Once the overpayment or underpayment of tax is calculated for each redetermination year, the interest is determined by applying the overpayment rate designated under IRC § 6621, compounded daily.
Generally, the time period over which the interest is charged begins on the due date (not including extensions) of the return for the redetermination year and ends on the earlier of:
• The due date (not including extensions) of the return for the filing year (i.e. year of completion or adjustment) and
• The date both the income tax return for the filing year is filed and the tax for that year has been paid in full. Treas. Reg. § 1.460-6(c)(4)(i).
Example of Interest Computation Period
In Year 3, contracts were completed by a corporate calendar year-end taxpayer. Look- back is required to be computed for Years 1 and Year 2. The interest computation for Year 1 look-back would be computed from the due date of the Year 1 tax return
(3/15/X2) to the due date of the Year 3 tax return (3/15/X4), if not filed before the due date of the Year 3 tax return. The interest computation for Year 2 look-back would be computed from the due date of the Year 2 tax return (3/15/X3) until the due date of the Year 3 tax return (3/15/X4).
(Treas. Reg. § 1.460-6(c)(4)(ii))
As previously mentioned, if the allocation of contract income under Step 1 changed the amount of a net operating loss that was carried back to a year preceding the year the taxpayer entered into the contract, the tax liability for the earlier year must be
redetermined. The interest is computed from the due date of the tax return that gives rise to the net operating loss carryback and not from the due date of the return in which the net operating loss is absorbed. However, for net operating loss carryovers, the interest is computed from the due date of tax return in which the net operating loss carryover is absorbed.
Example of Interest Computation Period on Changes in NOLs
In Year 5, a contract is completed which was in process in Year 3 and 4. On the
original tax return for Year 3, the taxpayer incurred a NOL, which was carried back and fully absorbed in Year 1. When computing look-back for Year 5, the completion year, the reallocation of contract income to Year 3 “hypothetically” decreases the NOL that was carried back to Year 1. The tax liability for Year 1 would be recomputed to
determine the underpayment or overpayment of tax for look-back purposes. However, the interest computation period would be from the due date of the Year 3 tax return until the due date of the Year 5 tax return.
In the above example, if the NOL in Year 3 was not carried back but carried over and fully absorbed in Year 4, the interest computation period for look-back would be
computed from the due date of the Year 4 tax return until the due date of the Year 5 tax return.
Different Interest Period for Changes in Tax Liability That Generated a Subsequent Refund (Treas. Reg. § 1.460-6(c)(4)(iii))
If the tax liability in a redetermination year is decreased by the application of look-back and any portion was absorbed by a loss or credit carryback in a year subsequent to the redetermination year, the interest computation period would be as follows:
• To the extent the amount of tax absorbed because of the carryback exceeds the total hypothetical tax liability for the year, the interest period for look-back ends on the due date (not including extensions) of the return for the year in which the carryback arose and not the due date of the filing year (i.e. completion year). Example:
In Year 5, upon the completion of a long-term contract, the taxpayer redetermines its tax liability for Year 3 under the look-back method. This redetermination results in a
hypothetical reduction of tax liability of $300 determined as follows: Year 3
Hypothetical Overpayment of Tax 300
In Year 4, a NOL was incurred and carried back to Year 3. The interest computation period for look-back would depend on the amount of reported tax liability of Year 3 that was refunded:
(A) If the amount refunded because of the NOL is $1,500: interest is credited to the taxpayer on the entire hypothetical overpayment of $300 from the due date of the Year 3 return, when the hypothetical overpayment occurred, until the due date of the Year 4 return, when the taxpayer received a refund for the entire amount of the Year 3 tax, including the hypothetical overpayment. Treas. Reg. § 1.460- 6(c)(4)(iii)(A).
(B) If the amount refunded because of the NOL is $1,000: interest is credited to the taxpayer on the entire amount of the hypothetical overpayment of $300 from the due date of the Year 3 return, when the hypothetical overpayment occurred, until the due date of the Year 5 return. In this situation interest is credited until the due date of the return for the completion year of the contract, rather than the due date of the return for the year in which the carryback arose, because the amount refunded was less than the hypothetical tax liability. Therefore, no portion of the hypothetical overpayment is treated as having been refunded to the taxpayer before the filing year. Treas. Reg. § 1.460-6(c)(4)(iii)(B).
(C) If the amount refunded because of the NOL is $1,300: interest is credited to the taxpayer on $100 ($1,300 - $1,200) from the due date of the Year 3 return until the due date of the Year 4 return because only this portion of the total
hypothetical overpayment is treated as having been refunded to the taxpayer before the filing year. However, the taxpayer did not receive a refund for the remaining $200 of the overpayment at that time and, is therefore is credited with interest on $200 from the due date of the Year 3 return to the due date of the tax return for Year 5.
Interest Rate Computation Period is Annual, not Quarterly
Generally, IRS computes interest on a quarterly basis. Prior to the Taxpayer Relief Act of 1997, the look-back interest computation was also computed quarterly. However, the Taxpayer Relief Act of 1997 added IRC § 460(b)(7), which provided the annual rate for tax returns ending after August 5, 1997. Rather than using the rates in effect for each quarter, the look-back rate will change only once for each twelve month period. The interest rate to be used for this period is the rate in effect for the calendar quarter in which the interest rate accrual begins.
IRC § 460(b)(7) ADJUSTED OVERPAYMENT RATE.—
(A) IN GENERAL.—The adjusted overpayment rate for any interest accrual
period is the overpayment rate in effect under section 6621 for the calendar quarter in which such interest accrual period begins.
(B) INTEREST ACCRUAL PERIOD.—For purposes of subparagraph (A), the term
“interest accrual period” means the period—
(i) beginning on the day after the return due date for any taxable year of
the taxpayer, and
(ii) ending on the return due date for the following taxable year.
For purposes of the preceding sentence, the term “return due date” means the date prescribed for filing the return of the tax imposed by this chapter (determined without regard to extensions).
Corporate Interest Rates
For tax periods ending after 1994, corporate interest rates are different for increases or decreases of tax exceeding $10,000. Therefore, the first $10,000 of the look-back interest is computed at one interest rate with any amount over $10,000 being computed at a lower rate (i.e. 1.5% lower). IRC § 6621(a)(1).