Td 8996

Part I. Rulings and Decisions Under the Internal Revenue Code of 1986
Section 30.—Credit for
Qualified Electric Vehicles

Section 280G.—Golden
Parachute Payments

If a hybrid motor vehicle is a “qualified electric
vehicle”, does the motor vehicle constitute “cleanfuel vehicle property” for purposes of section
179A(c) of the Internal Revenue Code? See Rev.
Proc. 2002–42, page 1188.

Federal short-term, mid-term, and long-term
rates are set forth for the month of June 2002. See
Rev. Rul. 2002–36, page 1148.

Section 42.—Low-Income
Housing Credit
The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month
of June 2002. See Rev. Rul. 2002–36, page 1148.

Section 50.—Other Special
Rules
If a hybrid motor vehicle is used predominantly
outside the United States, is a clean-fuel vehicle
property deduction allowed with respect to the
motor vehicle under section 179A(a) of the Internal
Revenue Code? See Rev. Proc. 2002–42, page 1188.

Section 179.—Election to
Expense Certain Depreciable
Business Assets
If a taxpayer elects to treat the cost of the cleanfuel vehicle property in a hybrid motor vehicle as an
expense which is not chargeable to capital account,
is a clean-fuel vehicle property deduction allowed
with respect to the motor vehicle under section
179A(a) of the Internal Revenue Code? See Rev.
Proc. 2002–42, page 1188.

Section 179A.—Deduction for
Clean-Fuel Vehicles and
Certain Refueling Property
If a motor vehicle is propelled by both a gasoline internal combustion engine and an electric
motor that is recharged as the motor vehicle operates and the motor vehicle otherwise meets the
requirements of section 179A of the Internal Revenue Code, may taxpayers rely on the manufacturer’s certification of the incremental cost of the
motor vehicle’s clean-fuel vehicle property for purposes of the clean-fuel vehicle property deduction
under section 179A of the Internal Revenue Code?
See Rev. Proc. 2002–42, page 1188.

2002–24 I.R.B.

Section 382.—Limitation on
Net Operating Loss
Carryforwards and Certain
Built-In Losses Following
Ownership Change
The adjusted applicable federal long-term rate is
set forth for the month of June 2002. See Rev. Rul.
2002–36, page 1148.

Section 401.—Qualified
Pension, Profit-Sharing and
Stock Bonus Plans
26 CFR 1.401(a)(9)–1: Required distributions from
trusts and plans.
A revenue procedure provides model amendments that may be used in conjunction with the final
and temporary Income Tax Regulations published
under § 401(a)(9) of the Code which are effective
for years beginning on or after January 1, 2003. See
Rev. Proc. 2002–29, page 1176.

26 CFR 1.401(b)–1: Certain retroactive changes in
plan.
A revenue procedure describes how retroactive
remedial plan amendments may be made after the
end of the GUST remedial amendment period if certain criteria are met. See Rev. Proc. 2002–35, page
1187.

Section 412.—Minimum
Funding Standards
The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month
of June 2002. See Rev. Rul. 2002–36, page 1148.

1127

Section 441.—Period for
Computation of Taxable
Income
26 CFR 1.441–1: Period for computation of taxable
income.

T.D. 8996
DEPARTMENT OF THE
TREASURY
Internal Revenue Service
26 CFR Parts 1, 5c, 5f, 18,
and 602
Changes in Accounting
Periods
AGENCY: Internal Revenue Service
(IRS), Treasury.
ACTION: Final regulations and removal
of temporary regulations.
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).

June 17, 2002

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, 2001–27 I.R.B. 4 [66 FR
31850]). Written and electronic comments
were solicited, and a public hearing was

June 17, 2002

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
§ 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 52–53week 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, 2002–22 I.R.B.
1030 and Rev. Proc. 2002–38, 2002–22
I.R.B. 1037, 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-

1128

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 52–53week 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
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.

2002–24 I.R.B.

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 closelyheld 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 passthrough 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 passthrough 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

2002–24 I.R.B.

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
§ 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, 2002–22 I.R.B. 1046. 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.

1129

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

June 17, 2002

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 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
recordkeeping requirement for taxpayers
using a fiscal year to that of § 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 sat-

June 17, 2002

isfying 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 leastaggregate-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

1130

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 crossreferenced 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.

2002–24 I.R.B.

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 § 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 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.
*****
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
1.46–1(p)(2)(iv)

Remove
paragraph (b)(1) of § 1.441–2

Add
§ 1.441–2

1.48–3(d)(1)(iii)
1.280H–1T(a), last sentence

paragraph (b)(1) of § 1.441–2
§ 1.441–4T(d)

1.443–1(b)(1)(ii)
1.444–1T(a)(1), first sentence

and paragraph (c)(5) of § 1.441–2
§ 1.441–4T(d)

§ 1.441–2
§ 1.441–3(c)
and § 1.441–
2(b)(2)(ii).
§ 1.441–3(c)

1.444–2T(a), last sentence
1.448–1(h)(2)(ii)(B)(1)

§ 1.441–4T(d)
§ 1.441–2T(b)(1)

§ 1.441–3(c)
§ 1.441–2(c)

1.469–1(h)(4)(ii)(D)
1.469–1T(g)(2)(i)
1.1561–1(c)(2)
1.6654–2(a), concluding text
1.6655–2(a)(4), first sentence
301.7701(b)–6(a), third sentence

§ 1.441–4T(f)
§ 1.441–4T(d)
See paragraph (b)(1) of § 1.441–2
paragraph (b) of § 1.441–2
paragraph (b) of § 1.441–2
§ 1.441–1(e)

§ 1.441–3(e)
§ 1.441–3(c)
See § 1.441–2
§ 1.441–2(c)
§ 1.441-2(c)
§ 1.441–1(b)

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:
§ 1.441–0 Table of contents.
This section lists the captions contained in §§ 1.441–1 through 1.441–4 as
follows:
§ 1.441–1 Period for computation of
taxable income.
(a) Computation of taxable income.
(1) In general.

2002–24 I.R.B.

(2) Length of taxable year.
(b) General rules and definitions.
(1) Taxable year.
(2) 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.

1131

(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.

June 17, 2002

§ 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.
§ 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.

June 17, 2002

(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.
(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.
§ 1.441–4 Effective date.
§ 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., § 1.441–2 regarding 52–53-week

1132

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 § 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
§ 1.441–3;
(C) In the case of a nuclear decommissioning fund, the taxable year determined
under § 1.468A–4(c)(1);
(D) In the case of a designated settlement fund or a qualified settlement fund,
the taxable year determined under
§ 1.468B–2(j);
(E) In the case of a common trust
fund, the taxable year determined under
section 584(i);

2002–24 I.R.B.

(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 § 1.706–1;
(H) In the case of an insurance company, the taxable year determined under
section 843 and § 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
§ 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 § 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
§ 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, §§ 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

2002–24 I.R.B.

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 § 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.
(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

1133

(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 newlyformed 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

June 17, 2002

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 § 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 §§ 1.444–1T and 1.444–2T
for qualifications, and 1.444–3T for procedures, for making an election under
section 444.
§ 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

June 17, 2002

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 § 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 52–53week taxable year—(i) In general. A new
eligible taxpayer elects a 52–53-week
taxable year by adopting such year in
accordance with § 1.441–1(c). A newlyformed 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 § 1.441-1(b)(2)) or the taxable year
elected under section 444. See
§§ 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 § 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

1134

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 § 1.442–1. Thus, a taxpayer
must obtain approval to change from its
current 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 § 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 § 1.443–1(a)) of 359 days or more,
or six days or less, the tax computation
under § 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 § 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 § 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
§ 1.443–1(b)(2), relating to the alternative

2002–24 I.R.B.

tax computation, applies). For an adjustment in deduction for personal exemption, see § 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 52–53week 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.

2002–24 I.R.B.

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 § 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 52–53week 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,

1135

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 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

June 17, 2002

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 § 1.441–3(c))
and an employee-owner (within the
meaning of § 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 passthrough 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))

June 17, 2002

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 § 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.
§ 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

1136

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 § 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
§ 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
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
§ 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 §§ 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

2002–24 I.R.B.

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 § 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 § 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

2002–24 I.R.B.

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 § 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

1137

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.
(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

June 17, 2002

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 employeeowners 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 employeeowners.
(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

June 17, 2002

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 employeeowners 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

1138

(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 employeeowners 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.

§ 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.

2002–24 I.R.B.

§§ 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:
§ 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 § 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
§ 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 Com-

2002–24 I.R.B.

missioner’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 § 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 employeeowners 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. 1046, 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,

1139

2002–22 I.R.B. 1030, automatic approval
procedures for certain corporations; Rev.
Proc. 2002–38, 2002–22 I.R.B. 1037,
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 § 601.601(d)(2) of this chapter.
(4) Taxpayers to whom Section 441(g)
applies. If section 441(g) and § 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 § 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

June 17, 2002

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:
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.
§§ 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:
§ 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

June 17, 2002

taxable year ending within or with the
Partner’s taxable year.
(2) The rules of this paragraph (a)(1)
may beillustrated 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

1140

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

2002–24 I.R.B.

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 taxTest 6/30

able 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:

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:

Example 1. Partnership P is on a fiscal year ending June 30. Partner A reports income on the fiscal

Year End

Interest in
Partnership

Months of
Deferral for

Interest
x Deferral

Partner A

6/30

Profits
.5

6/30 Year End
0

0

Partner B

7/31

.5

1

.5

Aggregate deferral

Test 7/31

.5

Year End

Months of
Deferral for

Interest in
Partnership
Profits

7/31 Year End

Interest
x Deferral

Partner A

6/30

.5

11

5.5

Partner B

7/31

.5

0

0

Aggregate deferral

5.5

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:
Test 12/31

Year End

Interest in

Months of
Deferral for

Partnership
Profits

12/31 Year End

Interest
x Deferral

Partner A

12/31

.5

0

0

Partner B

11/30

.5

11

5.5

Aggregate deferral

Test 11/30

5.5

Year End

Interest in
Partnership

Months of
Deferral for

Profits

11/30 Year End

Interest
x Deferral

Partner A

12/31

.5

1

.5

Partner B

11/30

.5

0

0

Aggregate deferral

.5

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:

2002–24 I.R.B.

1141

June 17, 2002

Test 12/31

Year End

Interest in

Months of

Interest

Partnership
Profits

Deferral for
12/31 Year End

x Deferral

Partner A

12/31

.5

0

0

Partner B

6/30

.5

6

3.0

Aggregate deferral

Test 6/30

3.0

Year End

Interest

Interest in
Partnership

Months of
Deferral for

x Deferral

Partner A

12/31

Profits
.5

6/30 Year End
6

3.0

Partner B

6/30

.5

0

0

Aggregate deferral

3.0

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 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:
Test 7/31

Year End

Interest in
Partnership

Months of
Deferral for

Interest
x Deferral

Partner A
Partner B

6/30
7/31

Profits
.06
.5

7/31 Year End
11
0

.66
0

Partner C
Partner D

6/30
4/30

.04
.4

11
9

.44
3.60

Aggregate deferral

Test 6/30

4.70

Year End

Interest in
Partnership

Months of
Deferral for

Profits

6/30 Year End

Interest
x 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

4.5
Aggregate deferral

June 17, 2002

1142

2002–24 I.R.B.

Test 4/30

Year End

Interest in

Months of

Interest

Partnership
Profits

Deferral for
4/30 Year End

x Deferral

Partner A

6/30

.06

2

.12

Partner B

7/31

.5

3

1.50

Partner C
Partner D

6/30
4/30

.04
.4

2
0

.08
0

Aggregate deferral

1.70

§ 1.706–1(b)(3) Test:
Current taxable year (June 30)
Less: Taxable year producing the least
aggregate deferral (April 30)

4.5
1.7

Additional aggregate deferral (greater than .5)

2.8

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:
Test 3/31

Year End

Interest in
Partnership
Profits

Months of
Deferral for
3/31 Year End

Interest
x Deferral

Partner A

3/31

.5

0

0

Partner B

7/31

.5

4

2

Aggregate deferral

2

Year End

Interest in
Partnership
Profits

Deferral for
7/31 Year End

Interest
x Deferral

Partner A

3/31

.5

8

4

Partner B

7/31

.5

0

0

Test 7/31

Aggregate deferral

4

(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:
Test 3/31

Year End

Interest in
Partnership

Deferral for
3/31 Year End

Interest
x Deferral

Partner A

3/31

Profits
.05

0

0

Partner B
Partner C

7/31
4/30

.5
.45

4
1

2.0
.45

Aggregate deferral

2002–24 I.R.B.

2.45

1143

June 17, 2002

Test 7/31

Year End

Interest in

Deferral for

Interest

Partnership
Profits

7/31 Year End

Deferral
.40

Partner A

3/31

.05

8

Partner B

7/31

.5

0

0

Partner C

4/30

.45

9

4.05

Aggregate deferral

4.45

Test 4/30

Year End

Interest in
Partnership

Deferral for

Interest

4/30 Year End

Deferral

Profits
Partner A

3/31

.05

11

.55

Partner B
Partner C

7/31
4/30

.5
.45

3
0

1.50
0

Aggregate deferral

2.05

§ 1.706–1(b)(3) Test:
Current taxable year (3/31)
Less: Taxable year producing the leastaggregate deferral (4/30).

2.45
2.05
.40

Additional aggregate deferral (greater than .5)

(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

June 17, 2002

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 § 1.704–
1(b)(2)(iv), then for purposes of section

1144

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 newlyformed partnership may adopt, in accordance with § 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

2002–24 I.R.B.

year, pursuant to 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
§ 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 § 1.442–1(b) for procedures to
obtain the approval of the Commissioner

2002–24 I.R.B.

(automatically or otherwise) to adopt,
change, or retain a taxable year. See
§§ 1.444–1T and 1.444–2T for qualifications, and § 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.
§ 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:
§ 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 § 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 § 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

1145

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 § 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 §§ 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
§ 1.1362–6. See § 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.

June 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.
§ 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 * * *
§ 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

§ 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 § 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:
§ 602.101 OMB Control numbers.

Par. 14. The authority citation for part
18 continues to read as follows:
Authority 26 U.S.C. 7805.

*****
(b) * * *

CFR part or section where
identified and described
*****
1.441–2.....................................................................................................................................................................
*****
1.442–1.....................................................................................................................................................................

Current OMB
control No.
1545–1748
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.
(Filed by the Office of the Federal Register on May
16, 2002, 8:45 a.m., and published in the issue of
the Federal Register for May 17, 2002, 67 F.R.
35009)

Section 442.—Change of
Annual Accounting Period
26 CFR 1.442–1: Change of annual accounting
period.
Final regulations relate to obtaining approval of
the Commissioner to adopt, change, or retain an
annual accounting period under section 442 of the
Code. See T.D. 8996, page 1127.

Section 467.—Certain
Payments for the Use of
Property or Services
The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month
of June 2002. See Rev. Rul. 2002–36, page 1148.

Section 468.—Special Rules
for Mining and Solid Waste
Reclamation and Closing
Costs
The adjusted applicable federal short-term, midterm, and long-term rates are set forth for the month
of June 2002. See Rev. Rul. 2002–36, page 1148.

June 17, 2002

1146

2002–24 I.R.B.