IRS Revenue Procedure
2002-39

 Code Secs. 441, 442, 444, 706, 1378, 1502
<<FULL TEXT>>

26 CFR 601.204: Changes in accounting periods and in methods of
accounting.
(Also Part I, sections 441, 442, 444, 706, 1378, 1502; 1.441-1, 1.441-3,
1.442-1, 1.706-1, 1.1378-1, 1.1502-76.)


REV. PROC. 2002-39

CONTENTS

SECTION 1. PURPOSE

SECTION 2. BACKGROUND
.01 Taxable Year Defined
(1) In general
(2) Annual accounting period
(3) Required taxable year
.02 Adoption of Taxable Year
.03 Change in Taxable Year
(1) In general
(2) Annualization of short period return
(3) No retroactive change in annual accounting period
.04 Retention of Taxable Year
.05 Approval of an Adoption, Change, or Retention
(1) In general
(2) Automatic approval
.06 Business Purpose
(1) In general
(2) Sufficient business purposes
(3) Insufficient business purposes
.07 Section 444 Elections

SECTION 3. SCOPE
.01 Applicability
.02 Inapplicability
(1) Automatic approval
(2) Under examination
(3) Before an area office
(4) Before a federal court
(5) Partnerships and S corporations

SECTION 4. DEFINITIONS
.01 Taxpayer
.02 Corporation
.03 Pass-through Entity
.04 Required Taxable Year
.05 Permitted Taxable Year
.06 First Effective Year
.07 Short Period
.08 Field Office, Area Office, Director
.09 Under Examination
(1) In general
(2) Partnerships and S corporations subject to TEFRA
.10 Issue Under Consideration
(1) During an examination
(2) Before an area office
(3) Before a federal court

SECTION 5. BUSINESS PURPOSE AND TERMS, CONDITIONS, AND ADJUSTMENTS
.01 In General
(1) Approval of requests
(2) Exceptions
.02 Business Purpose
(1) Taxpayers that establish a business purpose
(2) Taxpayers that are deemed to have established a business
purpose
.03 Natural Business Year
(1) Annual business cycle test
(2) Seasonal business test
(3) 25-percent gross receipts test
.04 General Terms and Conditions
(1) Short period tax return
(2) Subsequent year tax returns
(3) Record keeping/book conformity
(4) Changes in natural business year
(5) 52-53-week taxable years
(6) Creation of net operating loss or capital loss
(7) Creation of general business credits
(8) Concurrent change for related entities
.05 Additional Terms, Conditions, and Adjustments
(1) Substantial distortion
(2) Deferral of substantial pass-through income
(3) Special rule for certain pass-through entities
(4) Use of expiring NOLs, CLs, and credits
(5) Other terms, conditions, and adjustments
.06 Examples

SECTION 6. GENERAL APPLICATION PROCEDURES
.01 What to File
(1) Application
(2) Signature requirement
(3) Additional information regarding prior applications
(4) Additional information for section 5.03(1) and (2)
(5) Additional information for section 5.03(3)
(6) Additional information for section 5.04
(7) Additional information for section 5.05
.02 When to File
(1) In general
(2) Electing S corporations
.03 Where to File
(1) In general
(2) Electing S corporations
(3) Exempt organizations
.04 User Fee
.05 Consolidated Groups -- Separate Forms 1128 Not Required
.06 Additional Procedures If Under Examination, Before an Area Office,
or Before a Federal Court
(1) Certain taxpayers under examination
(2) Certain taxpayers before an area office
(3) Certain taxpayers before a federal court

SECTION 7. PROCESSING OF APPLICATION
.01 Service Discretion
.02 Applicability of Rev. Proc. 2002-1, Rev. Proc. 2002-4, and Any
Successor Revenue Procedures
.03 Incomplete Application -- 21 Day Rule
.04 Conference in the National Office
.05 Letter Ruling
.06 Effect of Noncompliance
.07 Effect on Other Offices of the Service

SECTION 8. EFFECT OF APPROVAL
.01 Audit Protection
(1) In general
(2) Exceptions
.02 Subsequently Required Changes
(1) In general
(2) Retroactive change or modification

SECTION 9. REVIEW BY DIRECTOR
.01 In General
.02 National Office Consideration

SECTION 10. EFFECTIVE DATE AND TRANSITION RULE
.01 In General
.02 Transition Rule for Pending Applications

SECTION 11. EFFECT ON OTHER DOCUMENTS

SECTION 12. PAPERWORK REDUCTION ACT

DRAFTING INFORMATION


SECTION 1. PURPOSE

This revenue procedure provides the general procedures under section
442 of the Internal Revenue Code and section 1.442-1(b) of the Income Tax
Regulations for establishing a business purpose and obtaining the approval
of the Commissioner of Internal Revenue to adopt, change, or retain an
annual accounting period for federal income tax purposes. This revenue
procedure also describes the terms, conditions, and adjustments that the
Commissioner may deem necessary to effect the adoption, change, or
retention.


SECTION 2. BACKGROUND

.01 TAXABLE YEAR DEFINED.

(1) IN GENERAL. Section 441(b) and section 1.441-1(b)(1) provide that
the term "taxable year" generally means the taxpayer's annual accounting
period, if it is a calendar or fiscal year, or, if applicable, the
taxpayer's required taxable year.

(2) ANNUAL ACCOUNTING PERIOD. Section 441(c) and section 1.441-1(b)(3)
provide that the term "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.

(3) REQUIRED TAXABLE YEAR. Section 1.441-1(b)(2) provides that certain
taxpayers must use the particular taxable year that is required under the
Code and the regulations thereunder. For example, a partnership, S
corporation, or personal service corporation (PSC) has a required taxable
year that generally conforms to the taxable years of its partners,
shareholders, or employee-owners pursuant to sections 706(b), 1378, and
441(i), respectively. Similarly, a specified foreign corporation has a
required taxable year that generally represents the taxable year of its
majority U.S. shareholder pursuant to section 898. However, section
1.441-1(b)(2)(ii) describes exceptions under which certain taxpayers may
use a taxable year other than their required taxable year. For example, a
partnership, S corporation, electing S corporation, or PSC 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 references
its required taxable year or a taxable year elected under section 444, or
establishes a business purpose and obtains approval under section 442 for
that taxable year. See also sections 706(b), 1378, and 441(i).

.02 ADOPTION OF TAXABLE YEAR. Generally, a taxpayer may adopt any
taxable year that satisfies section 441 and the regulations thereunder
without the approval of the Commissioner. However, a partnership, electing
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 references its required taxable year or a
taxable year elected under section 444 must establish a business purpose
and obtain approval under section 442. See section 1.441-1(c).

.03 CHANGE IN TAXABLE YEAR.

(1) IN GENERAL. Section 1.442-1(a)(1) generally provides that a
taxpayer that wants to change its annual accounting period and use a new
taxable year must obtain approval of the Commissioner.

(2) ANNUALIZATION OF SHORT PERIOD RETURN. Section 443(b) and section
1.443-1(b)(1)(i) provide that if a return is made for a short period
resulting from a change of an annual accounting period, the taxable income
for the short period must be placed on an annual basis by multiplying the
income by 12 and dividing the result by the number of months in the short
period. Unless section 443(b)(2) and section 1.443-1(b)(2) apply, the tax
for the short period generally is the same part of the tax computed on an
annual basis as the number of months in the short period is of 12 months.
But see, for example, sections 1.706-1(b)(8)(i)(B), 1.852-3(e),
1.857-2(a)(4), 1.1378-1(c)(2), and 1.1502-76 for exceptions to this
general rule for a partnership, a regulated investment company (RIC), a
real estate investment trust (REIT), an S corporation, and a subsidiary
ceasing to be a member of a consolidated group, respectively.

(3) NO RETROACTIVE CHANGE IN ANNUAL ACCOUNTING PERIOD. Unless
specifically authorized by the Commissioner, a taxpayer may not request,
or otherwise make, a retroactive change in annual accounting period,
regardless of whether the change is to a required taxable year.


.04 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 establishes a business purpose and obtains the
approval of the Commissioner under section 442, or makes an election under
section 444, to retain its current taxable year. See section 1.441-1(d).
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, 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 generally must obtain the
approval of the Commissioner to retain that taxable year if its required
taxable year changes as a result of a change in ownership. But see section
706(b)(4)(B). However, a partnership that has previously established a
business purpose to the satisfaction of the Commissioner to use a
particular fiscal year is not required to obtain the approval of the
Commissioner to retain such fiscal year if its required taxable year
changes.

.05 APPROVAL OF AN ADOPTION, CHANGE, OR RETENTION.

(1) IN GENERAL. Section 1.442-1(b) provides that 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. In general, 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.

(2) AUTOMATIC APPROVAL. Under the Code and regulations, certain
taxpayers are allowed to change their annual accounting periods without
approval or with automatic approval (see, e.g., sections 444, 859(b), and
section 1.442-1(c) and (d)). In addition, the Service has issued revenue
procedures that enable certain taxpayers to obtain automatic approval to
adopt, change, or retain their annual accounting periods. See, for
example, Rev. Proc. 2002-37, 2002-22 I.R.B. 1030 (or any successor) for
corporations; Rev. Proc. 2002-38, 2002-22 I.R.B. 1037 (or any successor)
for partnerships, S corporations, electing S corporations, and PSCs; and
Rev. Proc. 66-50, 1966-2 C.B. 1260 (or any successor) for individuals.


.06 BUSINESS PURPOSE.

(1) IN GENERAL. Section 1.442-1(b) provides that 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. See also H.R. Rep. No.
99-841, 99th Cong., 2d Sess., II-318, 1986-3 (Vol. 4) C.B. 319.

(2) SUFFICIENT BUSINESS PURPOSES. Section 1.442-1(b)(2) provides that
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, ownership taxable year, or natural business year. A
taxpayer generally is deemed to have established a natural business year
if it satisfies the "25-percent gross receipts test." See Rev. Proc.
83-25, 1983-1 C.B. 689, superseded by Rev. Proc. 87-32, 1987-2 C.B. 396,
superseded by Rev. Proc. 2002-38, 2002-22 I.R.B. 1037. In Rev. Rul. 87-57,
1987-2 C.B. 117, the Service determined that a partnership, S corporation,
or PSC established, to the satisfaction of the Secretary, a business
purpose for adopting, retaining, or changing its taxable year in the
following four situations:

(a) the taxpayer established that the taxable year satisfied the
25-percent gross receipts test and resulted in less deferral than its
other natural business year;

(b) the taxpayer would have established a natural business year under
the 25-percent gross receipts test, except that a labor strike closed the
taxpayer's business during a period that included its normal peak season;

(c) the taxpayer, for the past 10 years, had a three-month period of
insignificant gross receipts during which, due to weather conditions, its
business was not operational; and

(d) the taxpayer, which previously used the cash receipts and
disbursements method and changed to an accrual method, would have
established a natural business year under the 25-percent gross receipts
test if it had calculated its gross receipts under an accrual method.


(3) INSUFFICIENT BUSINESS PURPOSES. Section 1.442-1(b) provides that,
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 for using a taxable year other than
its required taxable year. In addition, the legislative history to the Tax
Reform Act of 1986 provides that the following reasons ordinarily will not
be sufficient for a partnership, S corporation, or PSC to establish that
the business purpose requirement for a particular taxable year has been
met:

(a) the use of a particular year for regulatory or financial accounting
purposes;

(b) the hiring patterns of a particular business, e.g., the fact that a
firm typically hires staff during certain times of the year;

(c) the use of a particular year for administrative purposes, such as
the admission or retirement of partners or shareholders, promotion of
staff, and compensation or retirement arrangements with staff, partners,
or shareholders; and

(d) the fact that a particular business involves the use of price
lists, model years, or other items that change on an annual basis.


Although the above items are not themselves sufficient to establish a
business purpose, they may be considered in connection with other items by
the Commissioner in determining whether a taxpayer has a business purpose
for a particular taxable year. H.R. Rep. No. 99-841, 99th Cong., 2d Sess.,
II-318, 1986-3 (Vol. 4) C.B. 319

.07 SECTION 444 ELECTIONS. A partnership, S corporation, electing S
corporation, or PSC generally can elect under section 444 to use a taxable
year other than its required taxable year, but only if the deferral period
of the taxable year elected is not longer than the shorter of 3 months or
the deferral period of the taxable year being changed. A partnership and
an S corporation with a section 444 election must make required payments
under section 7519 that approximate the amount of the deferral benefit and
a PSC with a section 444 election is subject to the minimum distribution
requirements of section 280H. A taxpayer may automatically adopt, change
to, or retain a taxable year permitted by section 444 by filing a Form
8716, Election to Have a Taxable Year Other Than a Required Taxable Year.
A taxpayer that wants to terminate its section 444 election must follow
the automatic procedures under section 1.444-1T(a)(5) to change to its
required taxable year or establish a business purpose for using a
different taxable year pursuant to section 442, the regulations
thereunder, and Rev. Proc. 2002-38 or this revenue procedure (whichever is
applicable).


SECTION 3. SCOPE

.01 APPLICABILITY. Except as provided in section 3.02 of this revenue
procedure, this revenue procedure applies to any taxpayer requesting the
Commissioner's approval to adopt, change, or retain an annual accounting
period for federal income tax purposes.

.02 INAPPLICABILITY. This revenue procedure does not apply to:

(1) AUTOMATIC APPROVAL. An adoption, change, or retention of annual
accounting period that is permitted to be made pursuant to a provision of
the Code or regulations or a published automatic approval procedure.
Before submitting an application pursuant to this revenue procedure,
taxpayers are encouraged to review the automatic approval procedures
referenced in section 1.442-1 and the following revenue procedures: Rev.
Proc. 2002-37 (for corporations); Rev. Proc. 2002-38 (for partnerships, S
corporations, electing S corporations, and PSCs); Rev. Proc. 66-50, as
modified by Rev. Proc. 81-40, 1981-2 C.B. 604 (for individuals); Rev.
Proc. 85-58, 1985-2 C.B. 740, and Rev. Proc. 76-10, 1976-1 C.B. 548, as
modified by Rev. Proc. 79-3, 1979-1 C.B. 483 (for exempt organizations);
Rev. Proc. 87-27, 1987-1 C.B. 769 (for employee retirement plans and
employee trusts); and Rev. Proc. 85-15, 1985-1 C.B. 516 (for changes to
comply with section 441(g)).

(2) UNDER EXAMINATION. A taxpayer with a required taxable year that is
under examination, unless the taxpayer obtains the consent of the
appropriate director as provided in section 6.06(1) of this revenue
procedure.

(3) BEFORE AN AREA OFFICE. A taxpayer with a required taxable year that
is before an area office with respect to any income tax issue if its
annual accounting period is an issue under consideration by the area
office.

(4) BEFORE A FEDERAL COURT. A taxpayer with a required taxable year
that is before a federal court with respect to any income tax issue if its
annual accounting period is an issue under consideration by the federal
court.

(5) PARTNERSHIPS AND S CORPORATIONS. A partnership or S corporation if,
on the date the entity would otherwise file its application with the
Service Center, the entity's annual accounting period is an issue under
consideration in the examination of a partner's or shareholder's federal
income tax return or an issue under consideration by an area office or by
a federal court with respect to a partner's or shareholder's federal
income tax return.


SECTION 4. DEFINITIONS

.01 TAXPAYER. The term "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).

.02 CORPORATION. The term "corporation" includes each member of a
consolidated group. However, the common parent of a consolidated group may
change the group's annual accounting period under this revenue procedure
if every member of the consolidated group meets all the requirements and
complies with all the conditions of this revenue procedure.

.03 PASS-THROUGH ENTITY. For purposes of this revenue procedure, the
term "pass-through entity" means a partnership; an S corporation (as
defined in section 1361); an electing S corporation (i.e., a corporation
attempting to make an S election for the first effective year); a trust;
an estate; a common trust fund (as defined in section 584); a controlled
foreign corporation (CFC) (as defined in section 957), but only to the
extent the taxpayer is a U.S. shareholder (as defined in section 951(b));
a foreign personal holding company (FPHC) (as defined in section 552), but
only to the extent the taxpayer is a U.S. shareholder (as defined in
section 551(a)); a passive foreign investment company (PFIC), but only to
the extent the taxpayer has elected to treat the PFIC as a qualified
electing fund (as defined in section 1295); a closely-held REIT (as
defined in section 6655(e)(5)(B)), but only if the taxpayer is described
in section 6655(e)(5)(A)); or any other similar entity.

.04 REQUIRED TAXABLE YEAR. The "required taxable year" is the
particular taxable year that certain taxpayers are required to use under
the Code or regulations thereunder. For example, the "required taxable
year" is the taxable year determined under section 706(b) in the case of a
partnership, section 1378 in the case of an S corporation or an electing S
corporation, and section 441(i) in the case of a PSC, without taking into
account any taxable year that is allowable by reason of a section 444
election. See generally section 1.441-1(b)(2) (providing examples of other
entities with required taxable years).

.05 PERMITTED TAXABLE YEAR. The term "permitted taxable year" means the
required taxable year; a natural business year; the ownership taxable
year; a taxable year elected under section 444; a 52-53-week taxable year
that references the required taxable year, natural business year,
ownership taxable year, or taxable year elected under section 444; or any
other taxable year for which the taxpayer establishes a business purpose
to the satisfaction of the Commissioner.

.06 FIRST EFFECTIVE YEAR. The first effective year is the first taxable
year for which an adoption, change, or retention in annual accounting
period is effective. Thus, in the case of a change, the first effective
year is the short period required to effect the change. The first
effective year is also the first taxable year for complying with all the
terms and conditions set forth in the letter ruling granting permission to
effect the adoption, change, or retention of the taxpayer's annual
accounting period.

.07 SHORT PERIOD. In the case of a change in annual accounting period,
a taxpayer's short period is the period beginning with the day following
the close of the old taxable year and ending with the day preceding the
first day of the new taxable year.

.08 FIELD OFFICE, AREA OFFICE, DIRECTOR. The terms "field office,"
"area office," and "director" have the same meaning as those terms have in
Rev. Proc. 2002-1, 2002-1 I.R.B. 1 (or any successor).

.09 UNDER EXAMINATION.

(1) IN GENERAL.

(a) Except as provided in section 4.08(2) of this revenue procedure, an
examination of a taxpayer with respect to a federal income tax return
begins on the date the taxpayer is contacted in any manner by a
representative of the Service for the purpose of scheduling any type of
examination of the return. An examination ends:

(i) in a case in which the Service accepts the return as filed, on the
date of the "no change" letter sent to the taxpayer;

(ii) in a fully agreed case, on the earliest of the date the taxpayer
executes a waiver of restrictions on assessment or acceptance of
overassessment (for example, a Form 870, 4549, or 4605), the date the
taxpayer makes a payment of tax that equals or exceeds the proposed
deficiency, or the date of the "closing" letter (for example, Letter
891(IN) or 987(DO)) sent to the taxpayer; or

(iii) in an unagreed or a partially agreed case, on the earliest of the
date the taxpayer (or its representative) is notified by an appeals
officer that the case has been referred to an area office from a field
office, the date the taxpayer files a petition in the Tax Court, the date
on which the period for filing a petition with the Tax Court expires, or
the date of the notice of claim disallowance.


(b) An examination does not end as a result of the early referral of an
issue to an area office under the provisions of Rev. Proc. 96-9, 1996-1
C.B. 575, or Rev. Proc. 99-28, 1999-2 C.B. 109.

(c) An examination resumes on the date the taxpayer (or its
representative) is notified by an appeals officer (or otherwise) that the
case has been referred to a field office for reconsideration.


(2) PARTNERSHIPS AND S CORPORATIONS SUBJECT TO TEFRA. For an entity
(including a limited liability company) treated as a partnership or an S
corporation that is subject to the TEFRA unified audit and litigation
provisions (note that an S corporation is not subject to the TEFRA unified
audit and litigation provisions for taxable years beginning after December
31, 1996, see Small Business Job Protection Act of 1996, Pub. L. No.
104-188, section 1317(a), 110 Stat. 1755, 1787 (1996)), an examination
begins on the date of the notice of the beginning of an administrative
proceeding sent or personally delivered to the Tax Matters Partner/Tax
Matters Person (TMP). An examination ends:

(a) in the case in which the Service accepts the partnership or S
corporation return as filed, on the date of the "no adjustments" letter or
the "no change" notice of the final administrative adjustment sent to the
TMP;

(b) in a case in which no formal notice is given, on the date on which
the period under section 6229 expires;

(c) in a fully agreed case, when all the partners or shareholders
execute a Form 870-P, 870-L, 870-S, or any variation thereof; or

(d) in an unagreed or a partially agreed case, on the earliest of the
date the TMP (or its representative) is notified by an appeals officer
that the case has been referred to an area office from a field office, the
date the TMP (or a partner or shareholder) requests judicial review, or
the date on which the period for requesting judicial review expires.

<<END RULING>>



.10 ISSUE UNDER CONSIDERATION.

(1) DURING AN EXAMINATION. A taxpayer's annual accounting period is an
issue under consideration for the taxable years under examination if the
taxpayer receives written notification (for example, by examination plan,
information document request (IDR), or notification of proposed
adjustments or income tax examination changes) from the examining
officer(s) specifically citing the taxpayer's annual accounting period as
an issue under consideration. For example, a taxpayer's annual accounting
period is an issue under consideration as a result of an examination plan
that identifies the propriety of the taxpayer's annual accounting period
as a matter to be examined. The question of whether the taxpayer's annual
accounting period is an issue under consideration may be referred to the
national office as a request for technical advice under the provisions of
Rev. Proc. 2002-2, 2002-1 I.R.B. 82 (or any successor), or, for exempt
organizations, Rev. Proc. 2002-5, 2002-1 I.R.B. 173 (or any successor).

(2) BEFORE AN AREA OFFICE. A taxpayer's annual accounting period is an
issue under consideration for the taxable years before an area office if
the taxpayer's annual accounting period is included as an item of
adjustment in the examination report referred to an area office or is
specifically identified in writing to the taxpayer by an area office.

(3) BEFORE A FEDERAL COURT. A taxpayer's annual accounting period is an
issue under consideration for the taxable years before a federal court if
the taxpayer's annual accounting period is an item included in the
statutory notice of deficiency, the notice of claim disallowance, the
notice of final administrative adjustment, the pleadings (for example, the
petition, complaint, or answer) or amendments thereto, or is specifically
identified in writing to the taxpayer by the government counsel.


SECTION 5. BUSINESS PURPOSE AND TERMS, CONDITIONS, AND ADJUSTMENTS

.01 IN GENERAL.

(1) APPROVAL OF REQUESTS. Except as provided in section 5.01(2) of this
revenue procedure, a request to adopt, change, or retain an annual
accounting period ordinarily will be approved if the taxpayer:

(a) establishes a business purpose (within the meaning of section 5.02
of this revenue procedure) for the requested annual accounting period; and

(b) agrees to the Commissioner's prescribed terms, conditions, and
adjustments (as described in sections 5.04 and 5.05 of this revenue
procedure) under which the adoption, change, or retention will be
effected.


(2) EXCEPTIONS. Notwithstanding the general rule of section 5.01(1)(a)
of this revenue procedure, a taxpayer with a required taxable year (other
than a partnership, S corporation, electing S corporation, or PSC) will
not be granted approval under this revenue procedure to adopt, change, or
retain a taxable year other than its required taxable year or, in
appropriate circumstances, a 52-53-week taxable year that ends with
reference to its required taxable year. In addition, a partnership, S
corporation, electing S corporation, or PSC will be granted approval to
adopt, change, or retain an annual accounting period only if it
establishes a business purpose under section 5.02(1) for that annual
accounting period. Notwithstanding the general rule of section 5.01(1)(b)
of this revenue procedure, the Service may determine that, based on the
unique facts of a particular case and in the interest of sound tax
administration, terms, conditions, and adjustments that differ from those
provided in this revenue procedure are more appropriate for an adoption,
change, or retention made under this revenue procedure.


.02 BUSINESS PURPOSE.

(1) TAXPAYERS THAT ESTABLISH A BUSINESS PURPOSE. Taxpayers that
establish a business purpose for the requested annual accounting period
under this section 5.02(1) ordinarily will be granted approval to adopt,
change, or retain that annual accounting period under this revenue
procedure subject only to the general terms and conditions described in
section 5.04 of this revenue procedure.

(a) NATURAL BUSINESS YEAR. A taxpayer (including a partnership, S
corporation, electing S corporation, or PSC) requesting to adopt, change,
or retain an annual accounting period that is the taxpayer's natural
business year (as described in section 5.03 of this revenue procedure) has
established a business purpose to the satisfaction of the Commissioner.

(b) FACTS AND CIRCUMSTANCES. A taxpayer (including a partnership, S
corporation, electing S corporation, or PSC) may establish a business
purpose for the requested taxable year based on all the relevant facts and
circumstances. However, the Service anticipates that a taxpayer will be
granted permission to adopt, change, or retain an annual accounting period
under this facts and circumstances test only in rare and unusual
circumstances. For this purpose, deferral of income to owners will not be
treated as a business purpose. In addition, administrative and convenience
business reasons such as those described in Rev. Rul. 87-57 and the
following will not be sufficient to establish a business purpose under
this section:

(i) the use of a particular year for regulatory or financial accounting
purposes;

(ii) the hiring patterns of a particular business, e.g., the fact that
a firm typically hires staff during certain times of the year;

(iii) the use of a particular year for administrative purposes, such as
the admission or retirement of partners or shareholders, promotion of
staff, and compensation or retirement arrangements with staff, partners,
or shareholders;

(iv) the fact that a particular business involves the use of price
lists, model years, or other items that change on an annual basis;

(v) the use of a particular year by related entities; and

(vi) the use of a particular year by competitors.


(2) TAXPAYERS THAT ARE DEEMED TO HAVE ESTABLISHED A BUSINESS PURPOSE. A
taxpayer other than a partnership, S corporation, electing S corporation,
or PSC that does not establish a business purpose for the requested annual
accounting period under section 5.02(1) of this revenue procedure
generally will be deemed to have established a business purpose if it
provides a non-tax reason for the requested annual accounting period and
agrees to the additional terms, conditions, and adjustments described in
section 5.05 of this revenue procedure, which are intended to neutralize
the tax effects of any resulting substantial distortion of income. For
this purpose, non-tax reasons for the requested annual accounting period
may include administrative and convenience business reasons such as those
described in section 5.02(1)(b) that Congress intended, and the Service
has held, to be insufficient to satisfy the business purpose requirement
for a partnership, S corporation, electing S corporation, or PSC to adopt,
change to, or retain a taxable year other than its required taxable year.
The Service anticipates that an individual taxpayer that is not a sole
proprietor will be able to establish a non-tax reason for a fiscal year
only in rare and unusual circumstances.


.03 NATURAL BUSINESS YEAR. A natural business year is the annual
accounting period encompassing all related income and expenses. The
natural business year of a taxpayer may be determined under any of the
following tests (taking into account the principles of Rev. Rul. 87-57):

(1) ANNUAL BUSINESS CYCLE TEST.

(a) IN GENERAL. If the taxpayer's gross receipts from sales and
services for the short period and the three immediately preceding taxable
years indicate that the taxpayer has a peak and a non-peak period of
business, the taxpayer's natural business year is deemed to end at, or
soon after, the close of the highest peak period of business. A business
whose income is steady from month to month throughout the year will not
satisfy this test. A taxpayer that has not been in existence for a
sufficient period to provide gross receipts information for the three
immediately preceding taxable years may provide information other than
gross receipts to demonstrate a peak and non-peak period of business, such
as a description of its business and/or reasonable estimates of future
gross receipts.

(b) SAFE HARBOR. For purposes of section 5.03(1)(a) of this revenue
procedure, 1 month will be deemed to be "soon after" the close of the
highest peak period of business.

(c) EXAMPLE. A, a corporation, operates a retail business. The highest
peak of A's annual business cycle occurs in December each year. In
January, a significant amount of the merchandise that was purchased by A's
customers in December is either returned or exchanged. A's natural
business year is deemed to end at (December 31st), or soon after (January
31st), the close of the highest peak period of business in December.
Accordingly, under the provisions of this revenue procedure, a request by
A for a taxable year ending either December 31st or January 31st would be
granted, subject to the general terms and conditions of section 5.04 of
this revenue procedure.


(2) SEASONAL BUSINESS TEST.

(a) IN GENERAL. If the taxpayer's gross receipts from sales and
services for the short period and the three immediately preceding taxable
years indicate that the taxpayer's business is operational for only part
of the year (e.g., due to weather conditions) and, as a result, the
taxpayer has insignificant gross receipts during the period the business
is not operational, the taxpayer's natural business year is deemed to end
at, or soon after, the operations end for the season. A taxpayer that has
not been in existence for a sufficient period to provide gross receipts
information for the three immediately preceding taxable years may provide
information other than gross receipts to demonstrate that it satisfies the
requirements of a seasonal business, such as a description of its business
and/or reasonable estimates of future gross receipts.

(b) SAFE HARBOR. For purposes of section 5.03(2)(a) of this revenue
procedure, an amount equal to less than 10 percent of the taxpayer's total
gross receipts for the year will be deemed to be "insignificant," and 1
month will be deemed to be "soon after" the close of operations.

(c) EXAMPLE. B, a partnership, operates a ski resort from November
through March of each year. During September and October, and during
April, employees prepare the resort for the ski season, and close it down
for the season, respectively. The resort earns less than 10 percent of its
annual gross receipts during the period of April through October, when it
is closed to guests. B's natural business year is deemed to end at (March
31st), or soon after (April 30th), the close of the resort operations.
Accordingly, under the provisions of this revenue procedure, a request by
B for a taxable year ending either March 31st or April 30th would be
granted, subject to the general terms and conditions of section 5.04 of
this revenue procedure.


(3) 25-PERCENT GROSS RECEIPTS TEST. A natural business year may be
established by any taxpayer other than a member of a tiered structure (as
defined in section 444 and section 1.444-2T) using the 25-percent gross
receipts test. The 25-percent gross receipts test is determined as
follows:

(a) PRIOR THREE YEARS' GROSS RECEIPTS.

(i) Gross receipts from sales and services for the most recent 12-month
period that ends with the last month of the requested annual accounting
period are totaled and then divided into the amount of gross receipts from
sales and services for the last 2 months of this 12-month period.

(ii) The same computation as in (a)(i) above is made for the two
preceding 12-month periods ending with the last month of the requested
annual accounting period.


(b) NATURAL BUSINESS YEAR.

(i) Except as provided in (b)(ii) below, if each of the three results
described in (a) equals or exceeds 25 percent, the requested annual
accounting period is deemed to be the taxpayer's natural business year.

(ii) The taxpayer must determine whether any annual accounting period
other than the requested annual accounting period also meets the
25-percent gross receipts test of paragraph (b)(i). If one or more annual
accounting periods produce higher averages of the three percentages
(rounded to the 1/100 of a percent) described in (a) than the requested
annual accounting period, then the requested annual accounting period will
not qualify as the taxpayer's natural business year under the 25-percent
gross receipts test.


(c) SPECIAL RULES.

(i) To apply the 25-percent gross receipts test for any particular
taxable year, the taxpayer must compute its gross receipts under the
method of accounting used to prepare its federal income tax returns for
such taxable year.

(ii) Regardless of the taxpayer's method of accounting, the taxpayer's
share of income from a pass-through entity generally must be reported as
gross receipts in the month that the pass-through entity's taxable year
ends.

(iii) If a taxpayer has a predecessor organization and is continuing
the same business as its predecessor, the taxpayer must use the gross
receipts of its predecessor for purposes of computing the 25-percent gross
receipts test.

(iv) If the taxpayer (including any predecessor organization) does not
have a 47-month period of gross receipts (36-month period for requested
taxable year plus additional 11-month period for comparing requested
taxable year with other potential taxable years), then it cannot establish
a natural business year using the 25-percent gross receipts test.

(v) If the requested taxable year is a 52-53-week taxable year, the
calendar month ending nearest to the last day of the 52-53-week taxable
year is treated as the last month of the requested taxable year for
purposes of computing the 25-percent gross receipts test.


.04 GENERAL TERMS AND CONDITIONS. The following general terms and
conditions apply to all taxpayers that obtain approval under this revenue
procedure to adopt, change, or retain an annual accounting period:

(1) SHORT PERIOD TAX RETURN. The taxpayer must file a federal income
tax return for the short period required to effect a change in annual
accounting period by the due date of that return, including extensions
pursuant to section 1.443-1(a). The taxpayer's taxable income for the
short period generally must be annualized and the tax must be computed in
accordance with the provisions of section 443(b) and section 1.443-1(b).
However, for changes to (or from) a 52-53-week taxable year referencing
the same month as the current (or requested) taxable year, see special
rules in section 1.441-2. See also, for example, sections
1.706-1(b)(8)(i)(B), 1.852-3(e), 1.857-2(a)(4), 1.1378-1(c)(2), and
1.1502-76 for exceptions to the annualization rule for a partnership, RIC,
REIT, S corporation, and subsidiary corporation ceasing to be a member of
a consolidated group, respectively.

(2) SUBSEQUENT YEAR TAX RETURNS. Returns for subsequent taxable years
generally must be made on the basis of a full 12 months (or on a
52-53-week basis) ending on the last day of the requested taxable year,
unless the taxpayer secures the approval of the Commissioner to change its
requested taxable year.

(3) RECORD KEEPING/BOOK CONFORMITY. The books of the taxpayer must be
closed as of the last day of the first effective year. Thereafter, the
taxpayer must compute its income and keep its books and records (including
financial statements and reports to creditors) on the basis of the
requested taxable year, except that this requirement shall not apply (1)
to books and records maintained solely for foreign law purposes (e.g.,
foreign tax reporting purposes), or (2) if the requested taxable year is
either the taxpayer's required taxable year or ownership taxable year.

(4) CHANGES IN NATURAL BUSINESS YEAR. If a partnership, S corporation,
electing S corporation, or PSC changes to or retains a natural business
year under this revenue procedure and that annual accounting period no
longer qualifies as a permitted taxable year, the taxpayer is using an
impermissible annual accounting period and should change to a permitted
taxable year. Certain partnerships, S corporations, electing S
corporations, and PSCs may qualify for automatic approval to change their
annual accounting period under Rev. Proc. 2002-38. Other taxpayers must
request approval under this revenue procedure.

(5) 52-53-WEEK TAXABLE YEARS. If applicable, the taxpayer must comply
with section 1.441-2(e) (relating to the timing of taking items into
account in those cases where the taxable year of a pass-through entity or
PSC ends with reference to the same calendar month as one or more of its
partners or shareholders or employee-owners).

(6) CREATION OF NET OPERATING LOSS OR CAPITAL LOSS. If the taxpayer
generates a net operating loss (NOL) or capital loss (CL) in the short
period required to effect a change in annual accounting period, the
taxpayer may not carry the NOL or CL back, but must carry it over in
accordance with the provisions of sections 172 and 1212, respectively,
beginning with the first taxable year after the short period. However,
except as otherwise provided in the Code or regulations (e.g., section
280H and the regulations thereunder in the case of a PSC) the short period
NOL or CL is carried back or carried over in accordance with sections 172
or 1212, respectively, if it is either: (a) $50,000 or less, or (b)
results from a short period of 9 months or longer and is less than the NOL
or CL for a full 12-month period beginning with the first day of the short
period.

(7) CREATION OF GENERAL BUSINESS CREDITS. If there is an unused general
business credit or any other unused credit generated in the short period,
the taxpayer must carry that unused credit forward. An unused credit from
the short period may not be carried back.

(8) CONCURRENT CHANGE FOR RELATED ENTITIES. In appropriate cases, if a
taxpayer owns a majority interest in a pass-through entity, the entity
will be required to concurrently change its annual accounting period as a
term and condition of the approval of the taxpayer's request to change its
annual accounting period, notwithstanding the testing date provisions in
sections 706(b)(4)(A)(ii), 898(c)(1)(C)(ii), section 1.921-1T(b)(6), and
the special provision in section 706(b)(4)(B). If this condition applies,
the pass-through entity must comply with the appropriate procedures to
obtain approval for the change. See, e.g., Rev. Proc. 2002-37 and Rev.
Proc. 2002-38.


.05 ADDITIONAL TERMS, CONDITIONS, AND ADJUSTMENTS. The additional
terms, conditions, and adjustments described in this section 5.05 apply to
taxpayers that obtain approval under this revenue procedure to change an
annual accounting period and that establish a business purpose under
section 5.02(2) of this revenue procedure. These additional terms,
conditions, and adjustments are necessary to neutralize the tax effects of
a substantial distortion of income that otherwise would result from the
change, 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 of an estate; the creation of a short
period in which there is a substantial NOL, CL, 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 NOL, CL, or
credit.


(1) SUBSTANTIAL DISTORTION. Distortion of income will not be considered
substantial, and no adjustments under this section 5.05 will be required
for such distortion, if the amount of the distortion is less than both:

(i) five percent of the taxpayer's estimated gross receipts for its
current taxable year (computed as if the taxpayer remained on its existing
taxable year); and

(ii) $500,000.


(2) DEFERRAL OF SUBSTANTIAL PASS-THROUGH INCOME.

(a) IN GENERAL. An adjustment will be required under this section
5.05(2) if the change creates a substantial distortion of income as a
result of increasing the deferral of the taxpayer's distributive share of
income from a pass-through entity between the taxable year of the
pass-through entity and the taxpayer's taxable year. For this purpose, if
the pass-through entity's taxable year is determined based on the taxable
year of its owners, the taxpayer must compare the existing deferral period
(i.e., between the pass-through entity's and the taxpayer's current
taxable years) with the proposed deferral period (i.e., between the
taxable year of the pass-through entity that would be required after the
requested change and the taxpayer's requested taxable year) to determine
whether the deferral period is increased. If the taxpayer indirectly owns
an interest in a pass-through entity through one or more other
pass-through entities, the existing and proposed deferral periods
generally must be determined by comparing the taxable year of the
directly-owned pass-through entity with the taxpayer's taxable year.
However, if the proposed change does not increase the deferral period
between the taxable year of the directly-owned pass-through entity and the
taxpayer's taxable year, the existing and proposed deferral periods must
be determined by comparing the taxable year of the next lower-tier
indirectly-owned pass-through entity with the taxpayer's taxable year
until either: (1) an increase in the deferral period is found or (2) the
next lower-tier entity either does not exist or is not a pass-through
entity.

(b) COMPUTING DEFERRAL. The amount of deferral that results from the
change is the taxpayer's allocable share of income from each pass-through
entity described in (a), including ordinary income or loss, capital gain
or loss, rents, royalties, interest, dividends, and the deduction
equivalents of credits that accrue during the taxpayer's first effective
year. In the case of a partnership, the taxpayer's share of income also
includes guaranteed payments to the taxpayer that are both deductible by
the partnership under its method of accounting during the partnership's
first taxable year ending after the taxpayer's first effective year and
attributable (on a ratable basis) to the taxpayer's first effective year.
A taxpayer must aggregate the deferral of income from each pass-through
entity described in (a). However, if the aggregate deferral of income from
all pass-through entities described in (a) is negative (i.e., an aggregate
loss), there is no deferral of income. For this purpose, the taxpayer may
use reasonable estimates to determine the income that accrues during the
first effective year. The Service may, on examination, use any available
data, including information on previous years' Schedules K-1, to verify
the reasonableness of the taxpayer's estimates.

(c) ADJUSTMENT. If the deferral of income computed in section
5.05(2)(b) of this revenue procedure represents a substantial distortion
of income (as defined in section 5.05(1)), the taxpayer must include the
entire amount of the distortion (and not merely the excess over the
amounts specified in section 5.05(1)) as ordinary income for the first
effective year. The taxpayer also must report its allocable share of
income from the pass-through entity in the taxable year following the
first effective year in accordance with general tax principles (e.g.,
section 706). The taxpayer must establish a suspense account for the
amount included in ordinary income for the first effective year and deduct
this amount ratably over the four taxable years immediately succeeding the
first effective year. Notwithstanding the preceding sentence, if all or a
portion of the suspense account is attributable to an interest in a
pass-through entity that is subsequently disposed of, any amount so
attributable that remains in the suspense account in the year of the
disposition may be deducted in that year. In all cases, the deduction
under this paragraph will be treated as an ordinary deduction. The
adjustments described in this section do not affect the taxpayer's basis
in the pass-through entity (such as basis in a partnership determined
under section 705). See Examples 1, 2, and 3, section 5.06 of this revenue
procedure.


(3) SPECIAL RULE FOR CERTAIN PASS-THROUGH ENTITIES. An adjustment
similar to that described in this paragraph 5.05(2) will be required in
the case of a deferral of income or shifting of deductions to another
taxpayer, such as a beneficiary of an estate.

(4) USE OF EXPIRING NOLs, CLs, AND CREDITS. An adjustment will be
required under this section 5.05(4) if the change creates a substantial
distortion of income as a result of the creation of income in the short
period (or the shifting of foreign taxes paid or accrued) to offset
expiring NOLs, CLs, or credits (including general business credits). The
amount of distortion that results from a change is the amount by which any
NOL, CL, and credit that is carried over to the first effective year and
that expires in that year exceeds the NOL, CL, and credit that could have
been used to offset income in the taxpayer's current taxable year
(computed as if the taxpayer remained on its existing taxable year). If
this distortion is substantial (as defined in section 5.05(1)), any NOL,
CL, or credit carried over to the first effective year will be allowed to
offset income in the first effective year only to the extent that such
NOL, CL, or credit could have been used to offset income in the taxpayer's
current taxable year. See Example 4, section 5.06 of this revenue
procedure.

(5) OTHER TERMS, CONDITIONS, AND ADJUSTMENTS. In addition to the terms,
conditions, and adjustments described in this section 5.05, the Service
may impose any other term, condition, or adjustment that it deems
appropriate under the circumstances.


.06 EXAMPLES. The following examples illustrate the additional terms,
conditions, and adjustments that may be required under section 5.05 of
this revenue procedure to obtain the Commissioner's approval for a change
of an annual accounting period. In all examples, the taxpayer is within
the scope of this revenue procedure, the taxpayer has established a
business purpose under section 5.02(2) of this revenue procedure, and any
distortion of income resulting from the change is substantial.

EXAMPLE 1. P, a foreign corporation, maintains its books and files its
foreign country tax returns on the basis of a taxable year ending on May
31st. In 2001, P acquires all the stock of S, a domestic corporation, that
maintains its books and files its tax returns on the calendar year. S has
a minority interest in a partnership that uses the calendar year. In order
to facilitate the filing of consolidated financial statements for P and S,
S applies for approval to change its taxable year to a taxable year ending
on May 31st beginning on May 31, 2002. The change will create a
substantial distortion of income as a result of increasing the deferral of
S's distributive share of income from its partnership interest.
Consequently, S will be required, under section 5.05(2) of this revenue
procedure, to report the partnership income that accrues between January 1
and May 31, 2002, as an ordinary income adjustment on its short period tax
return as a term, condition, and adjustment of the change. Thereafter, on
subsequent tax returns filed for its taxable year ending on May 31st
(beginning May 31, 2003), S must report the partnership income for the
partnership's taxable year ending December 31 based on the Schedule K-1 in
accordance with section 706. To take into account S's double inclusion of
the 5 months of partnership income from January 1 to May 31, 2002, S must
recognize an ordinary deduction adjustment in each of the four taxable
years following the first effective year equal to one-fourth of the
ordinary income adjustment amount included on S's short period tax return.
Neither adjustment will affect S's basis in the partnership.

EXAMPLE 2. D is a domestic corporation that currently maintains its
books and files its tax returns on the calendar year, but applies in 2002
for approval to change its taxable year to a year ending on May 31st. D
owns a majority interest in a partnership, PS1, which in turn owns a
minority interest in another partnership, PS2. PS1 and PS2 have taxable
years ending on December 31st and September 30th, respectively, as
required by the majority interest rule of section 706(b)(1)(b)(i). If D
changes its annual accounting period to May 31st, and the first effective
year ends on May 31, 2002, PS1 will be required to conform its taxable
year with D using a first effective year of May 31, 2002, as required
under section 5.04(8) of this revenue procedure. Accordingly, D's
requested change in its taxable year would not increase the deferral of
D's distributive share of income or gain from PS1. However, PS2 will
retain its September 30th taxable year; thus, D's requested change will
increase the deferral of D's distributive share of income and gain from
PS2, which is passed through to D from PS1. Assuming the deferral results
in a substantial distortion of income, D will be required, under section
5.05(2) of this revenue procedure, to report its distributive share of
PS2's income and gain accruing between January 1, 2002, and May 31, 2002,
as an ordinary income adjustment on its tax return for the short period
ending May 31st as a term and condition of the change in D's taxable year.

EXAMPLE 3. The facts are the same as in Example 2, except that PS2 owns
a minority interest in partnership PS3, which has a December 31st taxable
year. Because D will be required as a term and condition of the change in
D's taxable year to report its distributive share of PS2's income and gain
accruing between January 1, 2002, and May 31, 2002, and because that
distributive share will include a portion of PS2's distributive share of
income from PS3, D does not need to make any additional ordinary income
adjustment to take account of any increased deferral from PS3.

EXAMPLE 4. Y, a domestic corporation that files its tax returns on the
calendar year, applies in 2002 for consent to change its taxable year to a
year ending on May 31st. Y has a general business credit carryover of
$100x that will expire in the current taxable year. Y reasonably expects
to incur on June 30, 2002, a substantial amount that is deductible for
federal income tax purposes. If Y changes its annual accounting period to
May 31st, and the first effective year ends on May 31, 2002, Y reasonably
expects it would be able to use $90x of the $100x credit. However, if Y
continues to use the calendar year for 2002, Y reasonably estimates that
it would be able to use only $25x of the expiring credit. Under section
5.05(4) of this revenue procedure, Y will be allowed to use only $25x of
the credit to offset income in the first effective year as a term,
condition, and adjustment of the change.


SECTION 6. GENER