Program Manager Technical Advice 2015-016
In Program Manager Technical Advice, IRS has concluded that look-back interest that either the taxpayer owes IRS or IRS owes the taxpayer, at the conclusion of a contract accounted for under the percentage-of-completion method (PCM), is not eligible for interest netting, but that any underpayment/overpayment interest arising from look-back interest may be eligible for netting.
Background. Code Sec. 460(a) requires that the taxable income from any long-term contract be determined under the PCM. Under the PCM, the taxpayer includes in income the percentage of the total estimated revenue from the contract corresponding to the “completion percentage.” The completion percentage is found by comparing costs allocated to the contract and incurred before the close of the tax year with the estimated total contract costs.
In the tax year a long-term contract is completed, taxpayers must perform a look-back computation of interest to compensate for any underestimation or overestimation of income from the contract. If the contract price is underestimated or the contract cost is overestimated, a taxpayer will owe interest on this deferral of liability. If the contract price is overestimated or contract costs are underestimated, the taxpayer will be entitled to receive interest as a result of the acceleration of the tax liability. In either case, this interest is referred to as “look-back interest”. (Code Sec. 460(b))
A taxpayer’s claim for credit or refund of look-back interest previously paid by or collected from a taxpayer is a claim for credit or refund of an overpayment of tax. A taxpayer’s claim for look-back interest (or interest payable on look-back interest) that is not attributable to an amount previously paid by or collected from a taxpayer is a general, non-tax claim against the federal government. (Reg. § 1.460-6(f)(3))
To the extent that, for any period, interest is payable under Chapter 67, subchapter A (Interest on Underpayments) and allowable under Chapter 67, subchapter B (Interest on Overpayments), on equivalent underpayments and overpayments by the same taxpayer, the net rate of interest on those amounts is zero for that period. (Code Sec. 6621(d))
- Are look-back interest amount owed to IRS and underpayment interest charged on that look-back amount eligible for interest netting?
- Are look-back interest amount owed to a taxpayer and the interest allowed on that look-back interest amount eligible for interest netting?
IRS’s conclusions regarding netting. IRS concluded that the look-back interest that either the taxpayer owes IRS, or IRS owes the taxpayer, is not eligible for interest netting, but that any underpayment/overpayment interest arising from look-back interest may be eligible for netting.
Issue 1. Look-back interest owed to IRS concluded that look-back interest is treated by the Code as additional tax. It cited the Code Sec. 460(b)(1) flush language which provides that for purposes of subtitle F (Procedure and Administration) of the Code (other than the estimated tax sections, Code Sec. 6654 and Code Sec. 6655), any look-back interest required to be paid by the taxpayer is treated as an increase in income tax. Therefore, IRS concluded, look-back interest does not meet the requirements of Code Sec. 6621(d) and isn’t eligible for netting.
IRS said that, presumably, such additional tax could result in an underpayment and that any interest arising from such underpayment would be eligible for netting because it would be interest payable under subchapter A.
Issue 2. Look-back interest owed to a taxpayer. IRS cited Reg. § 1.460-6(f)(3) and concluded that the Issue 2 answer depends on whether the look-back interest was previously paid by or collected from the taxpayer.
A claim for credit/refund of look-back interest that was not previously paid by the taxpayer is treated as a general, non-tax claim against the government, and is not an overpayment because it is not an amount that was previously paid by or collected from the taxpayer. The look-back interest itself is also not eligible for interest netting, because it is not interest on an underpayment payable under subchapter A or interest on an overpayment allowable under subchapter B that would be eligible for netting.
If the taxpayer had previously paid the look-back interest, interest arising from look-back interest owed to the taxpayer is eligible for interest netting. In this case, the look-back interest would be an overpayment, and interest on this overpayment is interest allowable under subchapter B. The look-back interest itself is not eligible for netting, because it is not interest on an underpayment or an overpayment.