Tax Year Taxable income is figured on the basis of a tax year. A "tax year"is the accounting period used for keeping records and reporting incomeand expenses. Partnership.A partnership determines its tax year as if it were a taxpayer.However, there are limits on the year it can choose. In general, apartnership must use its required tax year. Exceptions to this ruleare discussed under Exceptions to Required Tax Year, later. Partners.Partners can change their tax year only if they receive permissionfrom the IRS. This also applies to corporate partners, who are usuallyallowed to change their accounting periods without prior approval ifthey meet certain conditions. Closing of tax year.Generally, the partnership's tax year is not closed because of thesale, exchange, or liquidation of a partner's interest, the death of apartner, or the entry of a new partner. However, if a partner sells,exchanges, or liquidates his or her entire interest, the partnership'stax year is closed for that partner. For partnership tax yearsbeginning after 1997, the death of a partner also closes thepartnership's tax year for that partner. See Distributive Sharein Year of Disposition under Partner's Distributive Share,later. Required Tax Year A partnership generally must conform its tax year to its partners'tax years. The rules for determining the required tax year are asfollows. Majority interest tax year. If one or morepartners having the same tax year own an interest in partnershipprofits and capital of more than 50% (a majority interest), thepartnership must use the tax year of those partners. Testing day. The partnership determines if there is amajority interest tax year on the testing day, which is usually thefirst day of the partnership's current tax year. Change in tax year. If a partnership's majority interesttax year changes, it will not be required to change to another taxyear for 2 years following the year of change. Principal partner. If there is no majorityinterest tax year, the partnership must use the tax year of all itsprincipal partners. A principal partner is one who has a 5% or moreinterest in the profits or capital of the partnership. Least aggregate deferral of income. If there isno majority interest tax year and the principal partners do not havethe same tax year, the partnership generally must use a tax year thatresults in the least aggregate deferral of income to thepartners. Least aggregate deferral of income.The tax year that results in the least aggregate deferral of incomeis determined as follows. Figure the number of months of deferral for each partnerusing one partner's tax year. Count the months from the end of thattax year forward to the end of each other partner's tax year. Multiply each partner's months of deferral figured in step(1) by that partner's interest in the partnership profits for the yearused in step (1). Add the amounts in step (2) to get the aggregate (total)deferral for the tax year used in step (1). Repeat steps (1) through (3) for each partner's tax yearthat is different from the other partners' years. The partner's tax year that results in the lowest number in step(3) above is the tax year that must be used by the partnership. Ifmore than one year qualifies as the tax year that has the leastaggregate deferral of income, the partnership can choose any year thatqualifies. However, if one of the years that qualifies is thepartnership's existing tax year, the partnership must retain that taxyear. Example.Rose and Irene each have a 50% interest in a partnership that usesa fiscal year ending June 30. Rose uses a calendar year while Irenehas a fiscal year ending November 30. The partnership must change itstax year to a fiscal year ending November 30 because this results inthe least aggregate deferral of income to the partners. This wasdetermined as shown in the following table. Months Interest Year End Year Profits of 12/31: End Interest Deferral Deferral Rose 12/31 0.5 -0- -0- Irene 11/30 0.5 11 5.5         Total Deferral 5.5        Months Interest Year End Year Profits of 11/30: End Interest Deferral Deferral Rose 12/31 0.5 1 0.5 Irene 11/30 0.5 -0- -0-         Total Deferral 0.5        Special de minimis rule.If the tax year that results in the least aggregate deferralproduces an aggregate deferral that is less than 0.5 when compared tothe aggregate deferral of the current tax year, the partnership'scurrent tax year is treated as the tax year with the least aggregatedeferral. Procedures.Generally, determination of the partnership's required tax year ismade at the beginning of the partnership's current tax year. However,the IRS can require the partnership to use another day or period thatwill more accurately reflect the ownership of the partnership. The change to a required tax year is treated as initiated by thepartnership with the consent of the IRS. No formal application for achange in tax year is needed. Notifying IRS.Any partnership that changes to a required tax year must notify theIRS by writing at the top of the first page of its tax return for itsfirst required tax year, "FILED UNDER SECTION 806 OF THE TAX REFORMACT OF 1986." Short period return.When a partnership changes its tax year, a short period return mustbe filed. The short period return covers the months between the end ofthe partnership's prior tax year and the beginning of its new taxyear. If a partnership changes to the tax year resulting in the leastaggregate deferral of income, a statement must be attached to theshort period return showing the computations used to determine thattax year. The short period return must indicate at the top of page 1,"FILED UNDER SECTION 1.706-1T." Exceptions to RequiredTax Year There are two exceptions to the required tax year rule. Business purpose tax year.If a partnership establishes an acceptable business purpose forhaving a tax year different from its required tax year, the differenttax year can be used. The deferral of income to the partners is notconsidered a business purpose. See Business Purpose Tax Year in Publication 538 formore information. Section 444 election.Partnerships can elect under section 444 of the Internal RevenueCode to use a tax year different from both the required tax year andany business purpose tax year. Certain restrictions apply to thiselection. In addition, the electing partnership may be required tomake a payment representing the value of the extra tax deferral to thepartners. See Section 444 Election in Publication 538 for moreinformation.