`[Federal Register Volume 66, Number 114 (Wednesday, June 13, 2001)]
[Proposed Rules]
[Pages 31850-31868]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 01-13536]


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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 5c, 5f, 18, and 301

[REG-106917-99]
RIN 1545-AX15


Changes in Accounting Periods

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Notice of proposed rulemaking and notice of public hearing.

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SUMMARY: This document contains proposed regulations under sections 
441, 442, 706, and 1378 of the Internal Revenue Code of 1986 that 
relate to certain adoptions, changes, and retentions of annual 
accounting periods. The proposed regulations are necessary to update, 
clarify, and reorganize the rules and procedures for adopting, 
changing, and retaining a taxpayer's annual accounting period. The 
proposed 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. This document also contains a 
notice of public hearing on these proposed regulations.

DATES: Written and electronic comments and requests to speak (with 
outlines of oral comments) at a public hearing scheduled for October 2, 
2001, must be received by September 11, 2001.

ADDRESSES: Send submissions to: CC:M&SP:RU (REG-106917-99), room 5226, 
Internal Revenue Service, POB 7604, Ben Franklin Station, Washington, 
DC 20044. Submissions may be hand delivered Monday through Friday 
between the hours of 8 a.m. and 5 p.m. to: CC:M&SP:RU (REG-106917-99), 
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue, 
NW., Washington, DC. Alternatively,

[[Page 31851]]

taxpayers may submit comments electronically via the Internet by 
selecting the ``Tax Regs'' option on the IRS Home Page, or by 
submitting comments directly to the IRS Internet site at http://www.irs.ustreas.gov/tax_regs/regslist.html. The public hearing will be 
held in the IRS Auditorium, Internal Revenue Building, 1111 
Constitution Avenue, NW., Washington, DC.

FOR FURTHER INFORMATION CONTACT: Concerning the proposed regulations, 
Roy A. Hirschhorn and Martin Scully, Jr. (202) 622-4960; concerning 
submissions of comments and the hearing, and/or to be placed on the 
building access list to attend the hearing, Treena Garrett (202) 622-
7180 (not toll-free numbers).

SUPPLEMENTARY INFORMATION:

Paperwork Reduction Act

    The collections of information contained in this notice of proposed 
rulemaking have been submitted to the Office of Management and Budget 
for review in accordance with the Paperwork Reduction Act of 1995 (44 
U.S.C. 3507(d)). Comments on the collections of information should be 
sent 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, with copies to the Internal Revenue 
Service, Attn: IRS Reports Clearance Officer, W:CAR:MP:FP:S:O, 
Washington, DC 20224. Comments on the collections of information should 
be received by August 13, 2001. Comments are specifically requested 
concerning:
    Whether the proposed collections of information are necessary for 
the proper performance of the functions of the Internal Revenue 
Service, including whether the information will have practical utility;
    The accuracy of the estimated burden associated with the proposed 
collections of information (see below);
    How the quality, utility, and clarity of the information to be 
collected may be enhanced;
    How the burden of complying with the proposed collections of 
information may be minimized, including through the application of 
automated collection techniques or other forms of information 
technology; and
    Estimates of capital or start-up costs and costs of operation, 
maintenance, and purchase of services to provide information.
    The collection of information can be found in Secs. 1.441-2(b)(1), 
1.442-1(b)(1) and (b)(4) and (d), and 1.1378-1 of these regulations. 
Section 1.441-2(b)(1) requires certain taxpayers to file statements on 
their federal income tax returns to notify the Commissioner of the 
taxpayers' election to adopt a 52-53-week taxable year. Section 1.442-
1(b)(4) provides that certain taxpayers must establish books and 
records that clearly reflect income for the short period involved when 
changing their taxable year from their taxable year to a proposed 
fiscal taxable year. Section 1.442-1(d) requires a newly married 
husband or wife to file a statement with their short period return when 
changing to the other spouse's taxable year. This collection of 
information is mandatory. The likely respondents are businesses or 
other profit entities and individuals.
    The estimated average annual burden per respondent and/or 
recordkeeper required by Secs. 1.442-1(b)(1) and 1.1378-1 are reflected 
in the burdens of Forms 1128 and 2553.
    Further, the estimated average burden per respondent and/or 
recordkeeper required by Secs. 1.441-2(b)(1), 1.442-1(b)(4) and 1.442-
1(d) is as follows:
    Estimated total reporting/recordkeeping burden: 3,500 hours.
    Estimated average burden per respondent/recordkeeper: 21 minutes.
    Estimated number of respondents/recordkeepers: 10,000.
    Estimated annual frequency of responses: On occasion.
    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 OMB control number.
    Books or records relating to a 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 and Explanation of Provisions

A. Overview

    This document contains proposed amendments to regulations under 
section 441 (period for computing taxable income), and sections 442, 
706, and 1378 (regarding the requirement to obtain the approval of the 
Commissioner to adopt, change, or retain an annual accounting period).

B. Section 441: Period for Computing Taxable Income

    1. Background. Section 441 provides that taxable income must be 
computed on the basis of the taxpayer's taxable year and generally 
defines the term ``taxable year.'' The current temporary regulations 
under section 441 are primarily the product of two separate Treasury 
Decisions, TD 8167, 52 FR 485241 (published with a cross reference to a 
notice of proposed rulemaking) and TD 8123, 52 FR 3615 (1988). Prior to 
the issuance of TD 8167 and TD 8123 (the temporary regulations), the 
regulations under section 441 contained provisions relating mostly to 
the period for computing taxable income and the election of a 52-53-
week taxable year. The temporary regulations retain these provisions, 
but also add new provisions to implement section 806 of the Tax Reform 
Act of 1986, Public Law 99-512 (100 Stat. 2362), 1986-3 C.B. (Vol. 1) 
1, 279, (the 1986 Act). Enacted with the principal intent of 
eliminating the deferral period between certain entities and their 
owners, the 1986 Act generally required partnerships, S corporations, 
and personal service corporations (PSCs) to conform their taxable years 
to the taxable years of their partners, shareholders, or employee-
owners, respectively. H.R. Conf. Rep. No. 99-514, 99th Cong., 2d Sess 
318 (1986).
    In addition to general implementation provisions, the temporary 
regulations include transition and anti-abuse provisions specific to 
taxpayers in existence at the time the 1986 Act became effective. For 
example, Sec. 1.441-3T provides rules intended to prevent taxpayers 
from circumventing the effective date of the provisions of the 1986 Act 
by adopting or changing to (or from) a 52-53-week taxable year during 
the period beginning after September 29, 1986, and ending before 
January 5, 1987.
    Generally, this document reproposes the temporary regulations under 
section 441. However, this document also reorganizes, clarifies, 
modifies, and updates the temporary regulations. Many of the provisions 
contained in the temporary regulations remain essentially the same, 
including the general rules for adopting a taxable year, the provisions 
relating to electing a 52-53-week taxable year, and the rules for PSCs. 
However, provisions that are now obsolete have been removed, and new 
rules and definitions have been added, as described in more detail 
below. In addition, new cross-references to section 442 and the 
proposed regulations thereunder are included to guide taxpayers, where 
appropriate, to the rules and procedures for obtaining approval to 
adopt, change, or retain their annual accounting periods.
    2. General Rules and Definitions. Most of the substantive 
provisions in Sec. 1.441-1T of the temporary regulations

[[Page 31852]]

have been retained, including the general rules for the period for 
computing tax, numerous definitions, and the requirement that 
partnerships, S corporations, electing S corporations, and PSCs 
generally must demonstrate a business purpose and obtain the 
Commissioner's approval to adopt or retain a taxable year other than 
their required taxable year. However, Sec. 1.441-1T has been 
reorganized, obsolete transition rules have been removed, and some 
rules have been clarified. For example, the proposed regulations now 
define the term required taxable year, identify entities that have such 
a year (with appropriate cross-references), and clarify the applicable 
exceptions.
    In addition, the proposed regulations clarify the meaning of the 
requirement to keep books for taxpayers using a fiscal year. The 
temporary regulations provide that a fiscal year will be recognized 
only if the books of the taxpayer are kept in accordance with that 
fiscal year. The proposed regulations conform the book keeping 
requirement for taxpayers using a fiscal year to that of Sec. 1.446-
1(a)(4), which allows for a reconciliation between the taxpayer's books 
and return. However, 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 to compute income 
and keep their books (including financial statements and reports to 
creditors) on the basis of the requested annual accounting period. See, 
e.g., Rev. Proc. 2000-11 (2000-3 I.R.B. 309).
    The proposed regulations also provide that a taxable year is 
adopted by filing the first federal income tax return using that 
taxable year. Accordingly, filing an application for an employer 
identification number, filing an extension, or making estimated tax 
payments, indicating a particular taxable year do not constitute an 
adoption of that year. Consequently, Rev. Rul. 57-589 (1957-2 C.B. 
298), and Rev. Rul. 69-563 (1969-2 C.B. 104), holding that the filing 
of an extension and estimated tax payments establishes a taxable year, 
are proposed to be superseded. The IRS will continue to follow the 
decision in E.G. Wilson, 267 F. Supp. 89 (East. Dist. MO, 1967), with 
respect to the classification of an amended return as a ``first 
return.''
    3. 52-53-week Taxable Years. The proposed regulations retain most 
of the rules provided in Sec. 1.441-2T of the temporary regulations for 
taxpayers electing to use a 52-53-week taxable year or changing to or 
from a 52-53-week taxable year. However, the procedures for certain 
taxpayers to obtain approval (automatic or otherwise) to change to or 
from a 52-53-week taxable year have been removed and are now contained 
in administrative procedures published by the Commissioner. See Rev. 
Proc. 2000-11; and Notice 2001-35 (IRB 2001-23). In addition, although 
these administrative procedures continue to provide automatic approval 
for a change to a 52-53-week taxable year ending with reference to the 
same calendar month, the change will be effected with a Form 1128 
(Application to Adopt, Change or Retain a Tax Year) rather than with a 
statement, consistent with most other changes.
    The proposed regulations also expand the applicability of the rules 
for determining the inclusion of income and deductions from a pass-
through entity where either the entity or its owner uses a 52-53-week 
taxable year. In addition to applying to partnerships, S corporations, 
and PSCs (as in the temporary regulations), the proposed regulations 
apply these inclusion rules to trusts, common trust funds, controlled 
foreign corporations, foreign personal holding companies, and passive 
foreign investment companies that are qualified electing funds.
    4. Transition Rules. Section 1.441-3T of the temporary regulations 
provide transition rules for the 1986 Act that generally were effective 
from September 29, 1986, through January 5, 1987. Moreover, the rules 
contained in Sec. 1.441-3T regarding 52-53-week taxable years and the 
definition of a PSC were superseded by similar rules promulgated under 
Secs. 1.441-2T and 1.441-4T, respectively. Because these rules are now 
obsolete, this section has been removed from the proposed regulations.
    5. Personal Service Corporations. The rules for PSCs contained in 
Sec. 1.441-4T of the temporary regulations generally have been retained 
in the proposed regulations. However, the proposed regulations 
reorganize and clarify the required taxable year of a PSC and the rules 
for adopting, changing to, and retaining a year other than the required 
taxable year. For example, the proposed regulations make clear that a 
PSC may have a year other than a required taxable year by making an 
election under section 444. In addition, the provision allowing a PSC 
to obtain automatic approval to change to its required taxable year has 
been removed and is now contained in Notice 2001-35 (I.R.B. 2001-23). 
Similarly, the rules regarding establishing a business purpose and 
obtaining approval for the use of a fiscal year have been moved to 
Sec. 1.442-1(b) and Notice 2001-34 (I.R.B. 2001-23).
    Comments were received on the notice of proposed rulemaking that is 
cross-referenced by the temporary regulations under Sec. 1.441-4T. Most 
significantly, one commentator suggested that the testing period for 
determining whether a taxpayer is a PSC should be the three preceding 
taxable years, rather than the preceding taxable year, to prevent 
taxpayers from becoming a PSC due to temporary or aberrational 
conditions. The proposed regulations retain the one-year testing period 
provided in the temporary regulations. However, the IRS and Treasury 
Department will reconsider this testing period, as well as other 
comments received on the temporary regulations, to the extent similar 
comments are received on these proposed regulations now that taxpayers 
have significantly more experience with the provisions in the temporary 
regulations.

C. Section 442: Changes of Annual Accounting Period

    1. Background. Under section 442 and the current regulations, a 
taxpayer generally can change its annual accounting period only by 
obtaining the approval of the Commissioner. The current regulations set 
forth the general rules for obtaining such approval, including: (1) The 
manner and time for filing an application to change an annual 
accounting period; (2) the requirement that the taxpayer demonstrate a 
substantial business purpose for the change; and (3) the need for 
agreement between the taxpayer and the Commissioner to the terms, 
conditions, and adjustments that are necessary to effect the change. 
Under the current regulations, both tax and non-tax factors are 
considered in determining whether a taxpayer has established a 
substantial business purpose.
    2. Manner and Time for Filing. The proposed regulations retain the 
general requirement to file a Form 1128 to request approval, but extend 
the time for filing the Form 1128. The current regulations require that 
the Form 1128 be filed on or before the 15th day of the second calendar 
month (generally 45 days) following the close of the short period. 
Under the proposed regulations, the Form 1128 must be filed by the 15th 
day of the third calendar month (generally 75 days) after the close of 
the taxable year in which the taxpayer wants the adoption, change, or 
retention to be effective (i.e., the first effective year). However, 
taxpayers are encouraged to file their Forms 1128 as

[[Page 31853]]

soon after the close of the first effective year as possible to allow 
the IRS adequate time to process the Form 1128 before the extended due 
date of the return for the first effective year. Because the IRS has 
found that Forms 1128 filed before the close of the short period often 
lack complete information and result in processing delays, the proposed 
regulation provides that the Form 1128 may not be filed prior to the 
close of the first effective year.
    3. Business Purpose, Terms, Conditions, and Adjustments. Taxpayers 
have expressed concern with the substantial business purpose 
requirement set forth in the current regulations. In particular, 
taxpayers have complained that the Commissioner's interpretation of a 
substantial business purpose as demonstrated in the IRS's ruling 
practice has been unclear, inconsistent, and overly restrictive.
    As a result, the IRS and Treasury Department published Notice 99-19 
(1999-1 C.B. 919) soliciting comments on how the rules for obtaining 
approval of an adoption, change, or retention in annual accounting 
period could be clarified and simplified. In response, commentators 
urged the IRS and Treasury Department to expand the categories of 
taxpayers that would be granted automatic approval for an annual 
accounting period and to revise the substantial business purpose 
requirement to broaden the circumstances in which a taxpayer will be 
granted approval to change an annual accounting period.
    The IRS and Treasury Department believe that the proposed 
regulations, in combination with automatic and prior approval revenue 
procedures, will clarify the rules governing accounting periods, expand 
the circumstances in which taxpayers will be granted approval 
(automatically and otherwise), and result in a more clear, uniform 
ruling practice.
    The proposed regulations continue to provide the general standards 
for obtaining approval for an adoption, change, or retention in annual 
accounting period: taxpayers must demonstrate the existence of a 
``business purpose'' and must agree to the terms, conditions, and 
adjustments for the adoption, change, or retention. In modifying the 
``substantial business purpose'' requirement to ``business purpose,'' 
the IRS and Treasury Department intend merely to conform to the 
language of the business purpose requirement found in sections 441(i), 
706, and 1378 and not to lower the current standard. In addition, the 
proposed regulations contain business purpose guidelines generally 
applicable to all taxpayers. For example, the proposed regulations 
provide the general rule that deferral of income will not be treated as 
a business purpose. They also explain that a taxpayer will have 
demonstrated a business purpose by applying to adopt, change to, or 
retain a year coinciding with its required taxable year, ownership 
taxable year, or natural business year.
    The prior approval revenue procedure is intended to provide more 
detailed guidance about how a taxpayer's business purpose will be 
evaluated, and the terms, conditions, and adjustments that will apply 
to an adoption, change, or retention of annual accounting period. 
Notice 2001-34, issued concurrently with these proposed regulations, 
proposes a revenue procedure that, when finalized, will provide the 
rules and procedures applicable to taxpayers who must apply to the 
national office to obtain the Commissioner's prior approval for an 
adoption, change, or retention. Under the proposed revenue procedure, 
the IRS in its ruling practice would no longer weigh the merit of the 
taxpayer's stated business purpose against the amount of distortion of 
income or other tax consequences resulting from an adoption, change, or 
retention. Taxpayers wanting to adopt, change to, or retain a natural 
business year generally would be granted approval (provided they agree 
to general terms and conditions) under the proposed revenue procedure 
as under the current IRS ruling practice. Also consistent with the 
current IRS ruling practice, establishing a natural business year 
generally will be the only circumstance under which a partnership, S 
corporation, electing S corporation, or PSC will be granted approval. 
However, the IRS ruling practice for other taxpayers generally will be 
liberalized. These other taxpayers that do not establish a natural 
business year generally would be granted approval under the proposed 
revenue procedure if they agree to certain additional terms, 
conditions, and adjustments designed to neutralize the tax effects of 
substantial distortion of income resulting from the change. Under the 
IRS's current ruling practice, these other taxpayers generally would 
have been denied approval to change their annual accounting period if 
the change would have resulted in more than de minimis distortion of 
income.
    4. Automatic Approval. Under the current regulations, automatic 
approval is granted to a C corporation that satisfies certain 
conditions through the filing of a statement with the District 
Director. Among the requirements for automatic approval are that the 
taxpayer not have changed its annual accounting period at any time 
within the preceding ten calendar years, and that a C corporation not 
elect S corporation status for the taxable year immediately following 
the short period. The rules for C corporations contained in the current 
regulations are inconsistent with, and generally more restrictive than, 
the automatic approval procedures in Rev. Proc. 2000-11. For example, 
under Rev. Proc. 2000-11, six years (rather than ten) is the required 
period of time between automatic changes and an S corporation election 
is allowed for the tax year following the short period. Consequently, 
the proposed regulations remove the automatic approval provision 
contained in the current regulations.
    Further, the proposed regulations provide that the procedures to 
obtain automatic approval of the Commissioner for an adoption, change, 
or retention of annual accounting period generally are contained in 
administrative procedures. The IRS and Treasury Department believe that 
this structure will allow for the issuance of more detailed and useful 
guidance. See, for example, Rev. Proc. 2000-11 (2000-3 I.R.B. 309), 
which provides procedures for automatic approval for corporations; 
Notice 2001-35, proposing to update and supersede Rev. Proc. 87-32 
(1987-2 C.B. 396), which provides procedures for automatic approval for 
partnerships, S corporations, electing S corporations, and PSCs; and 
Rev. Proc. 66-50 (1966-2 C.B. 1260), which provides automatic approval 
provisions for individuals. As part of the finalization of these 
proposed regulations and the proposed revenue procedures contained in 
Notices 2001-34 and 2001-35, the IRS and Treasury Department intend to 
update the procedures in Rev. Proc. 2000-11 to make conforming changes. 
For example, Rev. Proc. 2000-11 may be modified to reduce the time 
period between automatic changes from six to four years (as proposed in 
Notice 2001-34) and to provide audit protection for taxpayers making 
voluntary period changes (as proposed in both notices).
    5. Obsolete Provisions. The rules relating to partners and 
partnerships contained in the current regulations are proposed to be 
removed because they have been superseded by the 1986 Act. Updated 
rules for partners and partnerships are provided in new proposed 
regulations under Sec. 1.706-1 contained in this notice of proposed 
rulemaking.
    Similarly, the rules relating to certain foreign corporations 
contained in the current regulations are proposed to be

[[Page 31854]]

removed because they have been superseded by section 898. Updated rules 
for these foreign corporations are contained in proposed regulations 
under section 898.
    Finally, the proposed regulations would remove the following 
transitional provisions, which are now obsolete: Secs. 5c.442-1, 
5f.442-1, 1.442-2T, and 1.442-3T.

D. Sections 706: Taxable Years of Partners and Partnerships

1. Partnership Taxable Year
    The current regulations under Sec. 1.706-1 have not been updated to 
reflect changes made to section 706(b) by the 1986 Act. These proposed 
regulations modify the current regulations to reflect the required 
taxable year of a partnership consistent with the 1986 Act and 
Sec. 1.706-1T (regarding the taxable year that results in the least 
aggregate deferral of income). The proposed regulations also remove the 
procedural aspects of establishing a business purpose and requesting 
approval of the Commissioner to adopt or change a taxable year and 
instead refer to the procedures in Sec. 1.442-1 (including the 
administrative procedures prescribed thereunder).
    These regulations also propose to remove Sec. 1.706-1T. This 
removal is not intended to effect a substantive change because the 
provisions of Sec. 1.706-1T generally are adopted by the proposed 
regulations. The IRS and Treasury recently expressed a commitment to 
the finalization of Sec. 1.706-1T, as well as other previously proposed 
regulations under section 706, LR-183-84 (49 FR 47048) and LR-53-88 (53 
FR 19715). See 66 FR 3920, 3922. However, it is believed that adopting 
the substantive provisions of Sec. 1.706-1T in the current proposed 
regulations will promote clarity and efficiency.
2. Inclusion Rule for Distributions, Sales, and Exchanges
    Section 1.706-1(a)(2) of the current regulations provides that any 
gain or loss from a partnership distribution or from a sale or exchange 
of all or part of a partnership interest is includible in the partner's 
gross income for the taxable year in which the payment is made. Gain or 
loss from a distribution or a sale or exchange of a partnership 
interest generally is includible in gross income in the taxable year in 
which payment is made, but not always. For example, a partner who sells 
his partnership interest in exchange for an installment note may be 
able to defer inclusion of the gain from that sale under the 
installment method of accounting. Because the IRS and Treasury 
Department believe that other provisions of the Code and regulations 
provide adequate guidance on the time for including gain or loss from a 
partnership distribution or from a sale or exchange of a partnership 
interest, the inclusion rule in Sec. 1.706-1(a)(2) is proposed to be 
removed.
3. Determination of Interest in Profits and Capital
    To apply any of the three required taxable year tests, a 
partnership must determine the partners' interests in partnership 
profits and capital. The proposed regulations elaborate on the meaning 
of a partner's interest in partnership profits and capital for purposes 
of these tests. With respect to profits interests, the regulations 
clarify that a partner's profits interest is the partner's share of the 
taxable income, rather than the book income, of the partnership. The 
regulations also clarify that the partners' profits interests are 
determined on an annual basis based on the manner in which the 
partnership expects to allocate its income for the year. If the 
partnership does not expect to have income in the current year, then 
the partnership determines the partner's profits interests based on the 
manner in which it expects to allocate its income in the first taxable 
year in which the partnership expects to have income.
    Generally, a partner's interest in partnership capital is 
determined through reference to the assets of the partnership that the 
partner would be entitled to upon withdrawal from the partnership or 
upon the liquidation of the partnership. See, e.g., Sec. 1.704-1(e)(v), 
Rev. Proc. 93-27 (1993 C.B. 343). As a practical matter, such a 
determination will require a valuation of the partnership's assets. 
Because the determination under section 706 must be made on an annual 
basis, the burden associated with actual valuations may make it 
difficult for partnerships to identify their taxable years quickly and 
easily. Therefore, for partnerships that maintain capital accounts in 
accordance with Sec. 1.704-1(b)(2)(iv), these proposed regulations 
provide that in making this determination, it will be reasonable for 
the partnership to assume that a partner's interest in partnership 
capital is the ratio of the partner's capital account to all partners' 
capital accounts. The IRS and Treasury Department are aware that this 
method will not always be as precise as an actual valuation, but 
believe that any imprecision is outweighed by the strong interest that 
partnerships have in being able to easily determine their taxable year.
    This definition of a partner's interest in partnership profits and 
capital was designed to be compatible with the provisions of, and 
policies underlying, section 706(b). Many other sections of the Code 
also contain references to a partner's interest in partnership profits 
or capital. As those sections address concerns that differ 
substantially from the concerns addressed by section 706(b), this 
proposed regulation should not be read to create any implication as to 
the meaning of a partner's interest in partnership profits and capital 
for purposes of those sections.

E. Section 1378: S Corporations

    The current regulations under Sec. 18.1378-1 describe the permitted 
year of an S corporation and provide procedural rules for an S 
corporation or electing S corporation to obtain approval to adopt, 
change, or retain its taxable year. However, the automatic change 
provision contained in these regulations is more restrictive than the 
automatic change proposed in Notice 2001-35. For this reason, and to be 
consistent with the policy decision to provide the procedural aspects 
of adopting, retaining, or changing a taxable year under Sec. 1.442-1 
(including the administrative procedures prescribed thereunder), these 
regulations propose to modify Sec. 18.1378-1 to remove these procedural 
rules and instead refer to Sec. 1.442-1.

F. Proposed Effective Date

    These regulations are proposed to be applicable for taxable years 
ending on or after the date these regulations are published in the 
Federal Register as final regulations.

Effect on Other Documents

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

Special Analyses

    It has been determined that this notice of proposed rulemaking 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 collection of information in these regulations will 
not

[[Page 31855]]

have a significant economic impact on a substantial number of small 
entities. This certification is based upon the fact that few small 
entities are expected to adopt a 52-53 week taxable year, triggering 
the collection of information, and that for those who do, the burden 
imposed under Sec. 1.441-2(b)(1)(ii) will be minimal. Therefore, a 
Regulatory Flexibility Analysis under the Regulatory Flexibility Act (5 
U.S.C. chapter 6) is not required. Pursuant to section 7805(f) of the 
Internal Revenue Code, this notice of proposed rulemaking will be 
submitted to the Chief Counsel for Advocacy of the Small Business 
Administration for comment on its impact on small business.

Comments and Public Hearing

    Before these proposed regulations are adopted as final regulations, 
consideration will be given to any written comments (a signed original 
and eight (8) copies) and electronic comments that are submitted timely 
to the IRS. The IRS and Treasury Department specifically request 
comments on the clarity of the proposed rules and how they can be made 
easier to understand. All comments will be available for public 
inspection and copying.
    A public hearing has been scheduled for October 2, 2001, at 10 
a.m., in the IRS Auditorium, Internal Revenue Building, 1111 
Constitution Avenue, NW., Washington, DC. Due to building security 
procedures, visitors must enter at the 10th Street entrance, located 
between Constitution and Pennsylvania Avenues, NW. In addition, all 
visitors must present photo identification to enter the building. 
Because of access restrictions, visitors will not be admitted beyond 
the immediate entrance area more than 15 minutes before the hearing 
starts. For information about having your name placed on the building 
access list to attend the hearing, see the FOR FURTHER INFORMATION 
CONTACT section of this preamble.
    The rules of 26 CFR 601.601(a)(3) apply to the hearing.
    Persons who wish to present oral comments at the hearing must 
submit timely written or electronic comments and must submit an outline 
of the topics to be discussed and the time to be devoted to each topic 
(preferably a signed original and eight (8) copies) by September 11, 
2001.
    A period of 10 minutes will be allocated to each person for making 
comments.
    An agenda showing the scheduling of the speakers will be prepared 
after the deadline for receiving outlines has passed. Copies of the 
agenda will be available free of charge at the hearing.

Drafting Information

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

List of Subjects

26 CFR Parts 1, 5f, and 18

    Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 5c

    Accounting, Income taxes, Reporting and recordkeeping requirements.

26 CFR Part 301

    Administrative practice and procedure, Income taxes.

Proposed Amendments to the Regulations

    Accordingly, 26 CFR parts 1, 5c, 5f, 18, and 301 are proposed to be 
amended as follows:

PART 1--INCOME TAXES

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

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

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

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

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


Sec. 1.441-0  Table of contents.

    This section lists the captions contained in Sec. 1A1.441-1 through 
1.441-4 as follows:

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

    (a) Computation of taxable income.
    (1) In general.
    (2) Length of taxable year.
    (b) General rules and definitions.
    (1) Taxable year.
    (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.
    (6) Grandfathered fiscal year.
    (7) Books.
    (c) Adoption of taxable year.
    (1) In general.
    (2) Approval required.
    (i) Taxpayers with required taxable years.
    (ii) Taxpayers without books.
    (d) Retention of taxable year.
    (e) Change of taxable year.
    (f) Obtaining approval of the Commissioner or making a section 
444 election.

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

    (a) In general.
    (1) Election.
    (2) Eligible taxpayer.
    (3) Example.
    (b) Procedures to elect a 52-53-week taxable year.

[[Page 31856]]

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

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

    (a) Taxable year.
    (1) Required taxable year.
    (2) Exceptions.
    (b) Adoption, change, or retention of taxable year.
    (1) Adoption of taxable year.
    (2) Change in taxable year.
    (3) Retention of taxable year.
    (4) Procedures for obtaining approval or making a section 444 
election.
    (5) Examples.
    (c) Personal service corporation defined.
    (1) In general.
    (2) Testing period.
    (i) In general.
    (ii) New corporations.
    (3) Examples.
    (d) Performance of personal services.
    (1) Activities described in section 448(d)(2)(A).
    (2) Activities not described in section 448(d)(2)(A).
    (e) Principal activity.
    (1) General rule.
    (2) Compensation cost.
    (i) Amounts included.
    (ii) Amounts excluded.
    (3) Attribution of compensation cost to personal service 
activity.
    (i) Employees involved only in the performance of personal 
services.
    (ii) Employees involved only in activities that are not treated 
as the performance of personal services.
    (iii) Other employees.
    (A) Compensation cost attributable to personal service activity.
    (B) Compensation cost not attributable to personal service 
activity.
    (f) Services substantially performed by employee-owners.
    (1) General rule.
    (2) Compensation cost attributable to personal services.
    (3) Examples.
    (g) Employee-owner defined.
    (1) General rule.
    (2) Special rule for independent contractors who are owners.
    (h) Special rules for affiliated groups filing consolidated 
returns.
    (1) In general.
    (2) Examples.

Sec. 1.441-4  Effective date.


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

    (a) Computation of taxable income--(1) In general. Taxable income 
must be computed and a return must be made for a period known as the 
``taxable year.'' For rules relating to methods of accounting, the 
taxable year for which items of gross income are included and 
deductions are taken, inventories, and adjustments, see parts II and 
III (section 446 and following), subchapter E, chapter 1 of the 
Internal Revenue Code, and the regulations thereunder.
    (2) Length of taxable year. Except as otherwise provided in the 
Internal Revenue Code and the regulations thereunder (e.g., Sec. 1.441-
2 regarding 52-53-week taxable years), a taxable year may not cover a 
period of more than 12 calendar months.
    (b) General rules and definitions. The general rules and 
definitions in this paragraph (b) apply for purposes of sections 441 
and 442 and the regulations thereunder.
    (1) Taxable year. Taxable year means--
    (i) The period for which a return is made, if a return is made for 
a period of less than 12 months (short period). See section 443 and the 
regulations thereunder;
    (ii) Except as provided in paragraph (b)(1)(i) of this section, the 
taxpayer's required taxable year (as defined in paragraph (b)(2) of 
this section), if applicable;
    (iii) Except as provided in paragraphs (b)(1)(i) and (ii) of this 
section, the taxpayer's annual accounting period (as defined in 
paragraph (b)(3) of this section), if it is a calendar year or a fiscal 
year; or
    (iv) Except as provided in paragraphs (b)(1)(i) and (ii) of this 
section, the calendar year, if the taxpayer keeps no books, does not 
have an annual accounting period, or has an annual accounting period 
that does not qualify as a fiscal year.
    (2) Required taxable year--(i) In general. Certain taxpayers must 
use the particular taxable year that is required under the Internal 
Revenue Code and the regulations thereunder (the required taxable 
year). For example, the required taxable year is--
    (A) In the case of a foreign sales corporation or domestic 
international sales corporation, the taxable year determined under 
section 441(h) and Sec. 1.921-1T(a)(11), (b)(4), and (b)(6);
    (B) In the case of a personal service corporation (PSC), the 
taxable year determined under section 441(i) and Sec. 1.441-3;
    (C) In the case of a nuclear decommissioning fund, the taxable year 
determined under Sec. 1.468A-4(c)(1);
    (D) In the case of a designated settlement fund or a qualified 
settlement fund, the taxable year determined under Sec. 1.468B-2(j);
    (E) In the case of a common trust fund, the taxable year determined 
under section 584(i);
    (F) In the case of certain trusts, the taxable year determined 
under section 644;
    (G) In the case of a partnership, the taxable year determined under 
section 706 and Sec. 1.706-1;
    (H) In the case of an insurance company, the taxable year 
determined under section 843 and Sec. 1.1502-76(a)(2);
    (I) In the case of a real estate investment trust, the taxable year 
determined under section 859;
    (J) In the case of a real estate mortgage investment conduit, the 
taxable year determined under section 860D(a)(5) and Sec. 1.860D-
1(b)(6);
    (K) In the case of a specified foreign corporation, the taxable 
year determined under section 898(c) and Secs. 1.898-1 through 1.898-4;
    (L) In the case of an S corporation, the taxable year determined 
under section 1378 and Sec. 1.1378-1; or
    (M) In the case of a member of an affiliated group that makes a 
consolidated return, the taxable year determined under Sec. 1.1502-76.
    (ii) Exceptions. Notwithstanding paragraph (b)(2)(i) of this 
section, the following taxpayers may have a taxable year other than 
their required taxable year:
    (A) 52-53-week taxable years. Certain taxpayers may elect to use a 
52-53-week taxable year that ends with reference to their required 
taxable year. See, for example, Secs. 1.441-3 (PSCs), 1.706-1 
(partnerships), 1.1378-1 (S corporations), and 1.1502-76(a)(1) (members 
of a consolidated group), and 1.898-4(c)(3) (specified foreign 
corporations).
    (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 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, elects to use a taxable year other than 
its required taxable year under section 444, or establishes a business 
purpose to the satisfaction of the Commissioner under

[[Page 31857]]

section 442 (such as a grandfathered fiscal year).
    (C) Specified foreign corporations. A specified foreign corporation 
(as defined in section 898(b)) may use a taxable year other than its 
required taxable year if it elects a 52-53-week taxable year that ends 
with reference to its required taxable year as provided in paragraph 
(b)(2)(ii)(A) of this section or makes a one-month deferral election 
under section 898(c)(1)(B) and Sec. 1.898-3(a)(2).
    (3) Annual accounting period. Annual accounting period means the 
annual period (calendar year or fiscal year) on the basis of which the 
taxpayer regularly computes its income in keeping its books.
    (4) Calendar year. Calendar year means a period of 12 consecutive 
months ending on December 31. A taxpayer who has not established a 
fiscal year must make its return on the basis of a calendar year.
    (5) Fiscal year--(i) Definition. Fiscal year means--
    (A) A period of 12 consecutive months ending on the last day of any 
month other than December; or
    (B) A 52-53-week taxable year, if such period has been elected by 
the taxpayer. See Sec. 1.441-2.
    (ii) Recognition. A fiscal year will be recognized only if the 
books of the taxpayer are kept in accordance with such fiscal year.
    (6) Grandfathered fiscal year. Grandfathered fiscal year means a 
fiscal year (other than a year that resulted in a three month or less 
deferral of income) that a partnership or an S corporation received 
permission to use on or after July 1, 1974, by a letter ruling (i.e., 
not by automatic approval).
    (7) Books. Books include the taxpayer's regular books of account 
and such other records and data as may be necessary to support the 
entries on the taxpayer's books and on the taxpayer's return, as for 
example, a reconciliation of any difference between such books and the 
taxpayer's return. Records that are sufficient to reflect income 
adequately and clearly on the basis of an annual accounting period will 
be regarded as the keeping of books. See section 6001 and the 
regulations thereunder for rules relating to the keeping of books and 
records.
    (c) Adoption of taxable year--(1) In general. Except as provided in 
paragraph (c)(2) of this section, a new taxpayer may adopt any taxable 
year that satisfies the requirements of section 441 and the regulations 
thereunder without the approval of the Commissioner. A taxable year of 
a new taxpayer is adopted by filing its first federal income tax return 
using that taxable year. The filing of an application for automatic 
extension of time to file a federal income tax return (e.g., Form 
7004), the filing of an application for an employer identification 
number (i.e., Form SS4), or the payment of estimated taxes, for a 
particular taxable year do not constitute an adoption of that taxable 
year.
    (2) Approval required--(i) Taxpayers with required taxable years. A 
newly-formed partnership, electing S corporation, or newly-formed PSC 
that wants to adopt a taxable year other than its required taxable 
year, 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, 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 sections 441(i) or 1378, respectively, must 
obtain the approval of the Commissioner to retain its current fiscal 
year. Similarly, a partnership using a taxable year that corresponds to 
its required taxable year must obtain the approval of the Commissioner 
to retain such taxable year if its required taxable year changes as a 
result of a change in ownership. However, a partnership that previously 
established a business purpose to the satisfaction of the Commissioner 
to use a taxable year is not required to obtain the approval of the 
Commissioner if its required taxable year changes as a result of a 
change in ownership.
    (e) Change of taxable year. Once a taxpayer has adopted a taxable 
year, such taxable year must be used in computing taxable income and 
making returns for all subsequent years unless the taxpayer obtains 
approval from the Commissioner to make a change or the taxpayer is 
otherwise authorized to change without the approval of the Commissioner 
under the Internal Revenue Code (e.g., section 444 or section 859) or 
the regulations thereunder.
    (f) Obtaining approval of the Commissioner or making a section 444 
election. See Sec. 1.442-1(b) for procedures for obtaining approval of 
the Commissioner (automatically or otherwise) to adopt, change, or 
retain an annual accounting period. See Secs. 1.444-1T and 1.444-2T for 
qualifications, and 1.444-3T for procedures, for making an election 
under section 444.


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

    (a) In general--(1) Election. An eligible taxpayer may elect to 
compute its taxable income on the basis of a fiscal year that--
    (i) Varies from 52 to 53 weeks;
    (ii) Ends always on the same day of the week; and
    (iii) Ends always on--
    (A) Whatever date this same day of the week last occurs in a 
calendar month; or
    (B) Whatever date this same day of the week falls that is the 
nearest to the last day of the calendar month.
    (2) Eligible taxpayer. A taxpayer is eligible to elect a 52-53-week 
taxable year if such fiscal year would otherwise satisfy the 
requirements of section 441 and the regulations thereunder. For 
example, a taxpayer that is required to use a calendar year under 
Sec. 1.441-1(b)(1)(D) is not an eligible taxpayer.
    (3) 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. Thus, 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.

    (b) Procedures to elect a 52-53-week taxable year--(1) Adoption of 
a 52-53 week taxable year--(i) In general. A new eligible taxpayer 
elects a 52-53-week taxable year by adopting such year in accordance 
with Sec. 1.441-1(c). A newly-formed partnership, electing S 
corporation, or newly-formed 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

[[Page 31858]]

defined in Sec. 1.441-1(b)(2)) or the taxable year elected under 
section 444. See Secs. 1.706-1, 1.1378-1 and 1.441-3. Similarly, a 
newly-formed specified foreign corporation (as defined in section 
898(b)) may adopt a 52-53-week taxable year if such year ends with 
reference to the taxpayer's required taxable year, or, if the one-month 
deferral election under section 898(c)(1)(B) is made, with reference to 
the month immediately preceding the required taxable year. See 
Sec. 1.898-4(c)(3). See also Sec. 1.1502-76(a)(1) for special rules 
regarding subsidiaries adopting 52-53-week taxable years.
    (ii) Filing requirement. A taxpayer adopting a 52-53-week taxable 
year must file with its federal income tax return for its first taxable 
year a statement containing the following information--
    (A) The calendar month with reference to which the new 52-53-week 
taxable year ends;
    (B) The day of the week on which the 52-53-week taxable year always 
will end; and
    (C) Whether the 52-53-week taxable year will always end on the date 
on which that day of the week last occurs in the calendar month, or on 
the date on which that day of the week falls that is nearest to the 
last day of that calendar month.
    (2) Change to (or from) a 52-53 week taxable year--(i) In general. 
An election of a 52-53-week taxable year by an existing eligible 
taxpayer with an established taxable year is treated as a change in 
annual accounting period that requires the approval of the Commissioner 
in accordance with Sec. 1.442-1. Thus, a taxpayer must obtain approval 
to change from its current taxable year to a 52-53-week taxable year. 
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, if a change to a 52-53-week taxable 
year ends with reference to the same calendar month as the existing 
taxable year, or if a change from a 52-53-week taxable year ends with 
reference to the same calendar month as the proposed taxable year, the 
taxpayer may obtain approval for the change automatically pursuant to 
administrative procedures published by the Commissioner. See 
Sec. 1.442-1(b) for procedures for obtaining such approval.
    (ii) Special rules for the short period required to effect the 
change. If a change to or from a 52-53-week taxable year results in a 
short period (within the meaning of Sec. 1.443-1(a)) of 359 days or 
more, or six days or less, the tax computation under Sec. 1.443-1(b) 
does not apply. If the short period is 359 days or more, it is treated 
as a full taxable year. If the short period is six days or less, such 
short period is not a separate taxable year but instead is added to and 
deemed a part of the following taxable year. (In the case of a change 
to or from a 52-53-week taxable year not involving a change of the 
month with reference to which the taxable year ends, the tax 
computation under Sec. 1.443-1(b) does not apply because the short 
period will always be 359 days or more, or six days or less.) In the 
case of a short period which is more than six days and less than 359 
days, taxable income for the short period is placed on an annual basis 
for purposes of Sec. 1.443-1(b) by multiplying such income by 365 and 
dividing the result by the number of days in the short period. In such 
case, the tax for the short period is the same part of the tax computed 
on such income placed on an annual basis as the number of days in the 
short period is of 365 days (unless Sec. 1.443-1(b)(2), relating to the 
alternative tax computation, applies). For an adjustment in deduction 
for personal exemption, see Sec. 1.443-1(b)(1)(v).
    (3) Examples. The following examples illustrate paragraph 
(b)(2)(ii) of this section:

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

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

    Example 1. Assume that an income tax provision is applicable to 
taxable years beginning on or after January 1, 2001. For that 
purpose, a 52-53-week taxable year beginning on any day within the 
period December 26, 2000, to January 4, 2001, inclusive, is treated 
as beginning on January 1, 2001.
    Example 2. Assume that an income tax provision requires that a 
return must be filed on or before the 15th day of the third month 
following the close of the taxable year. For that purpose, a 52-53-
week taxable year ending on any day during the period May 25 to June 
3, inclusive, is treated as ending on May 31, the last day of the 
month ending nearest to the last day of the taxable year, and the 
return, therefore, must be made on or before August 15.
    Example 3. X, a corporation created on January 1, 2001, elects a 
52-53-week taxable year ending on the Friday nearest the end of 
December. Thus, X's first taxable year begins on Monday, January 1, 
2001, and ends on Friday, December 28, 2001; its next taxable year 
begins on Saturday, December 29, 2001, and ends on Friday, January 
3, 2003; and its next taxable year begins on Saturday, January 4, 
2003, and ends on Friday, January 2, 2004. For purposes of applying 
the provisions of Part II, subchapter B, chapter 6 of the Internal 
Revenue Code, X's first taxable year is deemed to end on December 
31, 2001; its next taxable year is deemed to begin on January 1, 
2002, and end on December 31, 2002, and its next taxable year is 
deemed to begin on January 1, 2003, and end on December 31, 2003. 
Accordingly, each such taxable year is treated as including one and 
only one December 31st.

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

[[Page 31859]]

    (4) Examples. The provisions of paragraph (c)(3) of this section 
may be illustrated by the following examples:

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

    (d) Computation of taxable income. The principles of section 451, 
relating to the taxable year for inclusion of items of gross income, 
and section 461, relating to the taxable year for taking deductions, 
generally are applicable to 52-53-week taxable years. Thus, except as 
otherwise provided, all items of income and deduction must be 
determined on the basis of a 52-53-week taxable year. However, a 
taxpayer may determine particular items as though the 52-53-week 
taxable year were a taxable year consisting of 12 calendar months, 
provided that practice is consistently followed by the taxpayer and 
clearly reflects income. For example, an allowance for depreciation or 
amortization may be determined on the basis of a 52-53-week taxable 
year, or as though the 52-53-week taxable year is a taxable year 
consisting of 12 calendar months, provided the taxpayer consistently 
follows that practice with respect to all depreciable or amortizable 
items.
    (e) Treatment of taxable years ending with reference to the same 
calendar month--(1) Pass-through entities. If a pass-through entity (as 
defined in paragraph (e)(3)(i) of this section) or an owner of a pass-
through entity (as defined in paragraph (e)(3)(ii) of this section), or 
both, use a 52-53-week taxable year and the taxable year of the pass-
through entity and the owner end with reference to the same calendar 
month, then, for purposes of determining the taxable year in which 
items of income, gain, loss, deductions, or credits from the pass-
through entity are taken into account by the owner of the pass-through, 
the owner's taxable year will be deemed to end on the last day of the 
pass-through's taxable year. Thus, if the taxable year of a partnership 
and a partner end with reference to the same calendar month, then for 
purposes of determining the taxable year in which that partner takes 
into account items described in section 702 and items that are 
deductible by the partnership (including items described in section 
707(c)) and includible in the income of that partner, that partner's 
taxable year will be deemed to end on the last day of the partnership's 
taxable year. Similarly, if the taxable year of an S corporation and a 
shareholder end with reference to the same calendar month, then for 
purposes of determining the taxable year in which that shareholder 
takes into account items described in section 1366(a) and items that 
are deductible by the S corporation and includible in the income of 
that shareholder, that shareholder's taxable year will be deemed to end 
on the last day of the S corporation's taxable year.
    (2) Personal service corporations and employee-owners. If the 
taxable year of a PSC (within the meaning of Sec. 1.441-3(c)) and an 
employee-owner (within the meaning of Sec. 1.441-3(g)) end with 
reference to the same calendar month, then for purposes of determining 
the taxable year in which an employee-owner takes into account items 
that are deductible by the PSC and includible in the income of the 
employee-owner, the employee-owner's taxable year will be deemed to end 
on the last day of the PSC's taxable year.
    (3) Definitions--(i) Pass-through entity. For purposes of this 
section, a pass-through entity means a partnership, S corporation, 
trust, estate, 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 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, 
a participant in a common trust fund, a U.S. shareholder (as defined in 
section 951(b)) of a controlled foreign corporation, a U.S. shareholder 
(as defined in section 551(a)) of a foreign personal holding company, 
or a U.S. person that holds stock in a passive foreign investment 
company that is a qualified electing fund.
    (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 the date these regulations are 
published in the Federal Register as final regulations amounts 
attributable to two taxable years of a pass-through entity, the amount 
that otherwise would be required to be included in income for such 
first taxable year by reason of this paragraph (e) should be included 
in income ratably over the four-taxable-year period beginning with such 
first taxable year under principles similar to Sec. 1.702-3T, unless 
the owner of the pass-through elects to include all such income in its 
first taxable year ending on or after the date these regulations are 
published in the Federal Register as final regulations.


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

    (a) Taxable year--(1) Required taxable year. Except as provided in 
paragraph (a)(2) of this section, the taxable year of a personal 
service corporation (PSC) (as defined in paragraph (c) of this section) 
must be the calendar year.
    (2) Exceptions. A PSC may have a taxable year other than its 
required taxable year (i.e., a fiscal year) if elects to use a 52-53-
week taxable year that ends with reference to the calendar year, makes 
an election under section 444, or establishes a business purpose for 
such fiscal year and obtains the approval of the Commissioner under 
section 442.

[[Page 31860]]

    (b) Adoption, change, or retention of taxable year--(1) Adoption of 
taxable year. A PSC may adopt, in accordance with Sec. 1.441-1(c), the 
calendar year, a 52-53-week taxable year ending with reference to the 
calendar year, or a taxable year elected under section 444 without the 
approval of the Commissioner. See Sec. 1.441-1. A PSC that wants to 
adopt any other taxable year must establish a business purpose and 
obtain the approval of the Commissioner under section 442.
    (2) Change in taxable year. A PSC that wants to change its taxable 
year must obtain the approval of the Commissioner under section 442 or 
make an election under section 444. However, a PSC may obtain automatic 
approval for certain changes, including a change to the calendar year 
or to a 52-53-week taxable year ending with reference to the calendar 
year, pursuant to administrative procedures published by the 
Commissioner.
    (3) Retention of taxable year. In certain cases, a PSC will be 
required to change its taxable year unless it obtains the approval of 
the Commissioner under section 442, or makes an election under section 
444, to retain its current taxable year. For example, a corporation 
using a June 30 fiscal year that becomes a PSC and, as a result, is 
required to use the calendar year must obtain the approval of the 
Commissioner to retain its current fiscal year.
    (4) Procedures for obtaining approval or making a section 444 
election. See Sec. 1.442-1(b) for procedures to obtain the approval of 
the Commissioner (automatically or otherwise) to adopt, change, or 
retain a taxable year. See Secs. 1.444-1T and 1.444-2T for 
qualifications, and 1.444-3T for procedures, for making an election 
under section 444.
    (5) Examples. The provisions of paragraph (b)(4) of this section 
may be illustrated by the following examples:

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

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

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

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

[[Page 31861]]

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

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

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

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

[[Page 31862]]

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 paragraph (h)(1) of this section, AB must 
determine whether the employee-owners of A and B (i.e., B's 
employees) own more than 10 percent of the fair market value of A 
and B as of the last day of the testing period. Because the $140,000 
[($1,000,000  x  .09) + $50,000] fair market value of the stock held 
by B's employees is greater than 10 percent of the aggregate fair 
market value of A and B as of the last day of the testing period, or 
$105,000 [$1,000,000 + $50,000  x  .10], AB may be subject to this 
section if, on a consolidated basis during the testing period, the 
principal activity of AB is the performance of personal services and 
the personal services are substantially performed by employee-
owners.


Sec. 1.441-4  Effective date.

    Sections 1.441-0 through 1.441-3 are applicable for taxable years 
ending on or after the date these regulations are published in the 
Federal Register as final regulations.


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

    Par. 4. Sections 1.441-1T, 1.441-2T, 1.441-3T and 1.441-4T are 
removed.
    Par 5. Section 1.442-1 is revised to read as follows:


Sec. 1.442-1  Change of annual accounting period.

    (a) Approval of the Commissioner. A taxpayer that has adopted an 
annual accounting period (as defined in Sec. 1.441-1(b)(3)) as its 
taxable year generally must continue to use that annual accounting 
period in computing its taxable income and for making its federal 
income tax returns. If the taxpayer wants to change its annual 
accounting period and use a new taxable year, it must obtain the 
approval of the Commissioner, unless it is otherwise authorized to 
change without the approval of the Commissioner under either the 
Internal Revenue Code (e.g., section 444 and section 859) or the 
regulations thereunder (e.g., paragraph (c) of this section). In 
addition, as described in Sec. 1.441-1(c) and (d), a partnership, S 
corporation, electing S corporation, or personal service corporation 
(PSC) generally is required to secure the approval of the Commissioner 
to adopt or retain an annual accounting period other than its required 
taxable year. The manner of obtaining approval from the Commissioner to 
adopt, change, or retain an annual accounting period is provided in 
paragraph (b) of this section. However, special rules for obtaining 
approval may be provided in other sections.
    (b) Obtaining approval--(1) Time and manner for requesting 
approval. Except as otherwise provided in paragraph (b)(3) of this 
section, 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. The Form 1128 must be filed 
no earlier than the day 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) and no later than the 15th day of 
the third calendar month following the close of the first effective 
year. However, in the case of a change that results in a short period 
of six days or less, the Form 1128 must be filed no later than the 15th 
day of the third calendar month following the close of the short 
period, even though the short period is not treated as a separate 
taxable year under Sec. 1.441-2(b)(2).
    (2) General requirements for approval. Except as provided in 
paragraph (b)(3) of this section, an adoption, change, or retention in 
annual accounting period will be approved where the taxpayer 
establishes a business purpose for the requested annual accounting 
period and agrees to the Commissioner's prescribed terms, conditions, 
and adjustments for effecting the adoption, change, or retention. In 
determining whether a taxpayer has established a business purpose and 
which terms, conditions, and adjustments will be required, 
consideration will be given to all the facts and circumstances relating 
to the adoption, change, or retention, including the tax consequences 
resulting therefrom. Generally, the requirement of a business purpose 
will be satisfied, and adjustments to neutralize any tax consequences 
will not be required, if the requested annual accounting period 
coincides with the taxpayer's required taxable year (as defined in 
Sec. 1.441-1(b)(2)), ownership taxable year, or natural business year. 
In the case of a partnership, S corporation, electing S corporation, or 
PSC, deferral of income to partners, shareholders, or employee-owners 
will not be treated as a business purpose.
    (3) Administrative procedures. Notwithstanding the provisions of 
paragraphs (b)(1) and (2) of this section, the Commissioner may 
prescribe administrative procedures under which a taxpayer will 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, Notice 2001-34 (2001-23 
I.R.B. 1302), procedures to obtain the Commissioner's prior approval of 
an adoption, change, or retention in annual accounting period through 
application to the national office; Rev. Proc. 2000-11 (2000-3 I.R.B. 
309), automatic approval procedures for certain corporations; Notice 
2001-35 (2001-23 I.R.B. 1314), automatic approval procedures for 
partnerships, S corporations, electing S corporations, and PSCs; and 
Rev. Proc. 66-50 (1966-2 C.B. 1260), automatic approval procedures for 
individuals. For availability of Revenue Procedures and Notices, see 
Sec. 601.601(d)(2) of this chapter.
    (4) Taxpayers to whom section 441(g) applies. If section 441(g) and 
Sec. 1.441-1(b)(1)(iv) apply to a taxpayer, the adoption of a fiscal 
year is treated as a change in the taxpayer's annual accounting period 
under section 442. Therefore, that fiscal year can become the 
taxpayer's taxable year only with the approval of the Commissioner. In 
addition to any other terms and conditions that may apply to such a 
change, the taxpayer must establish and maintain books that adequately 
and clearly reflect income for the short period involved in the change 
and for the fiscal year proposed.
    (c) Special rule for change of annual accounting period by 
subsidiary corporation. A subsidiary corporation that is required to 
change its annual accounting period under Sec. 1.1502-76, relating to 
the taxable year of members of an affiliated group that file a 
consolidated return, does not need to obtain the approval of the

[[Page 31863]]

Commissioner or file an application on Form 1128 with respect to that 
change.
    (d) Special rule for newly married couples. (1) A newly married 
husband or wife may obtain automatic approval under this paragraph (d) 
to change his or her annual accounting period in order to use the 
annual accounting period of the other spouse so that a joint return may 
be filed for the first or second taxable year of that spouse ending 
after the date of marriage. Such automatic approval will be granted 
only if the newly married husband or wife adopting the annual 
accounting period of the other spouse files a federal income tax return 
for the short period required by that change on or before the 15th day 
of the 4th month following the close of the short period. See section 
443 and the regulations thereunder. If the due date for any such short-
period return occurs before the date of marriage, the first taxable 
year of the other spouse ending after the date of marriage cannot be 
adopted under this paragraph (d). The short-period return must contain 
a statement at the top of page one of the return that it is filed under 
the authority of this paragraph (d). The newly married husband or wife 
need not file Form 1128 with respect to a change described in this 
paragraph (d). For a change of annual accounting period by a husband or 
wife that does not qualify under this paragraph (d), see paragraph (b) 
of this section.
    (2) The provisions of this paragraph (d) may be illustrated by the 
following example:

    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 the date these regulations are 
published in the Federal Register as final regulations.


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

    Par. 6. Sections 1.442-2T and 1.442-3T are removed.
    Par. 7. Section 1.706-1 is amended by revising paragraphs (a) and 
(b) and adding paragraph (d) to read as follows:


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

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

    Example. Partner A reports his income using a calendar year, 
while the partnership of which he 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 Sec. 1.706-1(b)(3).
    (ii) Exceptions. A partnership may have a taxable year other than 
its required taxable year if it elects to use a 52-53-week taxable year 
that ends with reference to its required taxable year, makes an 
election under section 444, or establishes a business purpose for such 
taxable year and obtains approval of the Commissioner under section 
442.
    (3) Least aggregate deferral--(i) Taxable year that results in the 
least aggregate deferral of income. The taxable year that results in 
the least aggregate deferral of income will be the taxable year of one 
or more of the partners in the partnership which will result in the 
least aggregate deferral of income to the partners. The aggregate 
deferral for a particular year is equal to the sum of the products 
determined by multiplying the month(s) of deferral for each partner 
that would be generated by that year and each partner's interest in 
partnership profits for that year. The partner's taxable year that 
produces the lowest sum when compared to the other partner's taxable 
years is the taxable year that results in the least aggregate deferral 
of income to the partners. If the calculation results in more than one 
taxable year qualifying as the taxable year with the least aggregate 
deferral, the partnership may select any one of those taxable years as 
its taxable year. However, if one of the qualifying taxable years is 
also the partnership's existing taxable year, the partnership must 
maintain its existing taxable year. The determination of the taxable 
year that results in the least aggregate deferral of income generally 
must be made as of the beginning of the partnership's current taxable 
year. The district 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

[[Page 31864]]

of the calculation described in paragraph (b)(3)(i) of this section, 
the taxable year of a partner or partnership that uses a 52-53 week 
taxable year must be the same year determined under the rules of 
section 441(f) and the regulations thereunder with respect to the 
inclusion of income by the partner or partnership.
    (iii) Special de minimis rule. If the taxable year that results in 
the least aggregate deferral produces an aggregate deferral that is 
less than .5 when compared to the aggregate deferral of the current 
taxable year, the partnership's current taxable year will be treated as 
the taxable year with the least aggregate deferral. Thus, the 
partnership will not be permitted to change its taxable year.
    (iv) Examples. The principles of this section may be illustrated by 
the following examples:

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

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


----------------------------------------------------------------------------------------------------------------
                                                                                            Months of
                                                                              Interest in    deferral   Interest
                           Test 7/31                              Year end    partnership    for 7/31      x
                                                                                profits      year end   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:

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


----------------------------------------------------------------------------------------------------------------
                                                                                            Months of
                                                                              Interest in    deferral   Interest
                           Test 11/30                             Year end    partnership   for 11/30      x
                                                                                profits      year end   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. This 
determination is made as follows:

[[Page 31865]]



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


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

    Example 4. The facts are the same as in Example 1except 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 4except 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:

----------------------------------------------------------------------------------------------------------------
                                                                                            Months of
                                                                              Interest in    deferral   Interest
                           Test 7/31                              Year end    partnership    for 7/31      x
                                                                                profits      year end   deferral
----------------------------------------------------------------------------------------------------------------
Partner A......................................................       6/30             .06         11        .66
Partner B......................................................       7/31              .5          0          0
Partner C......................................................       6/30             .04         11        .44
Partner D......................................................       4/30              .4          9       3.60
                                                                                                      ----------
    Aggregate deferral.........................................                                             4.70
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                                            Months of
                                                                              Interest in    deferral   Interest
                           Test 6/30                              Year end    partnership    for 6/30      x
                                                                                profits      year end   deferral
----------------------------------------------------------------------------------------------------------------
Partner A......................................................       6/30             .06          0          0
Partner B......................................................       7/31              .5          1         .5
Partner C......................................................       6/30             .04          0          0
Partner D......................................................       4/30              .4         10        4.0
                                                                                                      ----------
    Aggregate deferral.........................................                                              4.5
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                                            Months of
                                                                              Interest in    deferral   Interest
                           Test 4/30                              Year end    partnership    for 4/30      x
                                                                                profits      year end   deferral
----------------------------------------------------------------------------------------------------------------
Partner A......................................................       6/30             .06          2        .12
Partner B......................................................       7/31              .5          3       1.50
Partner C......................................................       6/30             .04          2        .08
Partner D......................................................       4/30              .4          0          0
                                                                                                      ----------
    Aggregate deferral.........................................                                             1.70
----------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------
 
------------------------------------------------------------------------
Sec.  1.706-1(b)(3) Test:
    Current taxable year (June 30).............................      4.5
    Less: Taxable year producing the least aggregate deferral        1.7
     (April 30)................................................
                                                                --------
        Additional aggregate deferral (greater than .5)........      2.8
------------------------------------------------------------------------


[[Page 31866]]

    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 Sec. 1.706-1(b)(3) to be the 
fiscal year ending March 31 as follows:

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


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

----------------------------------------------------------------------------------------------------------------
                                                                              Interest in    Deferral   Interest
                           Test 3/31                              Year end    partnership    for 3/31      x
                                                                                profits      year end   deferral
----------------------------------------------------------------------------------------------------------------
Partner A......................................................       3/31             .05          0          0
Partner B......................................................       7/31              .5          4        2.0
Partner C......................................................       4/30             .45          1        .45
                                                                                                      ----------
    Aggregate deferral.........................................                                             2.45
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                              Interest in    Deferral   Interest
                           Test 7/31                              Year end    partnership    for 7/31      x
                                                                                profits      year end   deferral
----------------------------------------------------------------------------------------------------------------
Partner A......................................................       3/31             .05          8        .40
Partner B......................................................       7/31              .5          0          0
Partner C......................................................       4/30             .45          9       4.05
                                                                                                      ----------
    Aggregate deferral.........................................                                             4.45
----------------------------------------------------------------------------------------------------------------


----------------------------------------------------------------------------------------------------------------
                                                                              Interest in    Deferral   Interest
                           Test 4/30                              Year end    partnership    for 4/30      x
                                                                                profits      year end   deferral
----------------------------------------------------------------------------------------------------------------
Partner A......................................................       3/31             .05         11        .55
Partner B......................................................       7/31              .5          3       1.50
Partner C......................................................       4/30             .45          0          0
                                                                                                      ----------
    Aggregate deferral.........................................                                             2.05
----------------------------------------------------------------------------------------------------------------


------------------------------------------------------------------------
 
------------------------------------------------------------------------
Sec.  1.706-1(b)(3) Test:
    Current taxable year (3/31)................................     2.45
    Less: Taxable year producing the least aggregate deferral       2.05
     (4/30)....................................................
                                                                --------
        Additional aggregate deferral (less than .5)...........      .40
------------------------------------------------------------------------

    (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.

[[Page 31867]]

    (B) Percentage share of partnership net income. The partner's 
percentage share of partnership net income for a partnership taxable 
year is the ratio of: the partner's distributive share of partnership 
net income for the taxable year, to the partnership's net income for 
the year. If a partner's percentage share of partnership net income for 
the taxable year depends on the amount or nature of partnership income 
for that year (due to, for example, preferred returns or special 
allocations of specific partnership items), then the partnership must 
make a reasonable estimate of the amount and nature of its income for 
the taxable year. This estimate must be based on all facts and 
circumstances known to the partnership as of the first day of the 
current partnership taxable year. The partnership must then use this 
estimate in determining the partners' interests in partnership profits 
for the taxable year.
    (C) Distributive share. For purposes of this paragraph (b)(4)(ii), 
a partner's distributive share of partnership net income is determined 
by taking into account all rules and regulations affecting that 
determination, including, without limitation, section 704(b), (c), and 
(e), section 736, and section 743.
    (iii) Capital interest. Generally, a partner's interest in 
partnership capital is determined by reference to the assets of the 
partnership that the partner would be entitled to upon withdrawal from 
the partnership or upon liquidation of the partnership. If the 
partnership maintains capital accounts in accordance with Sec. 1.704-
1(b)(2)(iv), then for purposes of section 706(b), the partnership may 
assume that a partner's interest in partnership capital is the ratio of 
the partner's capital account to all partners' capital accounts as of 
the first day of the partnership taxable year.
    (5) Certain tax-exempt partners disregarded. [Reserved]
    (6) Foreign partners. [Reserved]
    (7) Adoption of taxable year. A newly-formed partnership may adopt, 
in accordance with Sec. 1.441-1(c), its required taxable year, a 52-53-
week taxable year ending with reference to its required taxable year, 
or a taxable year elected under section 444 without securing the 
approval of the Commissioner. If a newly-formed partnership wants to 
adopt any other taxable year, it must establish a business purpose and 
secure the approval of the Commissioner under section 442.
    (8) Change in taxable year--(i) Partnerships--(A) Approval 
required. An existing partnership may change its taxable year only by 
securing the approval of the Commissioner under section 442 or making 
an election under section 444. However, a partnership may obtain 
automatic approval for certain changes, including a change to its 
required taxable year, pursuant to administrative procedures published 
by the Commissioner.
    (B) Short period tax return. A partnership that changes its taxable 
year must make its return for a short period in accordance with section 
443, but must not annualize the partnership taxable income.
    (C) Change in required taxable year. If a partnership is required 
to change to its majority interest taxable year, then no further change 
in the partnership's required taxable year is required for either of 
the two years following the year of the change. This limitation against 
a second change within a three-year period applies only if the first 
change was to the majority interest taxable year and does not apply 
following a change in the partnership's taxable year to the principal 
partners' taxable year or the least aggregate deferral taxable year.
    (ii) Partners. Except as otherwise provided in the Internal Revenue 
Code or the regulations thereunder (e.g., section 859 regarding real 
estate investment trusts or Sec. 1.442-2(c) regarding a subsidiary 
changing to its consolidated parent's taxable year), a partner may not 
change its taxable year without securing the approval of the 
Commissioner under section 442. However, certain partners may be 
eligible to obtain automatic approval to change their taxable years 
pursuant to the regulations or administrative procedures published by 
the Commissioner. A partner that changes its taxable year must make its 
return for a short period in accordance with section 443.
    (9) Retention of taxable year. In certain cases, a partnership will 
be required to change its taxable year unless it obtains the approval 
of the Commissioner under section 442, or makes an election under 
section 444, to retain its current taxable year. For example, a 
partnership using a taxable year that corresponds to its required 
taxable year must obtain the approval of the Commissioner to retain 
such taxable year if its required taxable year changes as a result of a 
change in ownership, unless the partnership previously obtained 
approval for its current taxable year or, if appropriate, makes an 
election under section 444.
    (10) Procedures for obtaining approval or making a section 444 
election. See Sec. 1.442-1(b) for procedures to obtain the approval of 
the Commissioner (automatically or otherwise) to adopt, change, or 
retain a taxable year. See Secs. 1.444-1T and 1.444-2T for 
qualifications, and Sec. 1.444-3T for procedures, for making an 
election under section 444.
* * * * *
    (d) Effective date. The rules of this section are applicable for 
taxable years ending on or after the date these regulations are 
published in the Federal Register as final regulations, except for 
paragraph (c) which applies for taxable years beginning after December 
31, 1953.


Sec. 1.706-1T  [Removed]

    Par. 8. Section 1.706-1T is removed.
    Par. 9. Section 1.898-4, as proposed to be added at 58 FR 297, 
January 5, 1993, is amended by adding paragraph (c)(3)(iv) to read as 
follows:


Sec. 1.898-4  Special rules.

* * * * *
    (c) * * *
    (3) * * *
    (iv) Recognition of income and deductions. See Sec. 1.441-2(e) for 
rules regarding the recognition of income and deductions (e.g., amounts 
includible in gross income pursuant to sections 951(a) or 553) if 
either the majority United States shareholder, or the specified foreign 
corporation, or both, elect to use a 52-53-week taxable year under this 
paragraph (c)(3).
* * * * *
    Par. 10. Section 1.1378-1 is added under the undesignated 
centerheading ``Small Business Corporations and Their Shareholders'' to 
read as follows:


Sec. 1.1378-1  Taxable year of S corporation.

    (a) In general. The taxable year of an S corporation must be a 
permitted year or a taxable year elected under section 444. No 
corporation may make an election to be an S corporation for any taxable 
year unless the taxable year is a permitted year or a taxable year 
elected under section 444. In addition, an S corporation may not change 
its taxable year to any taxable year other than a permitted year or a 
taxable year elected under section 444. A permitted year is the 
required taxable year (i.e., a taxable year ending on December 31), a 
52-53-week taxable year ending with reference to the required taxable 
year, or any other taxable year for which the corporation establishes a 
business purpose to the satisfaction of the Commissioner under section 
442.
    (b) Adoption of taxable year. An electing S corporation may adopt, 
in accordance with Sec. 1.441-1(c), its required taxable year, a 52-53-
week taxable year ending with reference to its required taxable year, 
or a taxable year elected under section 444 without the

[[Page 31868]]

approval of the Commissioner. See Sec. 1.441-1. An electing S 
corporation that wants to adopt any other taxable year, must establish 
a business purpose and obtain the approval of the Commissioner under 
section 442.
    (c) Change in taxable year. An S corporation or electing S 
corporation that wants to change its taxable year must obtain the 
approval of the Commissioner under section 442 or make an election 
under section 444. However, an S corporation or electing S corporation 
may obtain automatic approval for certain changes, including a change 
to its required taxable year, pursuant to administrative procedures 
published by the Commissioner.
    (d) Retention of taxable year. In certain cases, an S corporation 
or electing S corporation will be required to change its taxable year 
unless it obtains the approval of the Commissioner under section 442, 
or makes an election under section 444, to retain its current taxable 
year. For example, a corporation using a June 30 fiscal year that 
elects to be an S corporation and, as a result, is required to use the 
calendar year must obtain the approval of the Commissioner to retain 
its current fiscal year.
    (e) Procedures for obtaining approval or making a section 444 
election--(1) In general. See Sec. 1.442-1(b) for procedures to obtain 
the approval of the Commissioner (automatically or otherwise) to adopt, 
change, or retain a taxable year. See Secs. 1.444-1T and 1.444-2T for 
qualifications, and 1.444-3T for procedures, for making an election 
under section 444.
    (2) Special rules for electing S corporations. An electing S 
corporation that wants to adopt, change to, or retain a taxable year 
other than its required taxable year must request approval of the 
Commissioner on Form 2553 (Election by a Small Business Corporation) 
when the election to be an S corporation is filed pursuant to section 
1362(b) and Sec. 1.1362-6. See Sec. 1.1362-6(a)(2)(i) for the manner of 
making an election to be an S corporation. If such corporation receives 
permission to adopt, change to, or retain a taxable year other than its 
required taxable year, the election to be an S corporation will be 
effective. Denial of the request renders the election ineffective 
unless the corporation agrees that, in the event the request to adopt, 
change to, or retain a taxable year other than its required taxable 
year is denied, it will adopt, change to, or retain its required 
taxable year or, if applicable, make an election under section 444.
    (f) Effective date. The rules of this section are applicable for 
taxable years ending on or after the date these regulations are 
published in the Federal Register as final regulations.

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

    Par. 11. The authority citation for part 5c continues to read as 
follows:

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


Sec. 5c.442-1  [Removed]

    Par. 12. Section 5c.442-1 is removed.

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

    Par. 13. The authority citation for part 5f continues to read in 
part as follows:

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


Sec. 5f.442-1  [Removed]

    Par. 14. Section 5f.442-1 is removed.

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

    Par. 15. The authority citation for part 18 continues to read as 
follows:

    Authority: 26 U.S.C. 7805.


Sec. 18.1378-1  [Removed]

    Par. 16. Section 18.1378-1 is removed.

Robert E. Wenzel,
Deputy Commissioner of Internal Revenue.
[FR Doc. 01-13536 Filed 6-12-01; 8:45 am]
BILLING CODE 4830-01-P`