Prop. Treas. Reg. § 1.167(n)-6 Look-back method.

Par. 2. Sections 1.167(n)-0 through 1.167(n)-7 are added to read as follows:

(a) Application of the look-back method. If a taxpayer claims a depreciation deduction under the income forecast method for any eligible income forecast property, such taxpayer is required to pay (or is entitled to receive) interest computed as described in this paragraph for any year to which the look-back method applies (a recomputation year). The look-back method generally must be applied when income forecast property is disposed of or ceases to generate income. Further, the look-back method generally applies in the 3rd and 10th taxable years following the year in which income forecast property is placed in service. Under the look-back method, taxpayers must pay interest on deductions accelerated by the underestimation of either forecasted total income or revised forecasted total income from income forecast property. Conversely, taxpayers are entitled to receive interest on deductions delayed by the overestimation of either forecasted total income or revised forecasted total income from income forecast property. If either forecasted total income or revised forecasted total income are overestimated or underestimated, interest may arise from basis redeterminations. The computation of adjusted tax liability as part of the look-back method is hypothetical; application of the look-back method does not require a taxpayer to adjust tax liability as reported on the taxpayer's tax returns, on an amended return, or as adjusted on examination for prior years.

(b) Operation of the look-back method —(1) In general. Under the look-back method, a taxpayer must perform a series of computations to determine look-back interest that the taxpayer is either required to pay or entitled to receive. As specified in paragraph (c) of this section, a taxpayer must first recompute depreciation allowances using revised forecasted total income rather than forecasted total income from income forecast property for the recomputation year (as defined in paragraph (e) of this section) and each prior year. These recomputed depreciation amounts are then used to determine a hypothetical tax liability that would have arisen had the taxpayer used revised forecasted total income rather than forecasted total income in determining depreciation allowances. The hypothetical tax liability is compared to the taxpayer's prior tax liability and interest is calculated in accordance with paragraph (d) of this section on the resulting hypothetical overpayments or underpayments of tax for each year. Reporting requirements and special rules for the resulting amounts of interest are specified in paragraph (g) of this section.

(2) Property-by-property application. Except as provided in this section, the look-back method applies to each property for which the income forecast method is used. Aggregations properly treated as a single income forecast property pursuant to § 1.167(n)-5(d) are treated as a single property for purposes of applying the look-back method.

(c) Recalculation of depreciation allowances —(1) Computation. Under the look-back method, a taxpayer must compute the depreciation allowances for each income forecast property subject to the look-back method that would have been allowable under § 1.167(n)-1 through § 1.167(n)-5 for prior taxable years if the computation of the amounts so allowable had been made using revised forecasted total income as calculated at the end of the recomputation year.

(2) Revised forecasted total income from the property —(i) In general. Except as provided in this paragraph (c)(2), revised forecasted total income is determined in accordance with § 1.167(n)-3(c).

(ii) Syndication income from television series. Income excluded from forecasted total income (or, if appropriate revised forecasted total income) in any taxable year prior pursuant to § 1.167(n)-3(d)(2) is excluded from revised forecasted total income for purposes of this section for that year.

(iii) Disposition of income forecast property. For purposes of this section, income from the disposition of property must be taken into account in determining the amount of revised forecasted total income. Thus, when income forecast property is disposed of prior to the end of the 10th taxable year following the taxable year the property is placed in service, revised forecasted total income from the property for the year of disposition is deemed to be the sum of the amount realized on the disposition of the property plus all amounts included in current year income in the year of disposition and in taxable years prior to the year of disposition.

(3) Special rule for basis redeterminations. For purposes of the look-back calculation, any amount that is not treated as a separate property under § 1.167(n)-5(c) that is paid or incurred with respect to income forecast property after the property is placed in service is taken into account by discounting (using the Federal mid-term rate determined under section 1274(d) as of the time the cost is paid or incurred) the amount to its value as of the date the property is placed in service. The taxpayer may elect for the recomputation year with respect to any income forecast property to have the preceding sentence not apply to the property by taking the amount into account in the year that the amount was paid or incurred in the same manner as it was taken into account under § 1.167(n)-2.

(d) Hypothetical overpayment or underpayment of tax —(1) In general —(i) Years for which a hypothetical overpayment or underpayment must be computed. After recalculating depreciation allowances in accordance with paragraph (c) of this section, a taxpayer must calculate a hypothetical overpayment or underpayment of tax for each prior taxable year for which income tax liability is affected by the change in depreciation allowances. A redetermination of income tax liability is required for every tax year for which the income tax liability would have been affected by a change in the allowance for income forecast depreciation in any year. For example, if the change in depreciation allowance results in a net operating loss carryforward that affects income tax liability in a subsequent taxable year, income tax liability must be recomputed for such subsequent year.

(ii) Methods of determining a hypothetical overpayment or underpayment. Generally, the calculation of the hypothetical overpayment or underpayment of tax must be made under the method described in paragraph (d)(2) of this section. Certain taxpayers are required to use the simplified method contained in paragraph (d)(3) of this section.

(iii) Cumulative determination of hypothetical income tax liability. The redetermination of income tax liability in any prior taxable year for which income tax liability is affected by the change in depreciation allowances must take into account all previous applications of the look-back calculation. Thus, for example, in computing the amount of a hypothetical overpayment or underpayment of tax for a prior taxable year for which income tax liability is affected by the change in depreciation allowances, the hypothetical income tax liability is compared to the hypothetical income tax liability for that year determined as of the previous application of the look-back method.

(2) Hypothetical overpayment or underpayment, actual recomputation —(i) Computation of change in income tax liability. The hypothetical overpayment or underpayment is calculated first by redetermining the tax liability for each prior taxable year (either as originally reported, or as subsequently adjusted on examination or by amended return) using depreciation allowances calculated in paragraph (c) of this section for each prior taxable year in which depreciation allowances were determined under the income forecast method for the income forecast property (affected year). These recomputed depreciation allowances are then substituted for the depreciation allowances allowed (or allowable) for each affected year (whether originally reported, or as subsequently adjusted on examination or by amended return) and a revised taxable income is computed. A hypothetical income tax liability is then computed for each affected year using revised taxable income for that year. The hypothetical income tax liability for any affected year must be computed by taking into account all applicable additions to tax, credits, and net operating loss carrybacks and carryforwards. The tax, if any, imposed under section 55 (relating to alternative minimum tax) must be taken into account. Hypothetical income tax liability for each affected year is then compared to the tax liability determined as of the latest of the following dates—

(A) The original due date of the return (including extensions);

(B) The date of a subsequently amended or adjusted return; or

(C) The date of the previous application of the look-back method, in which case the hypothetical income tax liability for the affected year used in the most recent previous application of the look-back method (previous hypothetical tax liability) is used.

(ii) Determination of interest. Once the hypothetical overpayment or underpayment for each year is computed, the adjusted overpayment rate under section 460(b)(7), compounded daily, is applied to the overpayment or underpayment determined under paragraph (d)(2)(i) of this section for the period beginning with the due date of the return (determined without regard to extensions) for the year in which either an overpayment or underpayment arises, and ending on the earlier of the due date of the return (determined without regard to extensions) for the redetermination year, or the first date by which both the income tax return for the filing year is filed and the tax for that year has been paid in full. The amounts of interest on overpayments are then netted against interest on underpayments to arrive at look-back interest that must be paid by the taxpayer or that the taxpayer is entitled to receive.

(iii) Changes in the amount of a loss or credit carryback or carryforward. If a recomputation of income forecast depreciation results in an increase or decrease to a net operating loss carryback (but not a carryforward), the interest a taxpayer is entitled to receive or required to pay must be computed on the decrease or increase in tax attributable to the change to the carryback only from the due date (not including extensions) of the return for the prior taxable year that generated the carryback and not from the due date of the return for the prior taxable year in which the carryback was absorbed. In the case of a change in the amount of a carryforward as a result of applying the look-back method, interest is computed from the due date of the return for the years in which the carryforward was absorbed.

(iv) Changes in the amount of income tax liability that generated a subsequent refund. If the hypothetical income tax liability for any affected year is less than the amount of the affected year tax liability (as reported on the taxpayer's original return, as subsequently adjusted on examination, as adjusted by amended return, or as redetermined by the last previous application of the look-back method), and any portion of the affected year tax liability was refunded as a result of a loss or credit carryback arising in a year subsequent to the affected year, the look-back method applies as follows to properly reflect the time period of the use of the tax overpayment. To the extent the amount of refund because of the carryback exceeds the hypothetical income tax liability for the affected year, the taxpayer is entitled to receive interest only until the due date (not including extensions) of the return for the year in which the carryback arose.

(v) Example. The provisions of this paragraph (d)(2) are illustrated by the following example:

Example.

Upon the cessation of income from an income forecast property in 2003, the taxpayer computes a hypothetical income tax liability for 2001 under the look-back method. This computation results in a hypothetical income tax liability ($1,200x) that is less than the actual income tax liability the taxpayer originally reported ($1,500x). In addition, the taxpayer had already received a refund of some or all of the actual 2001 income tax liability by carrying back a net operating loss (NOL) that arose in 2002. The time period over which interest would be computed on the hypothetical overpayment of $300x for 2001 would depend on the amount of the refund generated by the carryback, as illustrated by the following three alternative situations:

(i) If the amount refunded because of the NOL is $1,500x, interest is credited to the taxpayer on the entire hypothetical overpayment of $300x from the due date of the 2001 return, when the hypothetical overpayment occurred, until the due date of the 2002 return, when the taxpayer received a refund for the entire amount of the 2001 tax, including the hypothetical overpayment.

(ii) If the amount refunded because of the NOL is $1,000x, interest is credited to the taxpayer on the entire amount of the hypothetical overpayment of $300x from the due date of the 2001 return, when the hypothetical overpayment occurred, until the due date of the 2003 return. In this situation interest is credited until the due date of the return for the recomputation year, 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 income tax liability of $1,200x. Therefore, no portion of the hypothetical overpayment is treated as having been refunded to the taxpayer before the recomputation year.

(iii) If the amount refunded because of the NOL is $1,300x, interest is credited to the taxpayer on $100x ($1,300x-$1,200x) from the due date of the 2001 return until the due date of the 2002 return because only this portion of the total hypothetical overpayment is treated as having been refunded to the taxpayer before the recomputation year. However, the taxpayer did not receive a refund for the remaining $200x of the overpayment at that time and, therefore, is credited with interest on $200x through the due date of the tax return for 2003, the recomputation year.

(3) Hypothetical overpayment or underpayment, simplified method —(i) Introduction. This paragraph provides a simplified method for calculating look-back interest. A pass-through entity that is not a closely held pass-through entity is required to apply the simplified method at the entity level with respect to income forecast property and the owners of the entity do not calculate look-back interest for the property. Under the simplified method, a taxpayer calculates the hypothetical underpayments or overpayments of tax for a prior year based on an assumed marginal tax rate.

(ii) Operation of the simplified method. Under the simplified method, depreciation allowances for income forecast property are first recomputed in accordance with the procedures contained in paragraph (c) of this section. These recomputed depreciation allowances are then compared with depreciation allowances allowed (or allowable) for each prior taxable year (whether originally reported, as subsequently adjusted on examination or by amended return, or as recomputed in the most recent previous application of the look-back method) to arrive at changes in depreciation allowances for the income forecast property. When multiple properties are subject to the look-back method in any given affected year, the changes in depreciation allowances attributable to each income forecast property determined in accordance with paragraph (c) of this section for each such year are cumulated or netted against one another to arrive at a net change in income forecast depreciation for purposes of computing the hypothetical overpayment or underpayment attributable to the year. The hypothetical underpayment or overpayment of tax for each affected year is then determined by multiplying the applicable regular tax rate (as defined in paragraph (d)(3)(iv) of this section) by the increase or decrease in depreciation allowances.

(iii) Determination of interest. Interest is credited to the taxpayer on the net overpayment and is charged to the taxpayer on the net underpayment for each affected year by applying the adjusted overpayment rate under section 460(b)(7), compounded daily, to the overpayment or underpayment determined under paragraph (d)(3)(ii) of this section for the period beginning with the due date of the return (determined without regard to extensions) for the affected year, and ending on the earlier of the due date of the return (determined without regard to extensions) for the recomputation year, or the first date by which both the income tax return for the recomputation year is filed and the tax for that year has been paid in full. The resulting amounts of interest are then netted to arrive at look-back interest that must be paid by the taxpayer or that the taxpayer is entitled to receive.

(iv) Applicable tax rate. For purposes of determining hypothetical underpayments or overpayments of tax under the simplified method, the applicable regular rate is generally the highest rate of tax in effect for corporations under section 11. However, the applicable regular tax rate is the highest rate of tax imposed on individuals under section 1 if, at all times during all affected years, more than 50 percent of the interests in the entity were held by individuals directly or through 1 or more pass-through entities. The highest rate of tax imposed on individuals is determined without regard to any additional tax imposed for the purpose of phasing out multiple tax brackets or exemptions.

(4) Definitions— (i) Pass-through entity. For purposes of this section, a pass-through entity is either a partnership, an S corporation, an estate or a trust.

(ii) Closely-held pass-through entity. A closely-held pass-through entity is a pass-through entity that, at any time during any year for which allowances for depreciation are recomputed, 50 percent or more (by value) of the beneficial interests in that entity are held (directly or indirectly) by or for 5 or fewer persons. For this purpose, the term person has the same meaning as in section 7701(a)(1), except that a pass-through entity is not treated as a person. In addition, the constructive ownership rules of section 1563(e) apply by substituting the term beneficial interest for the term stock and by substituting the term pass-through entity for the term corporation used in that section, as appropriate, for purposes of determining whether a beneficial interest in a pass-through entity is indirectly owned by any person.

(e) Recomputation year— (1) In general. Except as provided in this paragraph (e), the term recomputation year means, with respect to any income forecast property—

(i) The earlier of—

(A) The year the income from the income forecast property ceases with respect to the taxpayer (and with respect to any person who would be treated as a single taxpayer with the taxpayer under rules similar to those in section 41(f)(1)); or

(B) The 3rd taxable year beginning after the taxable year in which the income forecast property was placed in service; and

(ii) The earlier of—

(A) The year the income from the income forecast property ceases with respect to the taxpayer (and with respect to any person who would be treated as a single taxpayer with the taxpayer under rules similar to those in section 41(f)(1)); or

(B) The 10th taxable year following the taxable year the income forecast property is placed in service.

(2) Look-back method inapplicable in certain de minimis cases— (i) De minimis difference between actual and forecasted income. A taxable year described in paragraph (e)(1) of this section is not a recomputation year if forecasted total income (as defined in § 1.167(n)-3(b)) or, where applicable, revised forecasted total income (as defined in § 1.167(n)-3(c)), for each preceding taxable years is—

(A) Greater than 90 percent of revised forecasted total income for the taxable year that would otherwise be a recomputation year; and

(B) Less than 110 percent of revised forecasted total income for the taxable year that would otherwise be a recomputation year.

(ii) Application of the de minimis rule where the look-back method was previously applied. For purposes of applying paragraph (e)(2)(i) of this section in any taxable year after a taxable year in which the look-back method has previously been applied, revised forecasted total income for the year the look-back method was applied, forecasted total income for the year the income forecast property was placed in service, and revised forecasted total income for all taxable years preceding the taxable year in which the look-back method was previously applied are deemed to be equal to the amount of revised forecasted total income that was used for purposes of applying the look-back method in the most recent taxable year for which the look-back method was applied.

(f) De minimis basis exception. The look-back method does not apply to any income forecast property with an adjusted basis, determined in accordance with section 1011 but without regard to the adjustments described in section 1016(a)(2) and (3), as of the close of any year that would otherwise be a recomputation year of $100,000 or less.

(g) Treatment of look-back interest— (1) In general. The amount of interest a taxpayer is required to pay is treated as an income tax under Subtitle A of the Internal Revenue Code, but only for purposes of Subtitle F of the Internal Revenue Code (other than sections 6654 and 6655), which addresses tax procedure and administration. Thus, a taxpayer that fails to report look-back interest when due is subject to any penalties under Subtitle F of the Internal Revenue Code applicable to a failure to report and pay a tax liability. However, look-back interest to be paid is treated as interest arising from an underpayment of tax under Subtitle A of the Internal Revenue Code, even though it is treated as an income tax liability for penalty purposes. Thus, look-back interest required to be paid by an individual, or by a pass-through entity on behalf of an individual owner (or beneficiary) under the simplified method, is personal interest and, therefore, is not deductible in accordance with § 1.163-9T(b)(2). Interest received under the look-back method is treated as taxable interest income for all purposes, and is not treated as a reduction in tax liability. The determination of whether interest computed under the look-back method is treated as income tax under Subtitle A of the Internal Revenue Code is determined on a net basis for each recomputation year. Thus, if a taxpayer computes both hypothetical overpayments of tax and hypothetical underpayments of tax for years prior to any given recomputation year, the taxpayer has an increase in tax only if the total interest computed on underpayments for all prior taxable years for which income tax liability is affected by the application of the look-back method exceeds the total interest computed on overpayments for such years, taking into account all income forecast property for which the look-back method is required. Interest determined at the entity level under the simplified method is allocated among the owners (or beneficiaries) for reporting purposes in the same manner that interest income and interest expense are allocated to owners (or beneficiaries) and subject to the allocation rules applicable to such entities.

(2) Additional interest due on interest only after tax liability due. For each recomputation year, taxpayers are required to file a Form 8866, “Interest Computation Under the Look-back Method for Property Depreciated Under the Income Forecast Method,” at the time the return for that recomputation year is filed to report the interest a taxpayer is required to pay or entitled to receive under the look-back method. Even if the taxpayer has received an extension to file its income tax return for the recomputation year, look-back interest is computed with respect to the hypothetical increase (or decrease) in the tax liability determined under the look-back method only until the initial due date of that return (without regard to the extension). Interest is charged, unless the taxpayer otherwise has a refund that fully offsets the amount of interest due, (or credited) with respect to the amount of look-back interest due (or to be refunded) under the look-back method from the initial due date of the return through the date the return is filed. No interest is charged (or credited) after the due date of the return with respect to the amount of the hypothetical increases (or decreases) in tax liability determined under the look-back method.

(3) Timing of look-back interest. For purposes of determining taxable income under Subtitle A of the Internal Revenue Code, any amount refunded to the taxpayer as a result of the application of the look-back method is includible in gross income in accordance with the taxpayer's method of accounting for interest income. Any amount required to be paid is taken into account as interest expense arising from an underpayment of income tax in the tax year it is properly taken into account under the taxpayer's method of accounting for interest expense.

(4) Statute of limitations; compounding of interest on look-back interest. For guidance on the statute of limitations applicable to the assessment and collection of look-back interest owed by a taxpayer, see sections 6501 and 6502. 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 and is subject to the statute of limitations provided in section 6511. A taxpayer's claim for look-back interest (or interest payable on look-back interest) that is not attributable to an amount previously paid or collected from a taxpayer is a general claim against the federal government. For guidance on the statute of limitations that applies to general claims against the federal government, see 28 U.S.C. 2401 and 2501. For guidance applicable to the compounding of interest when the look-back interest is not paid, see sections 6601 to 6622.

(h) Example. The provisions of this section are illustrated by the following example:

Example.

(i) H , a calendar year corporation, creates a motion picture at a cost of $60x. H completes the motion picture in 2001 and begins exhibition of the film that same year. Assume that $60x is greater than $100,000. In 2001, H anticipates that it will earn $200x from the motion picture (net of distribution costs). H therefore uses this amount as Forecasted Total Income when computing depreciation allowances for the motion picture.

(ii) H earns current year income of $80x in 2001, $60x in 2002, and $40x in 2003. During the period from 2001 to 2004, one of the actors who appeared in H' s film became more popular, and this increase in the actor's popularity increased the demand for H 's film. In 2004, therefore, H revised its forecast of income from the film upward to $240x. H earns $20x in 2004 from the motion picture and $10x in 2005.

(iii) Based on these facts, H' s allowances for depreciation for the motion picture for 2001 would be $24x, computed by multiplying the depreciable basis of the motion picture of $60x by current year income of $80x divided by forecasted total income of $200x under § 1.167(n)-4(a). Similarly, H 's allowances for depreciation for the motion picture for 2002 would be $18x, computed by multiplying the depreciable basis of the motion picture of $60x by current year income of $60x divided by forecasted total income of $200x, and H 's allowances for depreciation for the motion picture for 2003 would be $12x, computed by multiplying the depreciable basis of the motion picture of $60x by current year income of $40x divided by forecasted total income of $200x.

(iv) In 2004, H determines revised forecasted total income of $240x in accordance with § 1.167(n)-3(c). Because revised forecasted total income in 2004 of $240x is greater than 110 percent of forecasted total income used in computing the allowance for depreciation in the immediately preceding year (110 percent of $200x equals $220x), H is required under § 1.167(n)-4(b)(2) to compute the allowance for depreciation in 2004 and thereafter using the revised computation. H first computes its unrecovered depreciable basis in the motion picture under § 1.167(n)-2(c) of $6x by subtracting from the depreciable basis of $60x the depreciation allowances for 2001, 2002, and 2003 of $24x, $18x, and $12x. H then multiplies the unrecovered depreciable basis of $6x by the current year income for 2004 of $20x divided by $60x (revised forecasted total income $240x less current year income for all years prior to 2004 ($80x + $60x + $40x or $180x), resulting in a depreciation allowance for 2004 of $2x.

(v) In 2005, H is required to use the revised computation because H used it in 2004. Thus, H multiplies the unrecovered depreciable basis of $6x times current year income for 2005 of $10x divided by $60x (revised forecasted total income as computed in 2004), resulting in a depreciation allowance for 2005 of $1x.

(vi) Thus, H 's allowances for depreciation may be summarized as follows:

(vii) Under paragraph (e)(1)(i)(B) of this section, 2004 is a recomputation year (because 2004 is the third taxable year after the year in which the motion picture was placed in service) unless a de minimis rule applies. The de minimis rule in paragraph (e)(2) of this section does not apply in 2004 because forecasted total income of $200x used in the computation of income forecast depreciation in 2001, 2002 and 2003 is not greater than 90 percent of year 2004 revised forecasted total income of $240x (90 percent of $240x = $216x). Thus, H must apply the look-back method for 2004.

(viii) If H sells the motion picture in 2006 for $25x prior to earning any current year income from the motion picture, H would not be entitled to any allowance for depreciation in 2006. (The special rule of § 1.167(n)-3(d)(1) precludes H from including income from the sale of the motion picture in current year income, H has no other current year income, and § 1.167(n)-4(d)(3) precludes the use of the final year depreciation rule of § 1.167(n)-4(d)(1).) Under paragraph (e)(1)(ii)(A) of this section, 2006 is a recomputation year (because in 2006 the income from the property to H ceases) unless a de minimis rule applies.

(ix) To determine whether the de minimis rule applies, H is required to determine revised forecasted total income for 2006. Under paragraph (c)(2) of this section, revised forecasted total income for 2006 is deemed to be the sum of current year income for the years 2001-2006 of $210x ($80x + $60x + $40x + $20x + $10x + $0x) plus the amount realized from the sale of the motion picture of $25x or $235x. Revised forecasted total income for 2005 is $240x, and pursuant to paragraph (e)(2)(ii) of this section, revised forecasted total income for the years 2001-2004 is deemed (for purposes of determining whether 2006 is a recomputation year) to be the amount of revised forecasted total income used in the 2004 application of the look-back method of $240x. Because $240x is greater than $212x (90 percent of $235x) and less than $259x (110 percent of $235x), the de minimis rule applies and H is not required to apply the look-back method in 2006.