's percentage share of partnership profits for the current 
partnership taxable year. If the partnership does not expect to have 
net income for the current partnership taxable year, then a partner's 
interest in partnership profits instead must be the partner's 
percentage share of partnership net income for the first taxable year 
in which the partnership expects to have net income.
    (B) Percentage share of partnership net income. The partner's 
percentage share of partnership net income for a partnership taxable 
year is the ratio of: the partner's distributive share of partnership 
net income for the taxable year, to the partnership's net income for 
the year. If a partner's percentage share of partnership net income for 
the taxable year depends on the amount or nature of partnership income 
for that year (due to, for example, preferred returns or special 
allocations of specific partnership items), then the partnership must 
make a reasonable estimate of the amount and nature of its income for 
the taxable year. This estimate must be based on all facts and 
circumstances known to the partnership as of the first day of the 
current partnership taxable year. The partnership must then use this 
estimate in determining the partners' interests in partnership profits 
for the taxable year.
    (C) Distributive share. For purposes of this paragraph (b)(4)(ii), 
a partner's distributive share of partnership net income is determined 
by taking into account all rules and regulations affecting that 
determination, including, without limitation, sections 704(b), (c), and 
(e), 736, and 743.
    (iii) Capital interest. Generally, a partner's interest in 
partnership capital is determined by reference to the assets of the 
partnership that the partner would be entitled to upon withdrawal from 
the partnership or upon liquidation of the partnership. If the 
partnership maintains capital accounts in accordance with Sec. 1.704-
1(b)(2)(iv), then for purposes of section 706(b), the partnership may 
assume that a partner's interest in partnership capital is the ratio of 
the partner's capital account to all partners' capital accounts as of 
the first day of the partnership taxable year.
    (5) Certain tax-exempt partners disregarded. [Reserved]
    (6) Foreign partners. [Reserved]
    (7) Adoption of taxable year. A newly-formed partnership may adopt, 
in accordance with Sec. 1.441-1(c), its required taxable year, a 
taxable year elected under section 444, or a 52-53-week taxable year 
ending with reference to its required taxable year or a taxable year 
elected under section 444 without securing the approval of the 
Commissioner. If a newly-formed partnership wants to adopt any other 
taxable year, it must establish a business purpose and secure the 
approval of the Commissioner under section 442.
    (8) Change in taxable year--(i) Partnerships-(A) Approval required. 
An existing partnership may change its taxable year only by securing 
the approval of the Commissioner under section 442 or making an 
election under section 444. However, a partnership may obtain automatic 
approval for certain changes, including a change to its required 
taxable year, pursuant to

[[Page 35024]]

administrative procedures published by the Commissioner.
    (B) Short period tax return. A partnership that changes its taxable 
year must make its return for a short period in accordance with section 
443, but must not annualize the partnership taxable income.
    (C) Change in required taxable year. If a partnership is required 
to change to its majority interest taxable year, then no further change 
in the partnership's required taxable year is required for either of 
the two years following the year of the change. This limitation against 
a second change within a three-year period applies only if the first 
change was to the majority interest taxable year and does not apply 
following a change in the partnership's taxable year to the principal 
partners' taxable year or the least aggregate deferral taxable year.
    (ii) Partners. Except as otherwise provided in the Internal Revenue 
Code or the regulations thereunder (e.g., section 859 regarding real 
estate investment trusts or Sec. 1.442-2(c) regarding a subsidiary 
changing to its consolidated parent's taxable year), a partner may not 
change its taxable year without securing the approval of the 
Commissioner under section 442. However, certain partners may be 
eligible to obtain automatic approval to change their taxable years 
pursuant to the regulations or administrative procedures published by 
the Commissioner. A partner that changes its taxable year must make its 
return for a short period in accordance with section 443.
    (9) Retention of taxable year. In certain cases, a partnership will 
be required to change its taxable year unless it obtains the approval 
of the Commissioner under section 442, or makes an election under 
section 444, to retain its current taxable year. For example, a 
partnership using a taxable year that corresponds to its required 
taxable year must obtain the approval of the Commissioner to retain 
such taxable year if its required taxable year changes as a result of a 
change in ownership, unless the partnership previously obtained 
approval for its current taxable year or, if appropriate, makes an 
election under section 444.
    (10) Procedures for obtaining approval or making a section 444 
election. See Sec. 1.442-1(b) for procedures to obtain the approval of 
the Commissioner (automatically or otherwise) to adopt, change, or 
retain a taxable year. See Sec. 1.444-1T and 1.444-2T for 
qualifications, and Sec. 1.444-3T for procedures, for making an 
election under section 444.
* * * * *
    (d) Effective date. The rules of this section are applicable for 
taxable years ending on or after May 17, 2002, except for paragraph 
(c), which applies for taxable years beginning after December 31, 1953.


Sec. 1.706-1T  [Removed]

    Par. 8. Section 1.706-1T is removed.
    Par. 9. Section 1.1378-1 is added under the undesignated 
centerheading ``Small Business Corporations and Their Shareholders'' to 
read as follows:


Sec. 1.1378-1  Taxable year of S corporation.

    (a) In general. The taxable year of an S corporation must be a 
permitted year. A permitted year is the required taxable year (i.e., a 
taxable year ending on December 31), a taxable year elected under 
section 444, a 52-53-week taxable year ending with reference to the 
required taxable year or a taxable year elected under section 444, or 
any other taxable year for which the corporation establishes a business 
purpose to the satisfaction of the Commissioner under section 442.
    (b) Adoption of taxable year. An electing S corporation may adopt, 
in accordance with Sec. 1.441-1(c), its required taxable year, a 
taxable year elected under section 444, or a 52-53-week taxable year 
ending with reference to its required taxable year or a taxable year 
elected under section 444 without the approval of the Commissioner. See 
Sec. 1.441-1. An electing S corporation that wants to adopt any other 
taxable year, must establish a business purpose and obtain the approval 
of the Commissioner under section 442.
    (c) Change in taxable year--(1) Approval required. An S corporation 
or electing S corporation that wants to change its taxable year must 
obtain the approval of the Commissioner under section 442 or make an 
election under section 444. However, an S corporation or electing S 
corporation may obtain automatic approval for certain changes, 
including a change to its required taxable year, pursuant to 
administrative procedures published by the Commissioner.
    (2) Short period tax return. An S corporation or electing S 
corporation that changes its taxable year must make its return for a 
short period in accordance with section 443, but must not annualize the 
corporation's taxable income.
    (d) Retention of taxable year. In certain cases, an S corporation 
or electing S corporation will be required to change its taxable year 
unless it obtains the approval of the Commissioner under section 442, 
or makes an election under section 444, to retain its current taxable 
year. For example, a corporation using a June 30 fiscal year that 
elects to be an S corporation and, as a result, is required to use the 
calendar year must obtain the approval of the Commissioner to retain 
its current fiscal year.
    (e) Procedures for obtaining approval or making a section 444 
election--(1) In general. See Sec. 1.442-1(b) for procedures to obtain 
the approval of the Commissioner (automatically or otherwise) to adopt, 
change, or retain a taxable year. See Sec. 1.444-1T and 1.444-2T for 
qualifications, and 1.444-3T for procedures, for making an election 
under section 444.
    (2) Special rules for electing S corporations. An electing S 
corporation that wants to adopt, change to, or retain a taxable year 
other than its required taxable year must request approval of the 
Commissioner on Form 2553, ``Election by a Small Business 
Corporation,'' when the election to be an S corporation is filed 
pursuant to section 1362(b) and Sec. 1.1362-6. See Sec. 1.1362-
6(a)(2)(i) for the manner of making an election to be an S corporation. 
If such corporation receives permission to adopt, change to, or retain 
a taxable year other than its required taxable year, the election to be 
an S corporation will be effective. Denial of the request renders the 
election ineffective unless the corporation agrees that, in the event 
the request to adopt, change to, or retain a taxable year other than 
its required taxable year is denied, it will adopt, change to, or 
retain its required taxable year or, if applicable, make an election 
under section 444.
    (f) Effective date. The rules of this section are applicable for 
taxable years ending on or after May 17, 2002.

PART 5c--TEMPORARY INCOME TAX REGULATIONS UNDER THE ECONOMIC 
RECOVERY TAX ACT OF 1981

    Par. 10. The authority citation for part 5c continues to read as 
follows:

    Authority: 26 U.S.C. 168(f)(8)(G) and 7805.


Sec. 5c.442-1  [Removed]

    Par. 11. Section 5c.442-1 is removed.

PART 5f--TEMPORARY INCOME TAX REGULATIONS UNDER THE TAX EQUITY AND 
FISCAL RESPONSIBILITY ACT OF 1982

    Par. 12. The authority citation for part 5f continues to read in 
part as follows:

    Authority: 26 U.S.C. 7805 * * *

[[Page 35025]]

Sec. 5f.442-1  [Removed]

    Par. 13. Section 5f.442-1 is removed.

PART 18--TEMPORARY INCOME TAX REGULATIONS UNDER THE SUBCHAPTER S 
REVISION ACT OF 1982

    Par. 14. The authority citation for part 18 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.

Sec. 18.1378-1T  [Removed]

    Par. 15. Section 18.1378-1 is removed.

PART 602--OMB CONTROL NUMBERS UNDER THE PAPERWORK REDUCTION ACT

    Par. 16. The authority citation for part 602 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.
    Par. 17. In Sec. 602.101, paragraph (b) is amended by adding an 
entry for ``1.441-2'', removing the entries for ``1.441-3T'', ``1.442-
2T'', and ``1.442-3T'', revising the entry for ``1.442-1'', and adding 
an entry for ``1.1378-1'' in numerical order to read as follows:


Sec. 602.101  OMB Control numbers.

* * * * *
    (b) * * *

------------------------------------------------------------------------
                                                          Current OMB
  CFR part or section where identified and described      control No.
------------------------------------------------------------------------
 
                                * * * * *
1.441-2..............................................          1545-1748
 
                                * * * * *
1.442-1..............................................          1545-0074
                                                               1545-0123
                                                               1545-0134
                                                               1545-0152
                                                               1545-1748
 
                                * * * * *
1.1378-1.............................................          1545-1748
 
                                * * * * *
------------------------------------------------------------------------


Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
    Approved: May 3, 2002.
Pamela F. Olson,
Acting Assistant Secretary of the Treasury.
[FR Doc. 02-12169 Filed 5-16-02; 8:45 am]
BILLING CODE 4830-01-P