IRC 1378: S-Corp Required Tax Year -- Permitted Year, Natural Business Year Test, and Section 444 Election
By Americas Tax | Last reviewed: July 2026 | Practitioner Reference Series
IRC 1378 establishes the S-corp required tax year rules that every newly-elected S-corp must navigate and every advising practitioner must master. This guide covers the statutory framework, the three-part natural business year test under Rev. Rul. 87-57, Section 444 election mechanics and Form 8716 deadlines, the IRC 7519 required payment calculation, automatic approval procedures, and the interaction with IRC 1377 allocation rules -- consolidated at the depth the code demands.
1. Statutory Framework: IRC 1378 and the Permitted Year
IRC 1378(a) states the baseline rule: an S-corp must use a "permitted year" as its taxable year. There is no discretion here -- the permitted year requirement is a condition of maintaining the S election, and a corporation that adopts a non-permitted year without proper authorization will face IRS scrutiny of its filing posture.
IRC 1378(b) defines what counts as a permitted year. Two categories qualify:
- December 31 year-end (calendar year). A tax year ending on December 31 is always a permitted year. No IRS approval, no filing, no business purpose showing is required. Most S-corps default here.
- Any other accounting period for which the corporation establishes a business purpose to the satisfaction of the Secretary. This is the natural business year route. The corporation must demonstrate, through the tests in Rev. Rul. 87-57, that its business operations naturally align with a non-calendar fiscal year.
In addition to the two permitted year categories, IRC 444 provides a third path -- an elective fiscal year that does not require a business purpose showing but is capped by a deferral-period limit. The Section 444 election is not a "permitted year" in the IRC 1378(b) sense; rather, it is a statutory override that allows a limited departure from the required year in exchange for an annual required payment under IRC 7519.
The S-corp calendar year requirement traces to Congress's concern about tax deferral: when a C-corp shareholder holds stock in a corporation with a January 31 fiscal year, the shareholder's income from the corporation flows through 11 months after the corporation earns it. Subchapter S does not have the same deferral opportunity by default, because the IRS requires the S-corp to match the shareholder's tax year in most circumstances.
2. Natural Business Year Test: Rev. Rul. 87-57
Rev. Rul. 87-57 sets out three tests for establishing a natural business year. A corporation that satisfies any one of them has established a business purpose for the proposed fiscal year end.
Test 1: The 25% Gross Receipts Test (Mechanical)
The 25% gross receipts test is the only one with a bright-line mechanical standard, and it is the test that practitioners rely on most frequently. The requirements are:
- 25% or more of the corporation's annual gross receipts were received in the last two months of the proposed fiscal year.
- This 25%-or-more threshold was satisfied in each of three consecutive preceding 12-month periods.
Example: A landscaping company proposes a fiscal year ending November 30. It must show that 25% or more of its annual gross receipts arrived in October and November in each of the three preceding 12-month periods ending November 30. If the corporation is newly formed and cannot produce three years of data, it must use estimates or projections -- and the IRS will scrutinize those projections closely.
The test uses gross receipts, not net income. Returns and allowances reduce gross receipts. Related-party transactions are subject to arm's-length scrutiny for purposes of this test.
If the proposed fiscal year produces a 25% result in two of the three required periods but not the third, the test fails. There is no averaging or substantial-compliance exception.
Test 2: The Annual Business Cycle Test (Subjective)
The annual business cycle test asks whether the corporation's natural business operations begin and end within the proposed fiscal year. A retail business that begins its buying cycle in February and completes its selling season by January might argue for a January 31 fiscal year on the grounds that it reflects one complete business cycle. The IRS applies this test with considerable subjectivity, and approval is less predictable than the 25% test.
Test 3: The Seasonal Business Test (Subjective)
The seasonal business test applies where the corporation's operations are demonstrably seasonal -- ski resorts, summer camps, seasonal agricultural processors. The proposed fiscal year end should fall at the natural conclusion of the operating season. Like the annual business cycle test, this is a facts-and-circumstances inquiry without a mechanical safe harbor.
Practitioner Note on Rev. Rul. 87-57
Rev. Rul. 87-57 has not been superseded as of the date of this guide, but practitioners should confirm its current status with the IRS website before citing it in a client submission. Revenue rulings can be modified, revoked, or superseded by subsequent guidance. The IRS's Internal Revenue Bulletin (IRB) search tool at IRS.gov is the authoritative source for revenue ruling status.
3. Section 444 Election Mechanics
An S-corp that cannot satisfy any of the three natural business year tests in Rev. Rul. 87-57 -- or that simply prefers a specific fiscal year without going through the business purpose determination -- may elect under IRC 444 to use a fiscal year, subject to the deferral-period limit.
The Deferral Period Limit
The deferral period under Section 444 may not exceed three months. The deferral period is the difference in months between the proposed fiscal year end and the end of the required year (calendar year end). Permitted elections are therefore limited to fiscal years ending September 30, October 31, or November 30 -- representing deferral periods of three, two, and one month, respectively. A fiscal year ending August 31 (four-month deferral) is not permitted under Section 444.
Eligibility
A corporation may make a Section 444 election only if:
- It is an S-corp (or a partnership or personal service corporation -- those entities follow similar rules).
- It has not previously had a Section 444 election in effect, or it is retaining the same fiscal year it used in the prior election.
- The requested fiscal year does not represent a deferral period longer than three months.
- The requested fiscal year is not the required year (calendar year) -- because electing your required year is a nullity.
Form 8716: Filing the Election
The Section 444 election is made on Form 8716 (Election to Have a Tax Year Other Than a Required Tax Year). Form 8716 must be filed by the earlier of:
- The 5th month after the first day of the tax year for which the election is to be effective, or
- The 15th day of the 4th month after the end of the tax year that would result if the deferral period were applied (i.e., the 15th day of the 4th month after the end of the deferral-period year).
Form 8716 is filed with the IRS Service Center where the corporation files its income tax return. There is no filing fee. The corporation retains a copy in its records.
Deadline Risk -- Form 8716 (Section 444 Election)
Missing the Form 8716 deadline is not correctable by extension. If the corporation files Form 8716 after the earlier-of deadline, the election is invalid for that tax year and the S-corp is required to use its permitted year (calendar year or an established natural business year) for that period. A short-period return may be required. Practitioners advising newly-elected S-corps should calendar the Form 8716 deadline alongside the Form 2553 S-election deadline -- the two filings are often concurrent for a new entity.
Verification required: Confirm current Form 8716 filing instructions and deadline rules at IRS.gov before advising. Revenue procedures can modify or clarify these deadlines.
4. IRC 7519 Required Payment
An S-corp that makes or retains a Section 444 election must make an annual required payment under IRC 7519. The required payment is reported on Form 8752 (Required Payment or Refund Under Section 7519) and is due by May 15 of the calendar year following the close of the fiscal year to which the Section 444 election applies.
Purpose of the Required Payment
The required payment exists to neutralize the tax deferral that shareholders receive when an S-corp uses a fiscal year. Consider an S-corp with a September 30 fiscal year: income earned in October, November, and December of the calendar year does not flow through to shareholders until the fiscal year closes on September 30 of the following year. That three-month deferral has real present-value benefit at the individual shareholder level. IRC 7519 captures an approximation of that benefit as a required payment held by the Treasury until the election ends.
Calculation
The required payment is calculated as follows:
- Net base amount: The applicable percentage of the "net base amount," which is the excess of the S-corp's "applicable amount" for the current applicable election year over its "net required payment balance" (the cumulative excess of prior-year required payments over prior-year refunds).
- Applicable percentage: Determined under the highest individual income tax rate in effect for the applicable election year. The IRS updates this rate as tax law changes.
- Minimum payment: The required payment for a given year is zero if the calculated amount is $500 or less (the minimum threshold under current guidance).
The Form 8752 instructions provide the current applicable percentage and step-by-step worksheet. Practitioners should use the current-year instructions rather than a prior-year form, because the applicable percentage can change.
The Required Payment Is Not a Tax -- Refund Rules Apply
IRC 7519 required payments are deposits, not taxes. They are held by the Treasury and are refunded to the corporation if: (1) the S election terminates, or (2) the Section 444 election is revoked or otherwise ceases to be in effect. The refund is reported on Form 8752 in the year the termination or revocation occurs. Because the required payment is a deposit rather than a tax, it does not produce a deduction for the S-corp or reduce shareholder basis. Confirm the current minimum threshold and applicable percentage in the Form 8752 instructions at IRS.gov before computing a client's required payment.
5. The 52/53-Week Tax Year Under IRC 441(f)
An S-corp may use a 52/53-week taxable year under IRC 441(f) if the year always ends on the same day of the week and that day falls on the date closest to the last day of a calendar month -- or always within 7 days of the last day of a particular calendar month.
For purposes of the permitted year analysis, a 52/53-week year is treated as ending on the last day of the calendar month in which it ends (or nearest which it ends). So a 52/53-week year that always ends on the last Friday nearest to December 31 would be treated as a December 31 year-end for all IRC 1378 purposes -- a permitted year with no additional filing required.
A 52/53-week year that ends nearest to a natural business year month-end (say, nearest to the last day of September) is treated as a September 30 year-end for these purposes, and the S-corp would still need either a natural business year determination or a Section 444 election to use it permissibly.
The 52/53-week structure is common in retail and restaurant industries where week-ending uniformity simplifies operations, inventory counts, and comparative financial reporting. Practitioners should confirm that the corporation's 52/53-week year falls within a permitted year (or is covered by a Section 444 election) before assuming it is automatically acceptable.
6. Changing the S-Corp's Tax Year
An S-corp that needs to change its tax year -- whether to adopt a new fiscal year, move from a fiscal year to a calendar year, or correct a prior non-permitted year -- has two procedural paths: automatic approval under Rev. Proc. 2006-46, or advance IRS consent via Form 1128.
Rev. Proc. 2006-46 Automatic Approval
Rev. Proc. 2006-46 provides an automatic consent procedure that allows an S-corp to change its annual accounting period without filing Form 1128 or obtaining a private letter ruling. The procedure applies when the corporation is changing to a permitted year -- specifically a calendar year or a natural business year established by the 25% gross receipts test. The corporation implements the change by attaching a required statement to the first income tax return filed under the new tax year (Form 1120-S for the short period), and no advance IRS filing is required.
Scope of Rev. Proc. 2006-46 Automatic Approval
Automatic approval under Rev. Proc. 2006-46 does not apply to every tax year change. The procedure has specific eligibility conditions, including limits on how recently the corporation last changed its tax year. A corporation that changed its tax year within the prior 48 months generally cannot use automatic approval again. Additionally, automatic approval does not cover changes to years other than a calendar year or a natural business year meeting the 25% gross receipts test -- a change to a fiscal year that requires a separate business purpose determination or a Section 444 election must go through the applicable IRS consent procedure for that path. Verify that Rev. Proc. 2006-46 has not been superseded before relying on it; the IRS has updated automatic approval procedures over time.
Form 1128 -- Advance Consent
Changes that fall outside the scope of Rev. Proc. 2006-46 require Form 1128 (Application to Adopt, Change, or Retain a Tax Year) and advance IRS consent. Form 1128 must generally be filed by the 15th day of the 2nd calendar month after the close of the short period for which the change is requested. The IRS will issue a letter ruling or determination letter approving or denying the change; the corporation may not use the new year until approval is received, except as specifically allowed by the applicable revenue procedure.
7. Newly-Elected S-Corps: C-Corp Conversions and LLC Elections
When an entity converts from C-corp status to S-corp status, or when an LLC files Form 2553 to elect S-corp status, the entity must adopt a permitted year at the time of the election. This timing requirement creates practical issues for C-corps with existing fiscal years that do not qualify as natural business years.
C-Corp Converting to S-Corp
A C-corp with a non-calendar fiscal year that does not meet the natural business year tests must, on the effective date of its S election: (1) change to a calendar year, or (2) make a Section 444 election (if the existing fiscal year produces a deferral period of three months or less). If the corporation's fiscal year-end creates a deferral period that exceeds three months, Section 444 is not available, and the corporation must move to a calendar year as a condition of the S election.
The short period required to bridge from the prior fiscal year to the permitted year is a C-corp short-period return (Form 1120) if the change occurs before the S election is effective. Careful sequencing of the Form 2553 effective date and the fiscal year change is essential.
Timing the C-to-S Conversion and Tax Year Change
The S election (Form 2553) and the tax year change must be coordinated carefully. If a C-corp with a fiscal year converts to S status without addressing the non-permitted fiscal year, the IRS may treat the S election as defective or may require a retroactive year change that triggers an unexpected short-period filing obligation. Best practice: confirm the tax year posture before filing Form 2553, and if a Section 444 election is needed, have Form 8716 ready to file concurrently or immediately after. Do not rely on curing the year-end issue after the S election is on file.
LLC Electing S-Corp Status
An LLC that was previously taxed as a partnership or disregarded entity (single-member) typically used a calendar year by default (most LLCs do not have fiscal years). But if the LLC had adopted a fiscal year as a partnership under IRC 706, that fiscal year may not be a permitted S-corp year. The same analysis applies: at the moment Form 2553 is effective, the entity must be on a permitted year or must concurrently file Form 8716 for a Section 444 election.
8. Consequences of Using a Non-Permitted Year
Using a non-permitted tax year without proper authorization does not cause an automatic termination of the S election. The S election terminates only on the specific grounds listed in IRC 1362(d): voluntary revocation, loss of eligibility (e.g., exceeding the shareholder count, adding an ineligible shareholder, issuing a second class of stock), or the passive income termination under IRC 1362(d)(3). An improper fiscal year is not on that list.
However, the practical consequences of an unauthorized non-permitted year are still serious:
- The IRS may require the corporation to change to a permitted year, which forces a short-period return and can disrupt the corporation's accounting and reporting cycle.
- If the original Form 2553 listed a fiscal year that was neither a permitted year nor supported by a concurrent Section 444 election, the IRS may treat the Form 2553 itself as defective and call the entire S election into question.
- Tax returns filed for non-permitted years may not be accepted as filed; amended returns for the correct year-end may be required, with potential penalties for late filing.
- The unauthorized fiscal year does not produce a separate ground for automatic termination under IRC 1362(d)(3), which is limited to passive investment income exceeding 25% of gross receipts for three consecutive years while C-corp earnings and profits are present. Practitioners should not conflate the two issues.
9. Interaction with IRC 1377: Per-Share Per-Day Allocation in a Fiscal Year S-Corp
IRC 1377 governs the allocation of S-corp items of income, loss, deduction, and credit to shareholders. The default method is the per-share per-day rule: each item is treated as recognized ratably over the tax year, and each shareholder's pro-rata share is determined by multiplying the per-day amount by the number of days in the year during which the shareholder held stock.
The permitted tax year is the measurement period for IRC 1377 calculations. An S-corp on a September 30 fiscal year applies IRC 1377 to the fiscal year period (October 1 through September 30), not to the calendar year. A shareholder who sells stock on March 15 of a September 30 fiscal year is allocated a pro-rata share based on 166 days out of 365 (or 366), measured within the October 1 -- September 30 fiscal year period.
The closing-of-books election under IRC 1377(a)(2) -- which allows a terminating year to allocate items as if the books were closed on the date of the shareholder's departure -- operates within the same fiscal year framework. A mid-year shareholder departure in a fiscal year S-corp triggers the same closing-of-books election mechanics as in a calendar year S-corp, but the "terminating year" is defined by the fiscal year, and the election must be made by all affected shareholders and the corporation for the fiscal year in which the termination occurs.
Cross-Reference: IRC 1377 Allocation Guide
The per-share per-day rules, closing-of-books election mechanics, and the definition of "terminating year" under IRC 1377 are covered in detail in our companion guide. If your S-corp uses a Section 444 fiscal year and has shareholder turnover during the year, the intersection of IRC 1377 and IRC 1378 requires careful attention -- particularly where the S-corp's fiscal year straddles two calendar years and affects the shareholder's income tax reporting year. See the IRC 1377 guide linked in the Related Practitioner Guides section below.
Practice Note: OBBBA and S-Corp Tax Year Considerations
Practitioners advising S-corps should monitor legislative developments that may affect the interaction between the S-corp calendar year requirement and pass-through income rules. The One Big Beautiful Budget Act (OBBBA) introduced modifications to the pass-through deduction framework that can affect the timing and character of S-corp income reported at the shareholder level. Because the S-corp's permitted tax year determines when income flows through to shareholders, a fiscal year S-corp operating under a Section 444 election may experience different OBBBA pass-through deduction results than a calendar year S-corp, depending on the character of income and the shareholder's individual tax year. Confirm current legislative status and IRS guidance on any OBBBA provisions before advising clients on fiscal year elections made in light of pass-through planning.
10. Comparison: Calendar Year vs. Natural Business Year vs. Section 444 Election
| Factor | Calendar Year (Dec. 31) | Natural Business Year | Section 444 Election |
|---|---|---|---|
| Legal basis | IRC 1378(b)(1) | IRC 1378(b)(2); Rev. Rul. 87-57 | IRC 444; Rev. Proc. 2006-46 (change rules) |
| Required payment (IRC 7519) | None | None | Yes -- Form 8752 due May 15 annually |
| Filing form | No special form needed | IRS ruling request or Rev. Proc. 2006-46 statement | Form 8716 (by the earlier-of deadline) |
| Deferral period | None (required year) | Varies (natural year-end may differ from Dec. 31) | Maximum 3 months (Sept. 30, Oct. 31, or Nov. 30) |
| Refund of deposit | N/A | N/A | Yes -- refunded on termination or revocation |
| Business purpose required | No | Yes -- 25% receipts test or subjective test | No |
| IRS approval required | No | Yes (ruling or auto-approval under Rev. Proc. 2006-46) | No (self-executing on timely Form 8716 filing) |
| Shareholder timing mismatch | None (matches most individual tax years) | Potential mismatch -- managed by IRC 1377 rules | Yes -- up to 3-month deferral at shareholder level |
| Applicable to C-to-S conversions | Yes -- default required year | Yes -- if natural business year tests are met | Yes -- if deferral period does not exceed 3 months |
| Rev. Proc. automatic approval | Yes -- changing TO calendar year | Yes -- if 25% gross receipts test is met (Rev. Proc. 2006-46) | Not applicable (Section 444 has its own filing mechanism) |
Frequently Asked Questions: IRC 1378 S-Corp Required Tax Year
Does every S-corp have to use a calendar year?
Yes, by default. IRC 1378(b)(1) makes December 31 the required year unless the corporation qualifies for an exception. The two exceptions are: (1) establishing a natural business year under IRC 1378(b)(2) and Rev. Rul. 87-57, and (2) making a Section 444 election under IRC 444 to use a fiscal year with a deferral period of no more than three months. Without one of these, the S-corp must use a calendar year.
What is the 25% gross receipts test for an S-corp natural business year?
The 25% gross receipts test under Rev. Rul. 87-57 requires that 25% or more of the corporation's annual gross receipts were received in the last two months of the proposed fiscal year, and that this threshold was met in each of three consecutive preceding 12-month periods. It is the only one of the three natural business year tests with a clear mechanical standard. Satisfying this test in just two out of three periods is insufficient -- all three periods must independently clear the 25% threshold.
What is Form 8716 and when is it due?
Form 8716 (Election to Have a Tax Year Other Than a Required Tax Year) is filed to make a Section 444 election. The deadline is the earlier of: the 5th month after the first day of the tax year for which the election is made, or the 15th day of the 4th month after the end of the deferral-period tax year. Missing this deadline makes the election invalid for that year and requires the S-corp to use a permitted year (typically the calendar year) for the period in question.
Is the IRC 7519 required payment a tax?
No. The IRC 7519 required payment is a deposit held by the Treasury, not a tax. It approximates the tax deferral benefit that shareholders receive when an S-corp uses a fiscal year under Section 444. If the S election terminates or the Section 444 election is revoked, the accumulated required payments are refunded to the corporation. The payment does not reduce shareholder basis or produce a corporate deduction. It is reported annually on Form 8752.
Can an LLC electing S-corp status use a fiscal year?
Yes, but the same IRC 1378 rules apply. When an LLC files Form 2553, it must adopt a permitted year at the time of the election. If the LLC previously used a fiscal year as a partnership that does not qualify as a natural business year, it must change to a calendar year or concurrently file Form 8716 for a Section 444 election. The Section 444 election can be filed at the same time as Form 2553 for a newly-electing entity, subject to the deferral-period limits.
What happens if an S-corp uses the wrong tax year?
Using a non-permitted tax year without authorization does not automatically terminate the S election -- that requires one of the specific grounds in IRC 1362(d). However, the IRS may require a change to a permitted year, which can force a short-period return and disrupt the reporting cycle. If the improper fiscal year was stated in the original Form 2553 without a concurrent Section 444 election or natural business year showing, the IRS may treat the S election itself as defective. This is a separate issue from the passive income termination under IRC 1362(d)(3).
How does the automatic approval procedure work for changing an S-corp's tax year?
Rev. Proc. 2006-46 allows an S-corp to change to a permitted year (calendar year or a natural business year satisfying the 25% gross receipts test) without filing Form 1128 or obtaining advance IRS consent. The corporation attaches a required statement to its first return filed under the new year. Automatic approval does not apply to corporations that changed their tax year within the prior 48 months, or to changes that involve fiscal years other than the calendar year or a qualified natural business year. For changes outside the automatic procedure, Form 1128 and advance IRS consent are required.
Can an S-corp that elected under Section 444 change back to a calendar year?
Yes. The S-corp may revoke its Section 444 election and return to a calendar year. Upon revocation, the accumulated IRC 7519 required payments are refunded. The revocation is generally effective for the tax year following the year in which it is made. If the corporation subsequently wants to use a fiscal year again, it must re-establish a natural business year or make a new Section 444 election, subject to all applicable filing requirements and deferral-period limits.
S-Corp Tax Year Planning -- Get It Right from the Start
The Section 444 election, Form 8716 deadline, and IRC 7519 required payment calculation involve judgment calls that affect your client's entire filing posture. Americas Tax works with CPAs, enrolled agents, and tax attorneys on S-corp tax year elections, C-to-S conversion year changes, and Form 8752 required payment computations.
Contact Americas Tax for S-Corp Tax Year Planning