In general, under section 103, gross income does not include the interest on any State or local bond. However, this exclusion does not apply to private activity bonds (other than certain qualified bonds). Section 141(a) defines a private activity bond as any bond issued as part of an issue that meets either (1) the private business use test in section 141(b)(1) and the private security or payment test in section 141(b)(2) (the private business tests) or (2) the private loan financing test in section 141(c) (the private business tests and the private loan financing test are referred to collectively as the “private activity bond tests”).

The private business use test is met if more than 10 percent of the proceeds of an issue are to be used for any private business use. Section 141(b)(6) defines private business use as use directly or indirectly in a trade or business that is carried on by any person other than a governmental unit.

The private security or payment test is met if the payment of the principal of, or the interest on, more than 10 percent of the proceeds of an issue is directly or indirectly (1) secured by an interest in property used or to be used for a private business use, (2) secured by an interest in payments in respect of such property, or (3) to be derived from payments, whether or not to the issuer, in respect of property, or borrowed money, used or to be used for a private business use.

The private loan financing test is satisfied if more than the lesser of $5 million or 5 percent of the proceeds of an issue are to be used to make or finance loans to persons other than governmental units.

On January 16, 1997, final regulations (T.D. 8712, 1997-1 C.B. 15) relating to the definition of private activity bonds and related rules under sections 103, 141, 142, 144, 145, 147, 148, and 150 were published in the Federal Register (62 FR 2275) (the 1997 regulations). Under the 1997 regulations, the amount of private business use of property financed by an issue is equal to the average percentage of private business use of that property during a defined measurement period. The measurement period begins on the later of the issue date of the issue or the date that the property is placed in service and ends on the earlier of the last date of the reasonably expected economic life of the property or the latest maturity date of any bond of the issue financing the property (determined without regard to any optional redemption dates). In general, under the 1997 regulations, the amount of private security or private payments is determined by comparing the present value of the private security or private payments to the present value of the debt service to be paid over the term of the issue, using the bond yield as the discount rate. The 1997 regulations reserve §1.141-13 for rules regarding the application of the private business tests and the private loan financing test to refunding issues.

The proposed regulations provide that, in general, a refunding issue and a prior issue are tested separately under section 141. Thus, the determination of whether a refunding issue consists of private activity bonds generally does not depend on whether the prior issue consists of private activity bonds.

Commentators supported this separate testing principle. The final regulations retain this approach.

The proposed regulations provide that, in applying the private business tests and the private loan financing test to a refunding issue, the proceeds of the refunding issue are allocated to the same purpose investments (including any private loan under section 141(c)) and expenditures as the proceeds of the prior issue.

Comments were not received on this allocation provision. The final regulations retain this rule.

The proposed regulations generally provide that the amount of private business use of a refunding issue is determined based on the separate measurement period for the refunding issue under §1.141-3(g) (for example, without regard to any private business use that occurred before the issue date of the refunding issue). Thus, for instance, if an issuer refunds a taxable bond or an exempt facility bond, any private business use of the refinanced facilities before the issue date of the refunding issue is disregarded in applying the private business use test to the refunding issue.

In the case of a refunding issue that refunds a prior issue of governmental bonds, however, the amount of private business use is generally determined based on a combined measurement period. For purposes of the proposed regulations, a governmental bond is any bond that, when issued, purported to be either a governmental bond, as defined in §1.150-1(b), or a qualified 501(c)(3) bond, as defined in section 145(a). The combined measurement period is the period that begins on the first day of the measurement period (as defined in §1.141-3(g)) for the prior issue (or the first issue of governmental bonds in the case of a series of refundings of governmental bonds) and ends on the last day of the measurement period for the refunding issue.

As an alternative to the combined measurement period approach, the proposed regulations permit issuers to measure private business use based on the separate measurement period of the refunding issue, but only if the prior issue of governmental bonds does not meet the private business use test during a shortened measurement period. The shortened measurement period begins on the first day of the measurement period of the prior issue (or the first issue of governmental bonds in the case of a series of refundings of governmental bonds) and ends on the issue date of the refunding issue. Whether a prior issue meets the private business use test during the shortened measurement period is determined based on the actual use of proceeds, without regard to the reasonable expectations test of §1.141-2(d).

Commentators suggested that the proposed regulations be modified with respect to governmental bonds: (1) to delete the shortened measurement period concept; (2) to provide, absent any evidence to the contrary, and subject to general anti-abuse rules, a presumption that an issuer did not exceed the ten percent private business use limit; and (3) to specify that the amount of private business use of the refunding issue is the amount of private business use during either the separate measurement period for the refunding issue or the combined measurement period.

These commentators suggested that a separate measurement period approach would not allow an issuer to increase the amount of private business use without jeopardizing the tax exemption of the prior issue, and thus an issuer generally should be permitted to measure private business use of a refunding issue using a separate measurement period. Nevertheless, these commentators suggested that the regulations include a general anti-abuse rule. They noted, for example, that a separate measurement period approach could permit an issuer to have an additional ten percent of private business use in connection with a refunding issue after the period of limitations for the prior bonds has run. These commentators suggested that, in such a situation, it would be fair to consider the refunding issue to be an abuse if the issuer is deliberately trying to exploit the private business use limit.

The final regulations retain the basic approach of the proposed regulations to measuring private business use. The final regulations do not adopt the suggestions to delete the shortened measurement period concept and to provide that private business use may be measured during either a separate or combined measurement period. These suggestions are not adopted because they could result in more private business use than otherwise would be permitted after the expiration of the period of limitations for the prior issue.

The final regulations do not adopt the suggestion to create a presumption that the private business use limit was not exceeded with respect to prior bonds. It is not clear such a presumption is warranted in all cases.

The final regulations also do not adopt the suggestion to add an anti-abuse rule. The IRS and Treasury Department have concluded that the bright-line rule in the proposed regulations for determining when issuers must apply a combined measurement period and when issuers may apply either a combined measurement period or a separate measurement period is an appropriate methodology for measuring the private business use of a refunding issue and provides more administrative certainty than would be provided by an anti-abuse rule.

Commentators expressed concern regarding an issuer’s ability to establish the amount of private business use during a combined measurement period if the period begins a significant amount of time before the refunding bonds are issued. They noted that, in some cases, the refunded bonds may have been issued as many as twenty years or more before the refunding bonds are issued. These commentators stated that document retention policies vary by issuer and retaining or locating the necessary information over such long periods of time may be difficult.

The final regulations apply prospectively and only to refunding bonds that are subject to the 1997 regulations. In general, under §1.141-15, the 1997 regulations apply to refunding bonds only if, among other requirements, (1) the refunded bonds were originally issued on or after May 16, 1997, (2) the weighted average maturity of the refunding bonds is longer than the weighted average maturity of the refunded bonds, or (3) the issuer chooses to apply the 1997 regulations to the refunding bonds. Thus, the final regulations will not apply to any refunding of bonds originally issued before May 16, 1997, unless the issuer extends the weighted average maturity of the prior bonds or otherwise chooses to have the 1997 regulations apply to the refunding bonds (or an earlier issue of bonds).

In addition, to address commentators’ concerns, the final regulations provide transitional relief for refundings of bonds originally issued before May 16, 1997 (the effective date of the 1997 regulations). Specifically, the final regulations provide that, if the prior issue (or, in the case of a series of refundings of governmental bonds, the first issue of governmental bonds in the series) was issued before May 16, 1997, then the issuer, at its option, may treat the combined measurement period as beginning on the date (the transition date) that is the earlier of (1) December 19, 2005, or (2) the first date on which the prior issue (or an earlier issue in the case of a series of refundings of governmental bonds) became subject to the 1997 regulations. This transitional relief, which was not contained in the proposed regulations, has been added to the final regulations in response to concerns expressed by commentators regarding an issuer’s ability to establish the amount of private business use during a combined measurement period if the period begins a significant amount of time before the refunding bonds are issued.

Some commentators requested guidance on how the private business tests apply to the shortened and combined measurement periods for refundings of bonds originally issued before the effective date of the Tax Reform Act of 1986, 100 Stat. 2085 (the 1986 Act), if the refunding does not qualify for transitional relief under the 1986 Act or prior law. Specifically, commentators requested guidance on whether (1) the ten-percent private business use limitation under the 1986 Act or (2) the applicable private business use limitation under prior law (for example, the 25-percent limitation under the Internal Revenue Code of 1954) applies in the case of a non-transitioned refunding of a bond issued under law in effect prior to the 1986 Act. The final regulations clarify in an example that the 1986 Act limitations apply to the shortened and combined measurement periods. The issuer, however, may treat these periods as beginning on the transition date described above.

Under the proposed regulations, if the amount of private business use is determined based on the separate measurement period for the refunding issue, then the amount of private security and private payments allocable to the refunding issue is determined under §1.141-4 by treating the refunding issue as a separate issue. On the other hand, if the amount of private business use is determined based on a combined measurement period, then the amount of private security and private payments allocable to the refunding issue is determined under §1.141-4 by treating the refunding issue and all earlier issues taken into account in determining the combined measurement period as a combined issue. The proposed regulations contain specific rules for determining the present value of the debt service on, and the private security and private payments allocable to, a combined issue.

Commentators requested clarification regarding how the private security or payment test applies under the combined issue methodology in the case of a refunding of only a portion of the original principal amount of a prior issue. The final regulations clarify that, in these circumstances, (1) the refunded portion of the prior issue is treated as a separate issue and (2) any private security or private payments with respect to the prior issue are allocated ratably between the combined issue and the unrefunded portion of the prior issue in a consistent manner based on relative debt service.

The proposed regulations also permit an issuer to use the yield on a prior issue of governmental bonds to determine the present value of private security or private payments under arrangements that were not entered into in contemplation of the refunding issue. For this purpose, any arrangement that was entered into more than one year before the issue date of the refunding issue will be treated as not entered into in contemplation of the refunding issue.

Comments were not received on this special rule for arrangements not entered into in contemplation of the refunding issue. The final regulations retain this provision.

Section 1.148-9(h) permits an issuer to use a reasonable, consistently applied allocation method to treat the portion of a multipurpose issue allocable to a separate purpose as a separate issue for certain of the arbitrage provisions of section 148. Section 1.141-13(d) of the proposed regulations allows an issuer to apply §1.148-9(h) to a multipurpose issue for certain purposes under section 141. An allocation will not be reasonable for this purpose if it achieves more favorable results under section 141 than could be achieved with actual separate issues. In addition, allocations under the proposed regulations and §1.148-9(h) must be consistent for purposes of sections 141 and 148. The proposed regulations do not permit allocations for purposes of section 141(c)(1) (relating to the private loan financing test) or section 141(d)(1) (relating to certain restrictions on acquiring nongovernmental output property).

Commentators supported the multipurpose allocation provisions in the proposed regulations. The final regulations retain those provisions. Commentators also requested clarification that an allocation under §1.141-13(d) may be made at any time. The final regulations provide that an allocation under §1.141-13(d) may be made at any time, but once made may not be changed. The final regulations also provide that the issue to be allocated and each of the separate issues under the allocation must consist of one or more tax-exempt bonds. Thus, an allocation of a multipurpose issue into two or more separate issues is not permitted under §1.141-13(d) if, at the time of the allocation, the issue to be allocated or any of the separate issues under the allocation consists of taxable private activity bonds.

Section 1.141-2(d) provides that an issue consists of private activity bonds if the issuer (1) reasonably expects, as of the issue date, that the issue will meet either the private business tests or the private loan financing test, or (2) takes a deliberate action, subsequent to the issue date, that causes the conditions of either the private business tests or the private loan financing test to be satisfied. Section 1.141-2(d)(3) provides, in general, that a deliberate action is any action taken by the issuer that is within its control.

The proposed regulations provide that an action that would otherwise cause a refunding issue to satisfy the private business tests or the private loan financing test is not taken into account under the reasonable expectations test of §1.141-2(d) if (1) the action is not a deliberate action within the meaning of §1.141-2(d)(3), and (2) the weighted average maturity of the refunding bonds is not greater than the remaining weighted average maturity of the prior bonds.

Commentators suggested that the limitation on the weighted average maturity of the refunding bonds to the remaining weighted average maturity of the prior bonds could penalize issuers for issuing shorter-term obligations initially, or provide an incentive to issue longer-term obligations initially. These commentators requested that the weighted average maturity of the refunding bonds be limited only to 120 percent of the weighted average reasonably expected economic life of the property financed by the prior bonds. The final regulations amend this provision to provide that the weighted average maturity of the refunding bonds may not exceed the weighted average reasonably expected economic life of the property financed by the prior bonds.

Commentators also requested that an example illustrating this provision be added to the regulations. The final regulations add such an example.

Section 1.141-2(d)(5) provides that the determination of whether bonds of an issue are private activity bonds may be based solely on the issuer’s reasonable expectations as of the issue date (and not on whether there are any subsequent deliberate actions) if, among other requirements, the issue is an issue of general obligation bonds of a general purpose governmental unit that finances at least 25 separate purposes.

Commentators suggested that a refunding issue should not consist of private activity bonds if the prior issue meets the requirements of §1.141-2(d)(5). The final regulations adopt this comment.

Under the 1997 regulations, the use of proceeds of an issue of qualified 501(c)(3) bonds to pay issuance costs of the issue is treated as a private business use. The proposed regulations provide that, solely for purposes of applying the private business use test to a refunding issue, the use of proceeds of the prior issue (or any earlier issue in a series of refundings) to pay issuance costs of the prior issue (or the earlier issue) is treated as a government use.

Comments were not received on this provision. The final regulations retain this rule.

Under section 149(d)(2), interest on a bond is not excluded from gross income if any portion of the issue of which the bond is a part is issued to advance refund a private activity bond (other than a qualified 501(c)(3) bond). The proposed regulations provide that, for purposes of section 149(d)(2), the term private activity bond includes a qualified bond described in section 141(e) (other than a qualified 501(c)(3) bond), regardless of whether the refunding issue consists of private activity bonds under the proposed regulations. The proposed regulations also provide that, for purposes of section 149(d)(2), the term private activity bond does not include a taxable bond. Section 1.150-1(b) defines taxable bond as any obligation the interest on which is not excludable from gross income under section 103.

Commentators recommended that the regulations be modified to permit a tax-exempt private activity bond to be advance refunded by a governmental bond if the nongovernmental entity’s participation in the financing has been terminated and the only beneficiary of the financing is the governmental unit. Based on the plain language of section 149(d)(2) and the policies underlying that Code provision, the final regulations do not adopt this comment.

* * * * *

(a) In general.

(b) Application of private business use test and private loan financing test.

(1) Allocation of proceeds.

(2) Determination of amount of private business use.

(c) Application of private security or payment test.

(1) Separate issue treatment.

(2) Combined issue treatment.

(3) Special rule for arrangements not entered into in contemplation of the refunding issue.

(d) Multipurpose issue allocations.

(1) In general.

(2) Exceptions.

(e) Application of reasonable expectations test to certain refunding bonds.

(f) Special rule for refundings of certain general obligation bonds.

(g) Examples.

* * * * *

* * * * *

(j) Effective dates for certain regulations relating to refundings.

* * * * *

Par. 3. In §1.141-1, paragraph (b) is amended by revising the definition of governmental bond to read as follows:

* * * * *

(b) * * *

Governmental bond has the same meaning as in §1.150-1(b), except that, for purposes of §1.141-13, governmental bond is defined in §1.141-13(b)(2)(iv).

* * * * *

Par. 4. Section 1.141-13 is added to read as follows:

(a) In general. Except as provided in this section, a refunding issue and a prior issue are tested separately under section 141. Thus, the determination of whether a refunding issue consists of private activity bonds generally does not depend on whether the prior issue consists of private activity bonds.

(b) Application of private business use test and private loan financing test—(1) Allocation of proceeds. In applying the private business use test and the private loan financing test to a refunding issue, the proceeds of the refunding issue are allocated to the same expenditures and purpose investments as the proceeds of the prior issue.

(2) Determination of amount of private business use—(i) In general. Except as provided in paragraph (b)(2)(ii) of this section, the amount of private business use of a refunding issue is determined under §1.141-3(g), based on the measurement period for that issue (for example, without regard to any private business use that occurred prior to the issue date of the refunding issue).

(ii) Refundings of governmental bonds. In applying the private business use test to a refunding issue that refunds a prior issue of governmental bonds, the amount of private business use of the refunding issue is the amount of private business use—

(A) During the combined measurement period; or

(B) At the option of the issuer, during the period described in paragraph (b)(2)(i) of this section, but only if, without regard to the reasonable expectations test of §1.141-2(d), the prior issue does not satisfy the private business use test, based on a measurement period that begins on the first day of the combined measurement period and ends on the issue date of the refunding issue.

(iii) Combined measurement period—(A) In general. Except as provided in paragraph (b)(2)(iii)(B) of this section, the combined measurement period is the period that begins on the first day of the measurement period (as defined in §1.141-3(g)) for the prior issue (or, in the case of a series of refundings of governmental bonds, the first issue of governmental bonds in the series) and ends on the last day of the measurement period for the refunding issue.

(B) Transition rule for refundings of bonds originally issued before May 16, 1997. If the prior issue (or, in the case of a series of refundings of governmental bonds, the first issue of governmental bonds in the series) was issued before May 16, 1997, then the issuer, at its option, may treat the combined measurement period as beginning on the date (the transition date) that is the earlier of December 19, 2005, or the first date on which the prior issue (or an earlier issue in the case of a series of refundings of governmental bonds) became subject to the 1997 regulations (as defined in §1.141-15(b)). If the issuer treats the combined measurement period as beginning on the transition date in accordance with this paragraph (b)(2)(iii)(B), then paragraph (c)(2) of this section shall be applied by treating the transition date as the issue date of the earliest issue, by treating the bonds as reissued on the transition date at an issue price equal to the value of the bonds (as determined under § 1.148-4(e)) on that date, and by disregarding any private security or private payments before the transition date.

(iv) Governmental bond. For purposes of this section, the term governmental bond means any bond that, when issued, purported to be a governmental bond, as defined in §1.150-1(b), or a qualified 501(c)(3) bond, as defined in section 145(a).

(v) Special rule for refundings of qualified 501(c)(3) bonds with governmental bonds. For purposes of applying this paragraph (b)(2) to a refunding issue that refunds a qualified 501(c)(3) bond, any use of the property refinanced by the refunding issue before the issue date of the refunding issue by a 501(c)(3) organization with respect to its activities that do not constitute an unrelated trade or business under section 513(a) is treated as government use.

(c) Application of private security or payment test—(1) Separate issue treatment. If the amount of private business use of a refunding issue is determined based on the measurement period for that issue in accordance with paragraph (b)(2)(i) or (b)(2)(ii)(B) of this section, then the amount of private security and private payments allocable to the refunding issue is determined under §1.141-4 by treating the refunding issue as a separate issue.

(2) Combined issue treatment. If the amount of private business use of a refunding issue is determined based on the combined measurement period for that issue in accordance with paragraph (b)(2)(ii)(A) of this section, then the amount of private security and private payments allocable to the refunding issue is determined under §1.141-4 by treating the refunding issue and all earlier issues taken into account in determining the combined measurement period as a combined issue. For this purpose, the present value of the private security and private payments is compared to the present value of the debt service on the combined issue (other than debt service paid with proceeds of any refunding bond). Present values are computed as of the issue date of the earliest issue taken into account in determining the combined measurement period (the earliest issue). Except as provided in paragraph (c)(3) of this section, present values are determined by using the yield on the combined issue as the discount rate. The yield on the combined issue is determined by taking into account payments on the refunding issue and all earlier issues taken into account in determining the combined measurement period (other than payments made with proceeds of any refunding bond), and based on the issue price of the earliest issue. In the case of a refunding of only a portion of the original principal amount of a prior issue, the refunded portion of the prior issue is treated as a separate issue and any private security or private payments with respect to the prior issue are allocated ratably between the combined issue and the unrefunded portion of the prior issue in a consistent manner based on relative debt service. See paragraph (b)(2)(iii)(B) of this section for special rules relating to certain refundings of governmental bonds originally issued before May 16, 1997.

(3) Special rule for arrangements not entered into in contemplation of the refunding issue. In applying the private security or payment test to a refunding issue that refunds a prior issue of governmental bonds, the issuer may use the yield on the prior issue to determine the present value of private security and private payments under arrangements that were not entered into in contemplation of the refunding issue. For this purpose, any arrangement that was entered into more than 1 year before the issue date of the refunding issue is treated as not entered into in contemplation of the refunding issue.

(d) Multipurpose issue allocations—(1) In general. For purposes of section 141, unless the context clearly requires otherwise, §1.148-9(h) applies to allocations of multipurpose issues (as defined in §1.148-1(b)), including allocations involving the refunding purposes of the issue. An allocation under this paragraph (d) may be made at any time, but once made may not be changed. An allocation is not reasonable under this paragraph (d) if it achieves more favorable results under section 141 than could be achieved with actual separate issues. The issue to be allocated and each of the separate issues under the allocation must consist of one or more tax-exempt bonds. Allocations made under this paragraph (d) and §1.148-9(h) must be consistent for purposes of section 141 and section 148.

(2) Exceptions. This paragraph (d) does not apply for purposes of sections 141(c)(1) and 141(d)(1).

(e) Application of reasonable expectations test to certain refunding bonds. An action that would otherwise cause a refunding issue to satisfy the private business tests or the private loan financing test is not taken into account under the reasonable expectations test of §1.141-2(d) if—

(1) The action is not a deliberate action within the meaning of §1.141-2(d)(3); and

(2) The weighted average maturity of the refunding bonds is not greater than the weighted average reasonably expected economic life of the property financed by the prior bonds.

(f) Special rule for refundings of certain general obligation bonds. Notwithstanding any other provision of this section, a refunding issue does not consist of private activity bonds if—

(1) The prior issue meets the requirements of §1.141-2(d)(5) (relating to certain general obligation bond programs that finance a large number of separate purposes); or

(2) The refunded portion of the prior issue is part of a series of refundings of all or a portion of an issue that meets the requirements of §1.141-2(d)(5).

(g) Examples. The following examples illustrate the application of this section:

Example 1. Measuring private business use. In 2002, Authority A issues tax-exempt bonds that mature in 2032 to acquire an office building. The measurement period for the 2002 bonds under §1.141-3(g) is 30 years. At the time A acquires the building, it enters into a 10-year lease with a nongovernmental person under which the nongovernmental person will use 5 percent of the building in its trade or business during each year of the lease term. In 2007, A issues bonds to refund the 2002 bonds. The 2007 bonds mature on the same date as the 2002 bonds and have a measurement period of 25 years under §1.141-3(g). Under paragraph (b)(2)(ii)(A) of this section, the amount of private business use of the proceeds of the 2007 bonds is 1.67 percent, which equals the amount of private business use during the combined measurement period (5 percent of 1/3rd of the 30-year combined measurement period). In addition, the 2002 bonds do not satisfy the private business use test, based on a measurement period beginning on the first day of the measurement period for the 2002 bonds and ending on the issue date of the 2007 bonds, because only 5 percent of the proceeds of the 2002 bonds are used for a private business use during that period. Thus, under paragraph (b)(2)(ii)(B) of this section, A may treat the amount of private business use of the 2007 bonds as 1 percent (5 percent of 1/5th of the 25-year measurement period for the 2007 bonds). The 2007 bonds do not satisfy the private business use test.

Example 2. Combined issue yield computation. (i) On January 1, 2000, County B issues 20-year bonds to finance the acquisition of a municipal auditorium. The 2000 bonds have a yield of 7.7500 percent, compounded annually, and an issue price and par amount of $100 million. The debt service payments on the 2000 bonds are as follows:

(ii) On January 1, 2005, B issues 15-year bonds to refund all of the outstanding 2000 bonds maturing after January 1, 2005 (in the aggregate principal amount of $86,500,000). The 2005 bonds have a yield of 6.0000 percent, compounded annually, and an issue price and par amount of $89,500,000. The debt service payments on the 2005 bonds are as follows:

(iii) In accordance with §1.141-15(h), B chooses to apply §1.141-13 (together with the other provisions set forth in §1.141-15(h)), to the 2005 bonds. For purposes of determining the amount of private security and private payments with respect to the 2005 bonds, the 2005 bonds and the refunded portion of the 2000 bonds are treated as a combined issue under paragraph (c)(2) of this section. The yield on the combined issue is determined in accordance with §§1.148-4, 1.141-4(b)(2)(iii) and 1.141-13(c)(2). Under this methodology, the yield on the combined issue is 7.1062 percent per year compounded annually, illustrated as follows:

Example 3. Determination of private payments allocable to combined issue. The facts are the same as in Example 2. In addition, on January 1, 2001, B enters into a contract with a nongovernmental person for the use of the auditorium. The contract results in a private payment in the amount of $500,000 on each January 1 beginning on January 1, 2001, and ending on January 1, 2020. Under paragraph (c)(2) of this section, the amount of the private payments allocable to the combined issue is determined by treating the refunded portion of the 2000 bonds ($86,500,000 principal amount) as a separate issue, and by allocating the total private payments ratably between the combined issue and the unrefunded portion of the 2000 bonds ($13,500,000 principal amount) based on relative debt service, as follows:

Example 4. Refunding taxable bonds and qualified bonds. (i) In 1999, City C issues taxable bonds to finance the construction of a facility for the furnishing of water. The bonds are secured by revenues from the facility. The facility is managed pursuant to a management contract with a nongovernmental person that gives rise to private business use. In 2007, C terminates the management contract and takes over the operation of the facility. In 2009, C issues bonds to refund the 1999 bonds. On the issue date of the 2009 bonds, C reasonably expects that the facility will not be used for a private business use during the term of the 2009 bonds. In addition, during the term of the 2009 bonds, the facility is not used for a private business use. Under paragraph (b)(2)(i) of this section, the 2009 bonds do not satisfy the private business use test because the amount of private business use is based on the measurement period for those bonds and therefore does not take into account any private business use that occurred pursuant to the management contract.

(ii) The facts are the same as in paragraph (i) of this Example 4, except that the 1999 bonds are issued as exempt facility bonds under section 142(a)(4). The 2009 bonds do not satisfy the private business use test.

Example 5. Multipurpose issue. In 2001, State D issues bonds to finance the construction of two office buildings, Building 1 and Building 2. D expends an equal amount of the proceeds on each building. D enters into arrangements that result in 8 percent of Building 1 and 12 percent of Building 2 being used for a private business use during the measurement period under §1.141-3(g). These arrangements result in a total of 10 percent of the proceeds of the 2001 bonds being used for a private business use. In 2006, D purports to allocate, under paragraph (d) of this section, an equal amount of the outstanding 2001 bonds to Building 1 and Building 2. D also enters into another private business use arrangement with respect to Building 1 that results in an additional 2 percent (and a total of 10 percent) of Building 1 being used for a private business use during the measurement period. An allocation is not reasonable under paragraph (d) of this section if it achieves more favorable results under section 141 than could be achieved with actual separate issues. D’s allocation is unreasonable because, if permitted, it would result in more than 10 percent of the proceeds of the 2001 bonds being used for a private business use.

Example 6. Non-deliberate action. In 1998, City E issues bonds to finance the purchase of land and construction of a building (the prior bonds). On the issue date of the prior bonds, E reasonably expects that it will be the sole user of the financed property for the entire term of the bonds. In 2003, the federal government acquires the financed property in a condemnation action. In 2006, E issues bonds to refund the prior bonds (the refunding bonds). The weighted average maturity of the refunding bonds is not greater than the reasonably expected economic life of the financed property. In general, under §1.141-2(d) and this section, reasonable expectations must be separately tested on the issue date of a refunding issue. Under paragraph (e) of this section, however, the condemnation action is not taken into account in applying the reasonable expectations test to the refunding bonds because the condemnation action is not a deliberate action within the meaning of §1.141-2(d)(3) and the weighted average maturity of the refunding bonds is not greater than the weighted average reasonably expected economic life of the property financed by the prior bonds. Thus, the condemnation action does not cause the refunding bonds to be private activity bonds.

Example 7. Non-transitioned refunding of bonds subject to 1954 Code. In 1985, County F issues bonds to finance a court house. The 1985 bonds are subject to the provisions of the Internal Revenue Code of 1954. In 2006, F issues bonds to refund all of the outstanding 1985 bonds. The weighted average maturity of the 2006 bonds is longer than the remaining weighted average maturity of the 1985 bonds. In addition, the 2006 bonds do not satisfy any transitional rule for refundings in the Tax Reform Act of 1986, 100 Stat. 2085 (1986). Section 141 and this section apply to determine whether the 2006 bonds are private activity bonds including whether, for purposes of §1.141-13(b)(2)(ii)(B), the 1985 bonds satisfy the private business use test based on a measurement period that begins on the first day of the combined measurement period for the 2006 bonds and ends on the issue date of the 2006 bonds.

Par. 5. Section 1.141-15 is amended by revising paragraphs (b)(1), (c), (d) and (h) and adding paragraph (j) to read as follows:

* * * * *

(b) Effective dates—(1) In general. Except as otherwise provided in this section, §§1.141-0 through 1.141-6(a), 1.141-9 through 1.141-12, 1.141-14, 1.145-1 through 1.145-2(c), and the definition of bond documents contained in §1.150-1(b) (the 1997 regulations) apply to bonds issued on or after May 16, 1997, that are subject to section 1301 of the Tax Reform Act of 1986 (100 Stat. 2602).

* * * * *

(c) Refunding bonds. Except as otherwise provided in this section, the 1997 regulations (defined in paragraph (b)(1) of this section) do not apply to any bonds issued on or after May 16, 1997, to refund a bond to which those regulations do not apply unless—

(1) The refunding bonds are subject to section 1301 of the Tax Reform Act of 1986 (100 Stat. 2602); and

(2)(i) The weighted average maturity of the refunding bonds is longer than—

(A) The weighted average maturity of the refunded bonds; or

(B) In the case of a short-term obligation that the issuer reasonably expects to refund with a long-term financing (such as a bond anticipation note), 120 percent of the weighted average reasonably expected economic life of the facilities financed; or

(ii) A principal purpose for the issuance of the refunding bonds is to make one or more new conduit loans.

(d) Permissive application of regulations. Except as provided in paragraph (e) of this section, the 1997 regulations (defined in paragraph (b)(1) of this section) may be applied in whole, but not in part, to actions taken before February 23, 1998, with respect to—

(1) Bonds that are outstanding on May 16, 1997, and subject to section 141; or

(2) Refunding bonds issued on or after May 16, 1997, that are subject to 141.

* * * * *

(h) Permissive retroactive application. Except as provided in paragraphs (d), (e) or (i) of this section, §§1.141-1 through 1.141-6(a), 1.141-7 through 1.141-14, 1.145-1 through 1.145-2, 1.149(d)-1(g), 1.150-1(a)(3), the definition of bond documents contained in §1.150-1(b) and §1.150-1(c)(3)(ii) may be applied by issuers in whole, but not in part, to—

(1) Outstanding bonds that are sold before February 17, 2006, and subject to section 141; or

(2) Refunding bonds that are sold on or after February 17, 2006, and subject to section 141.

* * * * *

(j) Effective dates for certain regulations relating to refundings. Except as otherwise provided in this section, §§1.141-13, 1.145-2(d), 1.149(d)-1(g), 1.150-1(a)(3) and 1.150-1(c)(3)(ii) apply to bonds that are sold on or after February 17, 2006, and that are subject to the 1997 regulations (defined in paragraph (b)(1) of this section).

Par. 6. Section 1.145-0 is amended by adding an entry to the table in numerical order for §1.145-2(d) to read as follows:

* * * * *

* * * * *

(d) Issuance costs financed by prior issue.

Par. 7. In §1.145-2, paragraph (d) is added to read as follows:

* * * * *

(d) Issuance costs financed by prior issue. Solely for purposes of applying the private business use test to a refunding issue under §1.141-13, the use of proceeds of the prior issue (or any earlier issue in a series of refundings) to pay issuance costs of the prior issue (or the earlier issue) is treated as a government use.

Par. 8. Section 1.149(d)-1 is amended by revising paragraph (g) and adding paragraph (h) to read as follows:

* * * * *

(g) Limitation on advance refundings of private activity bonds. Under section 149(d)(2) and this section, interest on a bond is not excluded from gross income if any portion of the issue of which the bond is a part is issued to advance refund a private activity bond (other than a qualified 501(c)(3) bond). For this purpose, the term private activity bond—

(1) Includes a qualified bond described in section 141(e) (other than a qualified 501(c)(3) bond), regardless of whether the refunding issue consists of private activity bonds under §1.141-13; and

(2) Does not include a taxable bond.

(h) Effective dates—(1) In general. Except as provided in this paragraph (h), this section applies to bonds issued after June 30, 1993, to which §§1.148-1 through 1.148-11 apply, including conduit loans that are treated as issued after June 30, 1993, under paragraph (b)(4) of this section. In addition, this section applies to any issue to which the election described in §1.148-11(b)(1) is made.

(2) Special effective date for paragraph (b)(3). Paragraph (b)(3) of this section applies to any advance refunding issue issued after May 28, 1991.

(3) Special effective date for paragraph (f)(3). Paragraph (f)(3) of this section applies to bonds sold on or after July 8, 1997, and to any issue to which the election described in §1.148-11(b)(1) is made. See §1.148-11A(i) for rules relating to certain bonds sold before July 8, 1997.

(4) Special effective date for paragraph (g). See §1.141-15 for the applicability date of paragraph (g) of this section.

Par. 9. Section 1.150-1 is amended by revising paragraphs (a)(3) and (c)(3)(ii) to read as follows:

(a) * * *

(3) Exceptions to general effective date. See §1.141-15 for the applicability date of the definition of bond documents contained in paragraph (b) of this section and the effective date of paragraph (c)(3)(ii) of this section.

* * * * *

(c) * * *

(3) * * *

(ii) Exceptions. This paragraph (c)(3) does not apply for purposes of sections 141, 144(a), 148, 149(d) and 149(g).

* * * * *

Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.

Approved November 23, 2005.

Eric Solomon,
Acting Deputy Assistant
Secretary of the Treasury.

* * * * *

(b) * * *

(8) * * *

(i) * * *

Estonia, Aktsiaselts

European Economic Area/European Union, Societas Europaea

* * * * *

Latvia, Akciju Sabiedriba

* * * * *

Liechtenstein, Aktiengesellschaft

Lithuania, Akcine Bendroves

* * * * *

Slovenia, Delniska Druzba.

* * * * *

(e) * * *

(3) [Reserved]. For further guidance, see §301.7701-2T(f).

(4) The reference to the Estonian, Latvian, Liechtenstein, Lithuanian, and Slovenian entities in paragraph (b)(8)(i) of this section applies to such entities formed on or after October 7, 2004, and to any such entity formed before such date from the date any person or persons, who were not owners of the entity as of October 7, 2004, own in the aggregate a 50 percent or greater interest in the entity. The reference to the European Economic Area/European Union entity in paragraph (b)(8)(i) of this section applies to such entities formed on or after October 8, 2004.

Par. 3. Section 301.7701-2T is amended by:

1. Removing paragraph (b)(8)(vi).

2. Revising paragraph (e)(3).

The revision reads as follows:

* * * * *

(e) * * *

(3) [Reserved]. For further guidance, see §301.7701-2(e)(4).

* * * * *

Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.

Approved December 8, 2005.

Eric Solomon,
Acting Deputy Assistant
Secretary of the Treasury.

* * * * *

(e) * * *

(5) Effective date.

Par. 3. In §1.56-1, paragraph (e)(4) is revised and paragraph (e)(5) is added to read as follows:

* * * * *

(e) * * *

(4) Estimating the book income adjustment for purposes of the estimated tax liability. See §1.6655-7, as issued by T.D. 8307, 1990-2 C.B. 9 (55 FR 33671), for special rules for estimating the corporate alternative minimum tax book income adjustment under the annualization exception.

(5) Effective date. Paragraph (e)(4) of this section is applicable for taxable years beginning after the date that is 30 days after the date the final regulations are published in the Federal Register.

Par. 4. In §1.6425-2, paragraph (a) is revised and paragraph (c) is added to read as follows:

(a) Income tax liability defined. For purposes of §§1.6425-1 through 1.6425-3 and 1.6655-7, relating to excessive adjustment, the term income tax liability means the excess of—

(1) The sum of—

(i) The tax imposed by section 11 or 1201(a), or subchapter L of chapter 1 of the Internal Revenue Code, whichever is applicable; plus

(ii) The tax imposed by section 55; over

(2) The credits against tax provided by part IV of subchapter A of chapter 1 of the Internal Revenue Code.

* * * * *

(c) Effective date. Paragraph (a) of this section is applicable to applications for adjustments of overpayments of estimated income tax that are filed in taxable years beginning after the date that is 30 days after the date the final regulations are published in the Federal Register.

Par. 5. Section 1.6425-3 is amended by:

1. Revising paragraphs (f)(1) and (f)(2).

2. Adding paragraph (f)(3).

The revisions and addition read as follows:

* * * * *

(f) Effect of adjustment. (1) For purposes of all sections of the Internal Revenue Code except section 6655, relating to additions to tax for failure to pay estimated income tax, any adjustment under section 6425 is to be treated as a reduction of prior estimated tax payments as of the date the credit is allowed or the refund is paid. For the purpose of sections 6655(a) through (g), (i), and (j), credit or refund of an adjustment is to be treated as if not made in determining whether there has been any underpayment of estimated income tax and, if there is an underpayment, the period during which the underpayment existed. However, an excessive adjustment under section 6425 shall be taken into account in applying the addition to tax under section 6655(h).

(2) For the effect of an excessive adjustment under section 6425, see §1.6655-7.

(3) This paragraph (f) is applicable to applications for adjustments of overpayments of estimated income tax that are filed in taxable years beginning after the date that is 30 days after the date the final regulations are published in the Federal Register.

Par. 6. Section 1.6655-0 is added to read as follows:

This section lists the table of contents for §§1.6655-1 through 1.6655-7.

(a) In general.

(b) Amount of underpayment.

(c) Period of the underpayment.

(d) Amount of required installment.

(e) Large corporation required to pay 100 percent of current year tax.

(1) In general.

(2) May use last year’s tax for 1^st installment.

(f) Required installment due dates.

(1) Number of required installments.

(2) Time for payment of installments.

(i) Calendar year.

(ii) Fiscal year.

(iii) Short taxable year.

(iv) Partial month.

(g) Definitions.

(h) Special rules for consolidated returns.

(i) Overpayments applied to subsequent taxable year’s estimated tax.

(1) In general.

(2) Subsequent examinations.

(j) Examples.

(k) Effective date.

(a) In general.

(b) Determination of annualized income installment—In general.

(c) Special rules.

(1) Applicable percentage.

(2) Partial month.

(d) Election of different annualization periods.

(e) 52-53 week taxable year.

(f) Determination of taxable income for an annualization period.

(1) In general.

(2) Exceptions.

(i) Annual expenses paid or incurred at or after the end of the taxable year.

(ii) Net operating loss carryover.

(iii) Credit carryover.

(iv) Section 481(a) adjustment.

(v) Depreciation and amortization.

(A) General rule.

(B) Short taxable years.

(vi) Member of partnership.

(3) Examples.

(g) Items that substantially affect taxable income but cannot be determined accurately by the installment due date.

(1) In general.

(2) Example.

(h) Events arising after installment due date that were not reasonably foreseeable.

(1) In general.

(2) Example.

(i) Effective date.

(a) In general.

(b) Limitation on application of section.

(c) Determination of amount.

(d) Special rules.

(1) Base period percentage.

(2) Filing month.

(3) Application of the rules related to the annualized income installment method to the adjusted seasonal installment method.

(e) Example.

(f) Effective date.

(a) Large corporation defined.

(b) Testing period.

(c) Computation of taxable income during testing period.

(1) Short taxable year.

(2) Computation of taxable income in taxable year when there occurs a transaction to which section 381 applies.

(d) Members of controlled group.

(1) In general.

(2) Aggregation.

(3) Allocation rule.

(4) Controlled group members.

(e) Effect on a corporation’s taxable income of items that may be carried back or carried over from any other taxable year.

(f) Consolidated returns. [Reserved]

(g) Example.

(h) Effective date.

(a) In general.

(b) Exception to payment of estimated tax.

(c) Installment due dates.

(1) In general.

(i) Taxable year of four months but less than twelve months.

(ii) Exception.

(2) Early termination of taxable year.

(i) In general.

(ii) Exception.

(d) Amount due for required installment.

(1) In general.

(2) Tax shown on the return for the preceding taxable year.

(3) Applicable percentage.

(e) Examples.

(f) 52 or 53 week taxable year.

(g) Use of annualized income or seasonal installment method.

(1) In general.

(2) Computation of annualized income installment.

(3) Annualization period for final required installment.

(4) Examples.

(h) Preceding taxable year a short taxable year.

(i) Effective date.

(a) In general.

(b) Exceptions.

(1) Automatic accounting method changes.

(2) Non-automatic accounting method changes.

(c) Examples.

(d) Effective date.

Par. 7. Sections 1.6655-1, 1.6655-2, and 1.6655-3 are revised to read as follows:

(a) In general. Section 6655 imposes an addition to the tax under chapter 1 of the Internal Revenue Code in the case of any underpayment of estimated tax by a corporation. An addition to tax due to the underpayment of estimated taxes is determined by applying the underpayment rate established under section 6621 to the amount of the underpayment, for the period of the underpayment. This addition to the tax is in addition to any applicable criminal penalties and is imposed whether or not there was reasonable cause for the underpayment.

(b) Amount of underpayment. The amount of the underpayment for any required installment is the excess of—

(1) The required installment; over

(2) The amount, if any, of the installment paid on or before the last date prescribed for such payment.

(c) Period of the underpayment. The period of the underpayment of any required installment runs from the date the installment was required to be paid to the 15^th day of the 3^rd month following the close of the taxable year, or to the date such underpayment is paid, whichever is earlier. For purposes of determining the period of the underpayment—

(1) The date prescribed for payment of any installment of estimated tax shall be determined without regard to any extension of time; and

(2) A payment of estimated tax will be credited against unpaid required installments in the order in which such installments are required to be paid.

(d) Amount of required installment. Except as otherwise provided in this section and §§1.6655-2 through 1.6655-7, the amount of any required installment is 25 percent of the lesser of—

(1) 100 percent of the tax shown on the return for the taxable year (or, if no return is filed, 100 percent of the tax for such year); or

(2) 100 percent of the tax shown on the return of the corporation for the preceding taxable year.

(3) Paragraph (d)(2) of this section shall not apply if the preceding taxable year was not a taxable year of 12 months or the corporation did not file a return for such preceding taxable year showing a liability for tax.

(e) Large corporation required to pay 100 percent of current year tax—(1) In general. Except as provided in paragraph (e)(2) of this section, paragraph (d)(2) of this section shall not apply in the case of a large corporation (as defined in §1.6655-4).

(2) May use last year’s tax for first installment. Paragraph (e)(1) of this section shall not apply for purposes of determining the amount of the 1^st required installment for any taxable year. Any reduction in such 1^st installment by reason of the preceding sentence shall be recaptured by increasing the amount of the next required installment determined under paragraph (d)(1) of this section by the amount of such reduction and, if the next required installment is reduced by use of the annualized income installment method under §1.6655-2 or the adjusted seasonal installment method under §1.6655-3, by increasing subsequent required installments determined under paragraph (d)(1) of this section to the extent that the reduction has not previously been recaptured.

(f) Required installment due dates—(1) Number of required installments. Unless otherwise provided, corporations must make 4 required installments for each taxable year.

(2) Time for payment of installments—(i) Calendar year. In the case of a calendar year taxpayer, the due dates of the required installments are as follows:

(ii) Fiscal year. In the case of a taxpayer other than a calendar year taxpayer, the due dates of the required installments are as follows:

(iii) Short taxable year. See §1.6655-5 for rules regarding required installments for corporations with a short taxable year.

(iv) Partial month. Except as otherwise provided, for purposes of determining the due date of any required installment a partial month shall be treated as a full month.

(g) Definitions. (1) The term tax as used in this section and §§1.6655-2 through 1.6655-7 means the excess of—

(i) The sum of—

(A) The tax imposed by section 11, section 1201(a), or subchapter L of chapter 1 of the Internal Revenue Code, whichever is applicable;

(B) The tax imposed by section 55; plus

(C) The tax imposed by section 887; over

(D) The credits against tax provided by part IV of subchapter A of chapter 1 of the Internal Revenue Code.

(ii) In the case of a foreign corporation subject to taxation under section 11, section 1201(a), or subchapter L of chapter 1 of the Internal Revenue Code, the tax imposed by section 881 shall be treated as a tax imposed by section 11.

(iii) In the case of a partnership that is treated, pursuant to regulations issued under section 1446(f)(2), as a corporation for purposes of this section, the tax imposed by section 1446 shall be treated as a tax imposed by section 11.

(2) For the purposes of paragraph (d)(2) of this section, the term return for the preceding taxable year means the Federal income tax return for such taxable year that is required by section 6012(a)(2). However, if an amended Federal income tax return has been filed before the due date for an installment, then the term return for the preceding taxable year means the Federal income tax return as amended. Paragraph (d)(2) of this section will apply without regard to whether the taxpayer’s Federal income tax return for the preceding taxable year is filed in a timely manner.

(3) If the tax rates for the current taxable year for which estimated tax is being determined differ from the rates applicable to the preceding taxable year, the tax determined for the preceding taxable year shall be recomputed using the rates applicable to the current taxable year.

(h) Special rules for consolidated returns. For special rules relating to the determination of the amount of the underpayment in the case of a corporation whose income is included in a consolidated return, see §1.1502-5(b).

(i) Overpayments applied to subsequent taxable year’s estimated tax—(1) In general. If a taxpayer elects under the provisions of sections 6402(b) and 6513(d) and the regulations to apply an overpayment in year one against the estimated tax liability for year two, the overpayment will be applied to the required installment payments for year two in the order due and to the extent necessary to satisfy such installments, similar to the manner in which an actual overpayment of one installment is carried forward to the next installment. No interest is accrued or paid on an overpayment if the election to apply the overpayment against estimated tax is made.

(2) Subsequent examinations. If a deficiency is determined in an examination of a return for a taxable year that originally reflected an overpayment that was applied against estimated tax for the succeeding taxable year, interest on the deficiency will not begin to accrue on an amount applied until that amount is used to satisfy a required estimated tax payment in such taxable year. Regardless of whether the taxpayer anticipated the application of such overpayment from the prior taxable year in calculating and paying its required estimated tax installment liabilities for the current taxable year, the subsequently determined underpayment and interest computation thereon will not change the taxpayer’s original election to apply the overpayment against the estimated tax liability of the succeeding taxable year. Any changes to the usage of the original overpayment from the prior taxable year are hypothetical only and solely for the purpose of computing deficiency interest. Overpayment interest will not be impacted. For further guidance, see Rev. Rul. 99-40, 1999-2 C.B. 441, (see §601.601(d)(2)(ii)(b) of this chapter).

(j) Examples. The method prescribed in paragraphs (d) through (g) of this section may be illustrated by the following examples:

Example 1. X, a calendar year corporation, estimates its tax liability for its taxable year ending December 31, 2006, will be $85,000. X is not a large corporation as defined in section 6655(g)(2) and §1.6655-4. X reported a liability of $74,900 on its return for the taxable year ended December 31, 2005, with no credits against tax. X paid four installments of estimated tax, each in the amount of $18,725 (25 percent of $74,900), on April 17, 2006, June 15, 2006, September 15, 2006, and December 15, 2006, respectively. X reported a tax liability of $88,900 on its return due March 15, 2007. X had a $5,000 credit against tax for tax year 2006 as provided by part IV of subchapter A of chapter 1 of the Internal Revenue Code. X did not underpay its estimated tax for tax year 2006 for any of the four installments, determined as follows:

Example 2. (i) Facts. Y, a calendar year corporation, estimates its tax liability for its taxable year ending December 31, 2006, will be $70,000. Y is not a large corporation as defined in section 6655(g)(2) and §1.6655-4. Y reported a Federal income tax liability of $90,000 for its taxable year ending December 31, 2005. Y paid no installment of estimated tax on or before April 17, 2006, June 15, 2006, or September 15, 2006, but made a payment of $63,000 on December 15, 2006. On March 15, 2007, Y filed its income tax return showing a tax of $70,000. Y had no credits against tax for tax year 2006. Of the $63,000 paid by Y on December 15, 2006, $17,500 is applied to each of the first three installments due on April 15, June 15, and September 15, 2006, and the remaining $10,500 is applied to the fourth installment. Y has an underpayment of estimated tax for each of the first three installments of $17,500 and for the fourth installment of $7,000. The addition to tax under section 6655(a) is computed as follows:

(ii) Addition to tax. Assuming that neither the annualized income installment method nor the adjusted seasonal installment method described in §§1.6655-2 and 1.6655-3 would result in a lower payment for any installment period, and the addition to tax is computed under section 6621(a)(2) at the rate of 8 percent per annum for the applicable periods of underpayment, the addition to tax is determined as follows:

(k) Effective date. This section applies to taxable years beginning after the date that is 30 days after the date the final regulations are published in the Federal Register.

(a) In general. In the case of any required installment, if the corporation establishes that the annualized income installment determined under this section, or the adjusted seasonal installment determined under §1.6655-3, is less than the amount determined under §1.6655-1—

(1) The amount of such required installment shall be the annualized income installment (or, if less, the adjusted seasonal installment); and

(2) Any reduction in a required installment resulting from the application of this section will be recaptured by increasing the amount of the next required installment determined under §1.6655-1 by the amount of such reduction (and, if the next required installment is similarly reduced, by increasing subsequent required installments to the extent that the reduction has not previously been recaptured).

(b) Determination of annualized income installment—In general. In the case of any required installment, the annualized income installment is the excess (if any) of—

(1) The product of the applicable percentage and the tax for the taxable year computed by annualizing the taxable income and alternative minimum taxable income—

(i) For the first 3 months of the taxable year, in the case of the first required installment;

(ii) For the first 3 months of the taxable year, in the case of the second required installment;

(iii) For the first 6 months of the taxable year in the case of the third required installment; and

(iv) For the first 9 months of the taxable year, in the case of the fourth required installment; over

(2) The aggregate amount of any prior required installments for the taxable year.

(c) Special rules—(1) Applicable percentage. Except as otherwise provided in §1.6655-5(d) with respect to short taxable years—

(2) Partial month. Except as otherwise provided, for purposes of paragraph (b) of this section a partial month shall be treated as a month.

(d) Election of different annualization periods. (1) If the taxpayer timely files Form 8842, “Election To Use Different Annualization Periods for Corporate Estimated Tax,” in accordance with section 6655(e)(2)(C)(iii), and elects Option 1—

(i) Paragraph (b)(1)(i) of this section will be applied by using the language “2 months” instead of “3 months”;

(ii) Paragraph (b)(1)(ii) of this section will be applied by using the language “4 months” instead of “3 months”;

(iii) Paragraph (b)(1)(iii) of this section will be applied by using the language “7 months” instead of “6 months”; and

(iv) Paragraph (b)(1)(iv) of this section will be applied by using the language “10 months” instead of “9 months”.

(2) If the taxpayer timely files Form 8842, in accordance with section 6655(e)(2)(C)(iii), and elects Option 2—

(i) Paragraph (b)(1)(ii) of this section will be applied by using the language “5 months” instead of “3 months”;

(ii) Paragraph (b)(1)(iii) of this section will be applied by using the language “8 months” instead of “6 months”; and

(iii) Paragraph (b)(1)(iv) of this section will be applied by using the language “11 months” instead of “9 months”.

(e) 52-53 week taxable year. (1) Generally, in the case of a taxpayer whose taxable year constitutes 52 or 53 weeks in accordance with section 441(f), the rules prescribed by §1.441-2 shall be applicable in determining—

(i) Whether a taxable year is a taxable year of 12 months; and

(ii) When the 2-, 3- ,4-, 5-, 6-, 7-, 8-, 9-, 10-, or 11-month period (whichever is applicable) commences and ends for purposes of paragraphs (b)(1), (d)(1) and (d)(2) of this section.

(2) If a taxpayer employs four 13-week periods or thirteen 4-week accounting periods and the end of any accounting period employed by the taxpayer does not correspond to the end of the 2-, 3- ,4-, 5-, 6-, 7-, 8-, 9-, 10-, or 11-month period (whichever is applicable), then, provided the taxpayer has at least one full 4-week or 13-week accounting period, as appropriate, within the applicable period, annualized taxable income for the applicable period shall be—

(i) [(x/(y*13))*z], in the case of a taxpayer using four 13-week periods, if—

(A) x = Taxable income for the number of full 13-week periods in the applicable period;

(B) y = The number of full 13-week periods in the applicable period; and

(C) z = The number of weeks in the taxable year; or

(ii) [(x/(y*4))*z], in the case of a taxpayer using thirteen 4-week periods, if—

(A) x = Taxable income for the full 4-week periods in the applicable period;

(B) y = The number of full 4-week periods in the applicable period; and

(C) z = The number of weeks in the taxable year.

(3) If a taxpayer employs four 13-week periods and the taxpayer does not have at least one 13-week period within the applicable 2-, 3- ,4-, 5-, 6-, 7-, 8-, 9-, 10-, or 11-month period, the taxpayer shall be permitted to determine annualized taxable income for the applicable period based upon—

(i) The taxable income for the number of weeks in the applicable period; or

(ii) The taxable income for the full 13-week periods that end before the due date of the required installment.

(4) The following examples illustrate the rules of this paragraph (e):

Example 1. Taxpayer A, an accrual method taxpayer, uses a 52/53 week year-end ending on the last Friday in December and uses four thirteen-week periods. For its year beginning December 30, 2006, A uses the annualized income installment method under section 6655(e)(2)(A)(i) to calculate all of its required installments. For purposes of computing its first and second required installments, the first 3 months of A’s taxable year under paragraph (b)(1)(i) of this section will end on March 30^th, the thirteenth Friday of A’s taxable year. For purposes of its third required installment, the first 6 months of A’s taxable year will end on June 29^th, the twenty-sixth Friday of A’s taxable year. For purposes of its fourth required installment, the first 9 months of A’s taxable year will end on September 28^th, the thirty-ninth Friday of A’s taxable year.

Example 2. Same facts as Example 1 except that A uses thirteen four-week periods and there are 52 weeks during A’s taxable year beginning December 30, 2006, and ending December 28, 2007. For purposes of computing A’s first and second required installments, A’s annualized taxable income for the first three months will be the taxable income for the first three four-week periods of A’s taxable year (December 30, 2006, through March 23, 2007) divided by 12 (number of full four-week periods in the first three months (3) multiplied by 4) and multiplied by 52 (the number of weeks in the taxable year). For purposes of computing A’s third required installment, A’s annualized taxable income for the first six months will be the taxable income for the first six four-week periods of A’s taxable year (December 30, 2006, through June 15, 2007) divided by 24 and multiplied by 52. For purposes of computing A’s fourth required installment, A’s annualized taxable income for the first nine months will be the taxable income for the first nine four-week periods of A’s taxable year (December 30, 2006, through September 7, 2007) divided by 36 and multiplied by 52.

(5) The application of the annualized income installment method is illustrated by the following example:

Example. (i) X, a calendar year corporation, had a taxable year of less than twelve months for tax year 2005 and no credits against tax for tax year 2006. X made an estimated tax payment of $15,000 on the installment dates of April 17, 2006, June 15, 2006, September 15, 2006, and December 15, 2006, respectively. Assume that, under paragraph (d)(1) of this section, X elected Option 1 by timely filing Form 8842, in accordance with section 6655(e)(2)(C)(iii), and determined that its taxable income for the first 2, 4, 7 and 10 months was $25,000, $64,000, $125,000, and $175,000 respectively. The income for each period is annualized as follows:

(ii)(A) To determine whether the installment payment made on April 17, 2006, equals or exceeds the amount that would have been required to have been paid if the estimated tax were equal to 100 percent of the tax computed on the annualized income for the 2-month period, the following computation is necessary:

(B) Because the total amount of estimated tax that was timely paid on or before the first installment date ($15,000) exceeds the amount required to be paid on or before this date if the estimated tax were 100 percent of the tax determined by placing on an annualized basis the taxable income for the first 2-month period, the exception described in paragraphs (a) and (b) of this section applies, and no addition to tax will be imposed for the installment due on April 15, 2006.

(iii)(A) To determine whether the installment payments made on or before June 15, 2006, equal or exceed the amount that would have been required to have been paid if the estimated tax were equal to 100 percent of the tax computed on the annualized income for the 4-month period, the following computation is necessary:

(B) Because the total amount of estimated tax actually paid on or before the second installment date ($19,562 ($15,000 second required installment payment plus $4,562 overpayment of first required installment)) exceeds the amount required to be paid on or before this date if the estimated tax were 100 percent of the tax determined by placing on an annualized basis the taxable income for the first 4-month period, the exception described in paragraphs (a) and (b) of this section applies, and no addition to tax will be imposed for the installment due on June 15, 2006.

(iv)(A) To determine whether the installment payments made on or before September 15, 2006, equal or exceed the amount that would have been required to have been paid if the estimated tax were equal to 100 percent of the tax computed on the annualized income for the 7-month period, the following computation is necessary:

(B) Because the total amount of estimated tax actually paid on or before the third installment date ($15,935 ($15,000 third required installment payment plus $935 overpayment of second required installment)) does not equal or exceed the amount required to be paid on or before this date if the estimated tax were 100 percent of the tax determined by placing on an annualized basis the taxable income for the first 7-month period, the exception described in paragraphs (a) and (b) of this section does not apply, and an addition to tax will be imposed with respect to the underpayment of the September 15, 2006, installment unless another exception applies to this installment payment.

(v)(A) To determine whether the installment payments made on or before December 15, 2006, equal or exceed the amount that would have been required to have been paid if the estimated tax were equal to 100 percent of the tax computed on the annualized income for the 10-month period, the following computation is necessary:

(B) Because the total amount of estimated tax payments made on or before the fourth installment date that is available to be applied to the estimated tax due for the fourth installment ($9,884 ($15,000 fourth required installment payment less $5,116 underpayment for the third installment of estimated tax ($21,051 third installment of estimated tax due less $15,935 payments available to be applied to the third installment of estimated tax))) does not equal or exceed the amount required to be paid on or before this date if the estimated tax were 100 percent of the tax determined by placing on an annualized basis the taxable income for the first 10-month period, the exception described in paragraphs (a) and (b) of this section does not apply, and an addition to tax will be imposed with respect to the underpayment of the December 15, 2006, installment unless another exception applies to this installment payment.

(vi) Assuming that no other exceptions apply and the addition to tax is computed under section 6621(a)(2) at the rate of 8 percent per annum for the applicable periods of underpayment, the amount of the addition to tax is as follows:

(f) Determination of taxable income for an annualization period—(1) In general. In determining the applicability of the exception described in paragraphs (a) and (b) of this section (relating to the annualization of income) and the exception described in §1.6655-3 (relating to annualization of income for corporations with seasonal income), and for purposes of computing a taxpayer’s taxable income (and applicable tax), an item must be taken into account in computing a taxpayer’s taxable income for the taxable year for which the estimated tax is being determined, and must be properly taken into account in determining a taxpayer’s taxable income (and applicable tax) for the applicable annualization period by the last day of the such period. Generally, except as provided in paragraph (f)(2) of this section, for an item to be taken into account during an annualization period, the following must occur on or before the last day of the applicable annualization period (determined based on the accounting period employed by the taxpayer):

(i) With respect to an item of gross income, such income is includible in computing taxable income in accordance with section 451 or the appropriate provision of the Internal Revenue Code (for example, section 453 for installment sales or section 460 for long-term contracts).

(ii) With respect to an item of loss, the loss must be permitted to be taken into account under the appropriate provision of the Internal Revenue Code.

(iii) With respect to an item of deduction, for taxpayers using the cash receipts and disbursements method of accounting, the deduction must be paid under §1.461-1(a)(1) and otherwise deductible in computing taxable income for the annualization period or, for taxpayers using an accrual method of accounting, the deduction must be incurred under §1.461-1(a)(2) and otherwise deductible in computing taxable income for the annualization period. In the case of an accrual method taxpayer, the provisions of section 170(a)(2) and §1.170A-11(b) (charitable contributions by accrual method corporations), §1.461-4(d)(6)(ii) (provision of services or property to a taxpayer), §1.461-5 (recurring item exception), and any other provision that has a similar effect can not be used in determining whether the item of deduction has been incurred under §1.461-1(a)(2) and is otherwise deductible for purposes of computing taxable income for an annualization period. For purposes of section 404 and the regulations, regardless of the overall method of accounting employed by the taxpayer, the applicable 2-, 3-, 4-, 5-, 6-, 7-, 8-, 9-, 10- or 11-month period shall not be treated as a short taxable year and the rules of section 404 and the regulations shall be applied on the basis of the taxpayer’s taxable year for which estimated tax is being determined. Thus, the determination of whether a payment to an employee is deferred compensation under §1.404(b)-1T shall be made by reference to whether the payment is received by the employee more than a brief period of time after the last day of the taxable year for which estimated tax is being determined and not the last day of the applicable annualization period. With respect to contributions to qualified plans governed by section 404 and the regulations, in determining whether an item is paid or incurred by the end of an annualization period, economic performance is satisfied only to the extent such item is paid by the last day of the applicable annualization period (without regard to section 404(a)(6)) and does not, in combination with other such items paid during the applicable annualization period, exceed the applicable deduction limit of section 404(a) for the taxable year. For purposes of sections 419 and 419A and the regulations, regardless of the overall method of accounting employed by the taxpayer, the applicable 2-, 3-, 4-, 5-, 6-, 7-, 8-, 9-, 10-, or 11-month period shall not be treated as a short taxable year and the rules of sections 419 and 419A and the regulations shall be applied on the basis of the taxpayer’s taxable year for which estimated tax is being determined. With respect to contributions to a welfare benefit fund governed by sections 419 and 419A and the regulations, in determining whether an item is paid or incurred by the end of an annualization period, economic performance is satisfied only to the extent such item is paid by the last day of the applicable annualization period and does not, in combination with other such items paid during such annualization period, exceed the applicable deduction limit of section 419 for the taxable year.

(iv) With respect to depreciation and amortization (depreciation) expense, a taxpayer shall take into account depreciation expense only as provided in paragraph (f)(2)(v) of this section.

(v) With respect to any item taken into account in computing taxable income for the annualization period that is not described in paragraphs (f)(1)(i), (ii), (iii), and (iv) of this section, the item is includible in computing taxable income in accordance with the appropriate provision of the Internal Revenue Code.

(vi) With respect to an item of credit, the amounts upon which the credit is computed must have been taken into account in computing taxable income for the annualization period pursuant to paragraphs (f)(1)(i), (ii), (iii), (iv), and (v) of this section, as applicable.

(2) Exceptions—(i) Annual expenses paid or incurred at or after the end of the taxable year. (A) Except as otherwise provided in paragraphs (f)(2)(ii) through (vi) of this section, if an accrual method taxpayer has a history of incurring a specific item of expense under §1.461-1(a)(2) (or a cash method taxpayer has a history of paying a specific item of expense under §1.461-1(a)(1)) that, while attributable to income earned throughout the current taxable year, is not incurred (or paid, in the case of a cash method taxpayer) until the end of the taxable year, or after the end of the current taxable year and is deemed incurred (or paid, in the case of a cash method taxpayer) during the current taxable year (taking into account, as applicable, section 170(a)(2) and §1.170A-11(b), section 404(a)(6), §1.461-4(d)(6)(ii), §1.461-5, and any other provision that has a similar effect), then the taxpayer may, in lieu of any amount determined under paragraph (f)(1) of this section, take into account for the applicable annualization period the amount of such expense properly allocable to such period provided the amount so allocated to such annualization period is determinable with reasonable accuracy and the amount of the item so allocated is properly deducted by the taxpayer during the current taxable year under the taxpayer’s method of accounting.

(B) For purposes of this paragraph (f)(2)(i), the portion of an annual expense item allocable to an annualization period will be considered to be determined with reasonable accuracy if such item is allocated evenly throughout the taxable year unless the taxpayer is able to clearly demonstrate such item is more appropriately allocable to an annualization period by some other method including, for example, in proportion to the earning of revenue, the use of property, or the provision of services. For purposes of this paragraph (f)(2)(i), a taxpayer has a history of incurring or paying a specific item of expense at the end of the taxable year, or after the end of the taxable year that is deemed incurred or paid during the taxable year, if, in each of the two taxable years immediately preceding the current taxable year (or the immediately preceding taxable year if the taxpayer was not in existence for the two preceding taxable years), the taxpayer incurred or paid the specific item of expense at the end of each taxable year, or after the end of each taxable year that was deemed incurred or paid during such taxable year. In addition, for purposes of this paragraph (f)(2)(i), the term “the end of the taxable year” means the period between and including the 15^th and last day of the last month of the taxable year.

(ii) Net operating loss carryover. Any net operating loss carryover to the current taxable year shall be taken into account in computing an annualized income installment only after annualizing the taxable income for the annualization period.

(iii) Credit carryover. Any credit carryover to the current taxable year shall be taken into account in computing an annualized income installment only after annualizing the taxable income for the annualization period and computing the applicable tax, and before applying the applicable percentage.

(iv) Section 481(a) adjustment. (A) Any section 481(a) adjustment required to be recognized during the taxable year shall be recognized ratably over the number of months in the taxable year.

(B) With respect to a Form 3115, “Application for Change in Accounting Method,” filed during the current taxable year or a preceding taxable year, if the change in method of accounting—

(1) Is permitted to be made with the automatic consent of the Commissioner, the appropriate portion of the section 481(a) adjustment determined under paragraph (f)(2)(iv)(A) of this section shall be taken into account in determining an annualized income installment if, and only if, the copy of the Form 3115 has been mailed to the IRS National Office on or before the last day of the annualization period; or

(2) Requires the prior consent of the Commissioner, the appropriate portion of the section 481(a) adjustment determined under paragraph (f)(2)(iv)(A) of this section shall be taken into account in determining an annualized income installment if, and only if, the consent agreement reflecting the Commissioner’s consent to the change in method of accounting and the prescribed terms and conditions for effecting such change has been signed by the taxpayer and mailed to the IRS National Office on or before the last day of the annualization period.

(v) Depreciation and amortization—(A) General rule. In determining any annualized income installment, a proportionate amount of the taxpayer’s estimated annual depreciation and amortization (depreciation) expense shall be taken into account. For purposes of the preceding sentence, estimated annual depreciation expense is the estimated depreciation expense to be properly taken into account in determining the taxpayer’s taxable income for the taxable year. In determining the estimated annual depreciation expense, a taxpayer may take into account purchases, sales or other dispositions, changes in use, depreciation deductions permitted under sections 168(k) and 1400L(b), and other similar events and provisions (for example, section 179) that, based on all the relevant information available as of the last day of the annualization period (such as capital spending budgets, financial statement data and projections, or similar reports that provide evidence of the taxpayer’s capital spending plans for the current taxable year), are reasonably expected to occur or apply during the taxable year. For purposes of the additional first-year depreciation deduction under sections 168(k) and 1400L(b), only a proportionate amount of the current year’s additional first-year depreciation deduction to be taken into account in determining a taxpayer’s taxable income for the taxable year is taken into account in computing taxable income for an annualization period. As an alternative to estimating annual depreciation expense based on events that are reasonably expected to occur, a taxpayer may claim for an annualization period at least a proportionate amount of 50 percent of the taxpayer’s estimated depreciation expense for the current taxable year attributable to assets that a taxpayer had in service on the last day of the preceding taxable year, that remain in service on the first day of the current taxable year, and that are subject to the half-year convention.

(B) Short taxable years. Unless the taxable year is, or will be, a short taxable year, in no circumstance may an annualization period be treated as a short taxable year for purposes of determining the depreciation allowance for such annualization period. If the taxable year is, or will be (based on all relevant information available as of the last day of the annualization period), a short taxable year, annual depreciation expense shall be computed using the rules applicable for computing depreciation during a short taxable year for purposes of determining the annual depreciation expense to be allocated to an annualization period. For this purpose, the rules applicable for computing depreciation during a short taxable year shall be applied on the basis of the date the taxable year is expected to end based on all relevant information available as of the last day of the annualization period. See Rev. Proc. 89-15, 1989-1 C.B. 816, (see §601.601(d)(2)(ii)(b) of this chapter).

(vi) Member of partnership. In determining a partner’s distributive share of partnership items that must be taken into account during an annualization period, the rules set forth in §1.6654-2(d)(2) are applicable.

(3) Examples. The provisions of this paragraph (f) are illustrated by the following examples:

Example 1. Corporation A, a calendar year taxpayer, uses an accrual method of accounting and uses the annualized income installment method under section 6655(e)(2)(A)(i) to calculate its first required installment payment for its 2006 taxable year. Consistent with its historical practice, the board of directors of A, on or before March 31, 2006, make a binding, irrevocable commitment to fund a minimum contribution of $10,000,000 to A’s qualified retirement plan by March 15, 2007, which fixes A’s liability to make the $10,000,000 contribution. Similarly, consistent with A’s historical practice, A plans to remit payments to the retirement plan of $1,000,000 on January 2, 2007, and $9,000,000 on March 1, 2007. The $10,000,000 commitment is not taken into account for purposes of determining A’s first annualized income installment, which is based on the income and deductions from the first three months of the taxable year, because A did not make any payments by March 31, 2006 (and therefore did not satisfy the economic performance requirements of §1.461-4(d)(2)(iii) by March 31, 2006), in accordance with paragraph (f)(1)(iii) of this section. The $10,000,000 is not treated as paid on or before March 31, 2006, under section 404(a)(6) because, pursuant to paragraph (f)(1)(iii) of this section, the last day of the annualization period is not to be treated as the last day of A’s taxable year. However, pursuant to paragraph (f)(2)(i)(A) of this section, because A has historically incurred a retirement plan expense during the taxable year pursuant to section 404 that, but for the deeming rule of section 404(a)(6), would have been incurred after the end of the taxable year, and because A satisfies the other requirements of paragraph (f)(2)(i)(A) of this section, A may take into account a $2,500,000 retirement plan expense for purposes of determining A’s taxable income to be annualized in computing A’s first annualized income installment for 2006 ($10,000,000/12 X 3 = $2,500,000) unless, pursuant to paragraph (f)(2)(i)(B) of this section, A is able to clearly demonstrate that the retirement plan expense is more appropriately allocable by some other method.

Example 2. Same facts as Example 1 except that, consistent with its historical practice, A remits $9,000,000 to the retirement plan on June 30, 2006, and $1,000,000 to the retirement plan on September 30, 2006. For purposes of determining A’s first and second required installments for 2006, which are based on the income and deductions from the first three months of the taxable year, A may not take into account any of the retirement plan expense because A did not make any payments by March 31, 2006 (and therefore did not satisfy the economic performance requirements of §1.461-4(d)(2)(iii) by March 31, 2006), in accordance with paragraph (f)(1)(iii) of this section. For A’s third required installment, which is based on the income and deductions from the first six months of the taxable year, A may take into account a $9,000,000 retirement plan expense for purposes of determining A’s annualized taxable income because A incurred the $9,000,000 expense by June 30, 2006. For A’s fourth required installment, which is based on the income and deductions from the first nine months of the taxable year, A may take into account a $10,000,000 retirement plan expense for purposes of determining A’s annualized taxable income because A incurred the $10,000,000 retirement plan expense by September 30, 2006.

Example 3. Corporation B, a calendar year taxpayer, uses an accrual method of accounting and the annualized income installment method under section 6655(e)(2)(A)(i) to calculate its first required installment. In each of the three preceding taxable years, B has paid annual bonuses on the Friday immediately preceding December 25 to those employees of B that provided services to B during the taxable year and were employed by B on the date such bonuses were paid. At the beginning of 2006, consistent with its historical experience, B’s board of directors pass a resolution that B will pay cash bonuses of $6,000,000 to those employees that have provided services to B during 2006 and are employed by B on December 22, 2006, the Friday immediately preceding December 25, 2006. B plans to pay, and does pay, the cash bonuses to eligible employees on March 1, 2007. The bonuses, pursuant to paragraph (f)(1)(iii) of this section, are not treated as deferred compensation for the taxable year or the annualization period under §1.404(b)-1T because the last day of the annualization period is not to be treated as the last day of B’s taxable year. Because the bonuses are not treated as deferred compensation, the bonuses are not subject to section 404, and instead are treated as service liabilities under §1.461-4(d)(2)(i) rather than employee benefit liabilities under §1.461-4(d)(2)(iii). Thus, the bonuses are incurred when all the events have occurred that establish the fact of the liability, the amount of the liability can be determined with reasonable accuracy, and the services are provided to B by B’s employees. If B’s first required installment is made under the provisions of section 6655(e)(1), the $6,000,000 is not taken into account for purposes of determining B’s first annualized income installment, which is based on the income and deductions from the first three months of the taxable year, because B did not incur any liability for bonus payments for the current taxable year by March 31, 2006, in accordance with paragraph (f)(1)(iii) of this section. However, pursuant to paragraph (f)(2)(i)(A) of this section, because B has historically incurred a bonus expense at the end of the taxable year, and because B satisfies the other requirements of paragraph (f)(2)(i)(A) of this section, B may take into account a $1,500,000 bonus expense for purposes of determining B’s taxable income to be annualized in computing B’s first annualized income installment for 2006 ($6,000,000/12 X 3 = $1,500,000) unless, pursuant to paragraph (f)(2)(i)(B) of this section, B is able to clearly demonstrate that the bonus expense is more appropriately allocable by some other method.

Example 4. Corporation C, a calendar year taxpayer, uses an accrual method of accounting and the annualized income installment method under section 6655(e)(2)(A)(i) to calculate its first required installment for its 2006 taxable year. C has a net operating loss carryover to 2006 of $400,000. C’s taxable income from January 1, 2006, through March 31, 2006, without regard to any net operating loss carryover, is $500,000. For purposes of determining C’s first annualized income installment, C’s annualized taxable income is $1,600,000, determined by placing C’s first three months of taxable income from January 1, 2006, through March 31, 2006, on an annualized basis ($500,000 X 12/3 = $2,000,000) and reducing the resulting amount of $2,000,000 by the $400,000 net operating loss carryover to 2006.

Example 5. Corporation D, a calendar year taxpayer, uses an accrual method of accounting and the annualized income installment method under section 6655(e)(2)(A)(i) to calculate all of its required installment payments for its 2006 taxable year. On April 15, 2005, D filed a Form 3115, “Application for Change in Accounting Method,” to request the consent of the Commissioner to change its method of accounting for recognizing revenue. The Commissioner consented to D’s requested change, and D signed and mailed the consent letter to the IRS National Office on December 15, 2005. The method change resulted in a positive section 481(a) adjustment of $200,000 to be taken into account over four taxable years beginning in 2005. D’s taxable income from January 1, 2006, through March 31, 2006, prior to any section 481(a) adjustment, is $500,000. For purposes of determining D’s first annualized income installment for its 2006 taxable year, D’s annualized taxable income is $2,050,000, determined by placing the sum of D’s first three months of taxable income from January 1, 2006, through March 31, 2006, ($500,000) plus, pursuant to paragraph (f)(2)(iv) of this section, the portion of the section 481(a) adjustment required to be recognized during the taxable year ($200,000/4 = $50,000) that is attributable to the period from January 1, 2006, through March 31, 2006, ($50,000 X 3/12 = $12,500) on an annualized basis ($512,500 X 12/3 = $2,050,000).

Example 6. Corporation E, a calendar year taxpayer, uses an accrual method of accounting and the annualized income installment method under section 6655(e)(2)(A)(i) to calculate all of its required installment payments for its 2006 taxable year. E’s taxable income from January 1, 2006, through March 31, 2006, prior to any section 481(a) adjustment, is $500,000. On June 30, 2006, E filed a copy of the Form 3115 with the IRS National Office to request a change in method of accounting that was permitted to be made with the automatic consent of the Commissioner and resulted in a negative section 481(a) adjustment of $400,000 to be taken into account entirely in 2006. For purposes of determining E’s first annualized income installment for its 2006 taxable year, E’s annualized taxable income is $2,000,000, determined by placing E’s first three months of taxable income from January 1, 2006, through March 31, 2006, ($500,000) on an annualized basis ($500,000 X 12/3 = $2,000,000). Because E did not file the accounting method change request until after the last day of the annualization period, no portion of the section 481(a) adjustment is taken into account in computing E’s first annualized income installment.

Example 7. Same facts as Example 6 except that E’s taxable income from January 1, 2006, through June 30, 2006, prior to any section 481(a) adjustment, is $800,000. For purposes of determining E’s third annualized income installment for its 2006 taxable year, E’s annualized taxable income is $1,200,000, determined by placing the sum of E’s first six months of taxable income from January 1, 2006, through June 30, 2006, ($800,000) less, pursuant to paragraph (f)(2)(iv) of this section, the portion of the 2006 section 481(a) adjustment required to be recognized during the taxable year that is attributable to the period from January 1, 2006, through June 30, 2006 ($400,000 X 6/12 = $200,000) on an annualized basis ($600,000 X 12/6 = $1,200,000).

Example 8. Same facts as Example 7 except that E’s request for change in method of accounting required the prior consent of the Commissioner and the Form 3115 was filed with the IRS National Office on June 30, 2006. On December 10, 2006, E received the consent of the Commissioner to change its method of accounting. E signed and mailed the consent letter to the IRS National Office on December 15, 2006. For purposes of determining E’s third annualized income installment for its 2006 taxable year, E’s annualized taxable income is $1,600,000, determined by placing E’s first six months of taxable income from January 1, 2006, through June 30, 2006, on an annualized basis ($800,000 x 12/6 = $1,600,000). No portion of the section 481(a) adjustment is taken into account in computing E’s third annualized income installment because, although E filed the accounting method change request on or before the last day of E’s third annualization period, E did not receive the Commissioner’s consent to change its method of accounting, and E did not sign and mail the consent agreement to the IRS National Office, on or before the last day of E’s third annualization period.

Example 9. Corporation F, a calendar year taxpayer that began business on January 1, 2003, adopted an accrual method of accounting and will use the annualized income installment method under section 6655(e)(2)(A)(i) to calculate its first required installment payment for its 2003 taxable year. As of March 31, 2003, F has purchased and placed in service $100,000 of “5-year property,” as defined in section 168(e), and anticipates purchasing and placing in service another $100,000 of “5-year property” before December 31, 2003. F does not anticipate being subject to the mid-quarter convention for the 2003 taxable year, does not anticipate making any depreciation elections for this class of property, does not anticipate making a section 179 election, will deduct the 30% additional first year depreciation deduction, does not anticipate any sales or other dispositions of depreciable property, and no events have occurred, and, based on all relevant information available as of the due date of F’s first required installment, F does not know of any event that will cause F’s taxable year to be a short taxable year. F’s annual depreciation expense for 2003 is estimated to be $88,000 (total depreciation deduction under section 168(k) of $60,000 ($200,000 X 30% = $60,000) plus annual depreciation of $28,000 (($200,000 minus $60,000) X 20%)). For purposes of determining F’s first annualized income installment for its 2003 taxable year, in accordance with paragraph (f)(2)(v)(A) of this section, depreciation expense of $22,000 ($88,000 x 3/12 = $22,000) may be taken into account in computing F’s January 1, 2003, through March 31, 2003, taxable income to be annualized. Under paragraph (f)(2)(v)(B) of this section, F may not consider its first annualization period to be a short taxable year for purposes of determining the depreciation allowance for such annualization period.

Example 10. Corporation G, a calendar year taxpayer that began business on January 5, 2004, adopted an accrual method of accounting and will use the annualized income installment method under section 6655(e)(2)(A)(i) to calculate its first required installment payment for its 2005 taxable year. On January 5, 2004, G purchased and placed in service an asset that cost $30,000, qualifies as “5-year property” as defined in section 168(e), is eligible for the 50% additional first year depreciation deduction under section 168(k), and is subject to the half-year convention. G will deduct the 50% additional first year depreciation deduction with respect to the “5-year property.” For tax year 2004, G takes a depreciation deduction under section 168(k) of $18,000 ($15,000 ($30,000 X 50% = $15,000) plus annual depreciation of $3,000 ($15,000 X 20% = $3,000)). G does not anticipate being subject to the mid-quarter convention for the 2004 taxable year, does not anticipate making any depreciation elections for this class of property, does not anticipate making a section 179 election, will deduct the 50% additional first year depreciation deduction, does not anticipate any sales or other dispositions of depreciable property, and no events have occurred, and, based on all relevant information available as of the due date of G’s first required installment, G does not know of any event that will cause G’s taxable year to be a short taxable year. G’s annual depreciation expense for 2005 is estimated to be $4,800 ($15,000 X 32% = $4,800). For purposes of determining G’s first annualized income installment for its 2005 taxable year, in accordance with paragraph (f)(2)(v)(A) of this section, depreciation expense of $1,200 ($4,800 x 3/12 = $1,200) may be taken into account in computing G’s January 1, 2005, through March 31, 2005, taxable income to be annualized. As an alternative to estimating annual depreciation expense based on events that are reasonably expected to occur, depreciation expense of at least $600 ($4,800 x 50% x 3/12 = $600) may be taken into account in computing G’s January 1, 2005, through March 31, 2005, taxable income to be annualized. Under paragraph (f)(2)(v)(B) of this section, G may not consider its first annualization period to be a short taxable year for purposes of determining the depreciation allowance for such annualization period.

Example 11. Corporation H, a calendar year taxpayer, uses an accrual method of accounting and the annualized income installment method under section 6655(e)(2)(A)(i) to calculate all of its required installment payments for its 2006 taxable year. H has owned real property in State Y since 2002 and has used the real property in its trade or business. H’s method of accounting for real estate taxes is to deduct the taxes on the lien date, subject to the recurring item exception of §1.461-5. Based on historical practice for the past five years, for the 2006 calendar year State Y imposes a lien for real estate taxes on real property owned in State Y on March 15, 2006, with 90% of the tax due on June 30, 2006, and the remaining 10% of the tax due on June 29, 2007. Based on the value of H’s real property in State Y, H’s real estate tax liability lien imposed on March 15, 2006, is $100,000. H pays the first 90% of this liability on June 30, 2006, and the remaining 10% on June 29, 2007. Under paragraph (f)(1)(iii) of this section, the $100,000 real estate tax liability is not taken into account for purposes of determining H’s first annualized income installment, which is based on the income and deductions from the first three months of the taxable year, because economic performance with respect to the real estate tax liability did not occur by March 31, 2006. However, pursuant to paragraph (f)(2)(i)(A) of this section, because H has historically incurred a real estate tax expense after the end of the taxable year and the real estate tax expense was deemed incurred in 2006 pursuant to §1.461-5, and because H satisfies the other requirements of paragraph (f)(2)(i)(A) of this section, a $2,500 real estate tax expense may be taken into account for purposes of determining H’s taxable income to be annualized in computing H’s first annualized income installment ($10,000/12 X 3 = $2,500) unless, pursuant to paragraph (f)(2)(i)(B) of this section, H is able to clearly demonstrate that the real estate tax expense is more appropriately allocable by some other method.

Example 12. Same facts as Example 11, except that H is computing its third required installment payment for H’s 2006 taxable year. Pursuant to paragraph (f)(1)(iii) of this section, H may take into account $90,000 ($100,000 real estate tax liability X 90% paid on June 30, 2006) for purposes of determining the taxable income to be annualized in computing H’s third annualized income installment because economic performance with respect to $90,000 of the real estate tax liability occurred by June 30, 2006. In addition, pursuant to paragraph (f)(2)(i)(A) of this section, because H has historically incurred a real estate tax expense after the end of the taxable year and the real estate tax expense was deemed incurred in 2006 pursuant to §1.461-5, and because H satisfies the other requirements of paragraph (f)(2)(i)(A) of this section, a $5,000 real estate tax expense also may be taken into account for purposes of determining H’s taxable income to be annualized in computing H’s third annualized income installment ($10,000/12 X 6 = $5,000) unless, pursuant to paragraph (f)(2)(i)(B) of this section, H is able to clearly demonstrate that $10,000 of the real estate tax expense is more appropriately allocable by some other method. Therefore, pursuant to paragraphs (f)(1)(iii) and (f)(2)(i)(A) of this section, H may take into account $95,000 of the real estate tax liability for purposes of computing the third required installment payment for H’s 2006 taxable year.

Example 13. Same facts as Example 11, except that H pays 90% of the real estate tax liability on June 30, 2006, and the remaining 10% of the real estate tax liability on November 30, 2006. Under paragraph (f)(1)(iii) of this section, the $100,000 real estate tax liability is not taken into account for purposes of determining H’s first annualized income installment, which is based on the income and deductions from the first three months of the taxable year, because economic performance with respect to the real estate tax liability did not occur by March 31, 2006. In addition, although H has a history of incurring a real estate tax expense after the end of the taxable year that is deemed incurred during the taxable year, H does not meet the requirements of paragraph (f)(2)(i)(A) of this section in order to take a real estate tax expense into account for purposes of determining H’s first annualized income installment because H does not incur a real estate tax at the end of the current taxable year or after the end of the current taxable year that will be deemed incurred during the current taxable year.

Example 14. Same facts as Example 13 except that H is computing its third required installment payment for H’s 2006 taxable year. Pursuant to paragraph (f)(1)(iii) of this section, H may take into account $90,000 ($100,000 real estate tax liability X 90% paid on June 30, 2006) for purposes of determining the taxable income to be annualized in computing H’s third annualized income installment because economic performance with respect to $90,000 of the real estate tax liability occurred by June 30, 2006.

Example 15. Corporation I, a calendar year taxpayer, uses an accrual method of accounting and the annualized income installment method under section 6655(e)(2)(A)(i) to calculate all of its required installment payments for its 2006 taxable year. As of December 31, 2005, I had a $1,000,000 account receivable due from Z related to the sale of goods from I to Z during 2005. I has traditionally incurred bad debt expense for worthless accounts receivable and, as of January 1, 2006, I projects that it will have a bad debt expense of $1,600,000 under section 166 and the regulations for its calendar year 2006. On March 31, 2006, I determined that its receivable from Z was totally worthless under section 166 and the regulations. No other receivables were determined to be worthless between January 1, 2006, and March 31, 2006. In accordance with paragraph (f)(1)(ii) of this section, a $1,000,000 bad debt write-off is taken into account for purposes of determining the taxable income to be annualized in computing I’s first annualized income installment.

Example 16. Same facts as Example 15 except that I determines that its receivable from Z was totally worthless under section 166 and the regulations on April 10, 2006. As of March 31, 2006, I had not determined that any receivables were worthless under section 166 and the regulations. In accordance with paragraph (f)(1)(ii) of this section, the $1,000,000 bad debt expense attributable to the receivable from Z is not taken into account for purposes of determining the taxable income to be annualized in computing I’s first annualized income installment, which is based on the income and deductions from the first three months of the taxable year, because the receivable from Z became totally worthless after the last day of I’s annualization period. Furthermore, I may not take the bad debt expense into account for purposes of determining the taxable income to be annualized in computing I’s first annualized income installment because the receivable from Z does not meet the requirements of paragraph (f)(2)(i) of this section.

Example 17. Corporation J, a calendar year taxpayer, uses an accrual method of accounting and the annualized income installment method under section 6655(e)(2)(A)(i) to calculate its first required installment payment for its 2006 taxable year. J projects its annualized tax for its 2006 taxable year, based on annualizing J’s taxable income for its first annualization period from January 1, 2006, through March 31, 2006, to be $1,500,000 before reduction for any credits. J has an unused credit for increasing research activities from 2005 of $500,000 that is carried over to 2006. For purposes of determining J’s first annualized income installment, J’s annualized tax for 2006 is $1,000,000, determined as the tax for the taxable year computed by placing on an annualized basis J’s taxable income from its first annualization period from January 1, 2006, through March 31, 2006, ($1,500,000) reduced by the $500,000 credit carryover from 2005.

Example 18. Corporation K, a calendar year taxpayer, uses an accrual method of accounting and the annualized income installment method under section 6655(e)(2)(A)(i) to calculate its first required installment payment for its 2006 taxable year. K projects its annualized tax for its 2006 taxable year, based on annualizing K’s taxable income for its first annualization period from January 1, 2006, through March 31, 2006, to be $2,000,000 before reduction for any credits. K has historically earned a credit for increasing research activities and, for 2006, K estimates that it will earn a credit for increasing research activities under section 41 of $1,200,000. However, pursuant to paragraph (f)(1)(vi) of this section, if K were to annualize all components involved in computing the current year credit based on K’s activity from January 1, 2006, through March 31, 2006, K would generate a credit of $1,600,000 for 2006. For purposes of determining K’s first annualized income installment, K’s annualized tax for 2006 is $400,000, determined as the tax for the 2006 taxable year ($2,000,000) computed by placing on an annualized basis K’s taxable income from its first annualization period January 1, 2006, through March 31, 2006, reduced by a $1,600,000 current year credit from increasing research activities.

Example 19. Same facts as Example 18 except that K does not begin any research activities until April 3, 2006, and will not incur any research expenses described in paragraph (f)(2)(i) of this section. As a result, if K were to annualize all components involved in computing the current year credit based on K’s activity from January 1, 2006, through March 31, 2006, K would generate no section 41 research credit for purposes of determining its first annualized income installment. Pursuant to paragraph (f)(1)(vi) of this section, K can not take into account any credit for its first annualization period because K did not incur the credit by the last day of the first annualization period. Accordingly, for purposes of determining K’s first annualized income installment, K’s annualized tax for its first annualization period January 1, 2006, through March 31, 2006, is $2,000,000.

Example 20. Corporation L, a calendar year taxpayer, uses an accrual method of accounting and the annualized income installment method under section 6655(e)(2)(A)(i) to calculate its first required installment payment for its 2006 taxable year. L has licensed technology from Corporation M for the past five years. Pursuant to the license agreement, L pays a license fee to M equal to $.01 for every dollar of gross receipts earned by L. For 2006, L projects gross receipts of $200,000,000, of which $100,000,000 is earned by March 31, 2006, and no portion of L’s license fee expense is described in paragraph (f)(2)(i) of this section. Pursuant to paragraph (f)(1)(iii) of this section, a license fee expense of $1,000,000 ($100,000,000 X $.01) is incurred by March 31, 2006, and may be taken into account for purposes of determining the taxable income to be annualized in computing L’s first annualized income installment.

Example 21. Same facts as Example 20 except that L does not earn any gross receipts by March 31, 2006. In accordance with paragraph (f)(1)(iii) of this section, because the license fee expense was not incurred under §1.461-1(a)(2) by the last day of the annualization period, no license fee expense is taken into account for purposes of determining the taxable income to be annualized in computing L’s first annualized income installment, which is based on the income and deductions from the first three months of the taxable year.

Example 22. Corporation N is a calendar year taxpayer that produces and sells candy bars. N uses an accrual method of accounting and the annualized income installment method under section 6655(e)(2)(A)(i) to calculate all of its required installment payments for its 2007 taxable year. N annually conducts, and will conduct for 2007 and 2008, a contest for its customers whereby N awards, on a quarterly basis, a cash prize of $100,000, $200,000, $300,000, and $400,000 to the first, second, third, and fourth quarter winners, respectively. Winners are announced on the last day of each calendar quarter and the prize is payable on the last day of the month following the announcement of the winner. N uses the recurring item exception of section 461(h) and the regulations with respect to its liability to the prize winner. On December 31, 2006, N announced its fourth quarter winner and remitted payment of $400,000 to the winner on January 31, 2007. Although the contest liability is incurred in accordance with §1.461-4(g)(4) on January 31, 2007, at the time payment is made to the award winner, N may not take such item into account in computing N’s first annualized income installment for 2007 because, pursuant to the recurring item exception, the $400,000 is deductible in determining N’s 2006 taxable income and is not taken into account in determining N’s taxable income for 2007, as required pursuant to paragraph (f)(1) of this section. However, because N has historically incurred an annual prize expense of $400,000 that is described in paragraph (f)(2)(i)(A) of this section, $100,000 may be taken into account for purposes of determining the taxable income to be annualized in computing N’s first annualized income installment for N’s 2007 taxable year based on the $400,000 liability N will incur for the 2007 taxable year when N makes the payment in January of 2008 to the 2007 fourth quarter winner ($400,000/12 X 3 = $100,000), unless, pursuant to paragraph (f)(2)(i)(B) of this section, N is able to clearly demonstrate that the annual prize expense is more appropriately allocable by some other method.

(g) Items that substantially affect taxable income but cannot be determined accurately by the installment due date—(1) In general. In determining the applicability of the annualization exceptions described in paragraphs (a) and (b) of this section and §1.6655-3, reasonable estimates may be made from existing data for items that substantially affect income if the amount of such items cannot be determined accurately by the installment due date. Examples of these items are the inflation index for taxpayers using the dollar-value LIFO (last-in, first-out) inventory method, intercompany adjustments for taxpayers that file consolidated returns, and the liquidation of a LIFO layer at the installment date that the taxpayer reasonably believes will be replaced at the end of the year.

(2) Example. The following example illustrates the rules of this paragraph (g):

Example. Corporation X accounts for its inventory using the dollar-value LIFO method of accounting. If, when computing its first annualized income installment, no reliable inflation index exists for the period January 1, 2006, through March 31, 2006, X may interpolate from an available inflation index for the same months in the previous year to calculate its cost of goods sold.

(h) Events arising after installment due date that were not reasonably foreseeable—(1) In general. Events arising subsequent to an installment due date that cause the taxpayer’s computation of its taxable income for a prior installment period to be understated will not result in a recomputation of its taxable income for the prior installment period. The preceding sentence applies only if, based on all the facts and circumstances as of the due date of an installment payment, it was not reasonably foreseeable that these subsequent events would occur.

(2) Example. The following example illustrates the rules of this paragraph (h):

Example. Assume that Congress enacts retroactively effective legislation that causes the taxable income for the applicable 2-, 3-, 4-, 5-, 6-, 7-, 8-, 9-, 10- or 11-month period to be understated. This event, which occurs after the applicable installment due date and was not reasonably foreseeable at the time the installment payment was made, will not result in a recomputation of a corporation’s taxable income for the applicable installment period because such an event was not reasonably foreseeable.

(i) Effective date. This section applies to taxable years beginning after the date that is 30 days after the date the final regulations are published in the Federal Register.

(a) In general. In the case of any required installment, the amount of the adjusted seasonal installment is the excess (if any) of—

(1) 100 percent of the amount determined under paragraph (c) of this section; over

(2) The aggregate amount of all prior required installments for the taxable year.

(b) Limitation on application of section. This section shall apply only if the base period percentage (as defined in section 6655(e)(3)(D)(i) and paragraph (d)(1) of this section) for any six consecutive months of the taxable year equals or exceeds seventy percent.

(c) Determination of amount. The amount determined under this section for any installment will be determined in the following manner—

(1) Take the taxable income for all months during the taxable year preceding the filing month;

(2) Divide such amount by the base period percentage for all months during the taxable year preceding the filing month;

(3) Determine the tax on the amount determined under paragraph (c)(2) of this section; and

(4) Multiply the tax computed under paragraph (c)(3) of this section by the base period percentage for the filing month and all months during the taxable year preceding the filing month.

(d) Special rules—(1) Base period percentage. The base period percentage for any period of months shall be the average percent that the taxable income for the corresponding months in each of the three preceding taxable years bears to the taxable income for the three preceding taxable years.

(2) Filing month. The term filing month means the month in which the installment is required to be paid.

(3) Application of the rules related to the annualized income installment method to the adjusted seasonal installment method. The rules governing the computation of taxable income (and resulting tax) for purposes of determining any required installment payment of estimated tax under the annualized income installment method under §1.6655-2 shall apply to the computation of taxable income (and resulting tax) for purposes of determining any required installment payment of estimated tax under the adjusted seasonal installment method.

(e) Example. The provisions of this section may be illustrated by the following example:

Example. (i) X, a corporation that reports on a calendar year basis, expected that it would have an estimated tax liability of $1,200,000 for its taxable year ending December 31, 2006. On its 2005 tax return, X reported a tax liability of $652,800. X paid four installments of estimated tax, each in the amount of $250,000, $250,000, $250,000, and $450,000 on April 17, 2006, June 15, 2006, September 15, 2006, and December 15, 2006, respectively. X reported a tax liability of $1,152,600 on its return due March 15, 2007, with no credits against tax. Under the general provision of section 6655(b) and section 6655(d), there was an underpayment in the amount of $76,300 for the second installment through September 15, 2006, and $114,450 for the third installment through December 15, 2006, determined as follows:

(ii) X wants to determine if it qualifies for the adjusted seasonal installment method. X determines that its monthly taxable income for the preceding three taxable years and for the current taxable year 2006 is as follows:

(iii) X must initially determine if its base period percentage for the same 6 consecutive months of the 3 preceding taxable years equals or exceeds 70 percent (see section 6655(e)(3) and paragraphs (b) and (c) of this section). By using its taxable income for the first 6 months of 2003, 2004, and 2005, X qualifies for the adjusted seasonal installment method because its base period percentage is 87.5 percent (which exceeds 70 percent) computed as follows:

(iv) To determine the amount of the first installment under the rules of section 6655(e)(3) and paragraph (a) of this section, the following computation is necessary:

(v) To determine the amount of the second installment under the rules of section 6655(e)(3) and paragraph (a) of this section, the following computation is necessary:

(vi) To determine the amount of the third installment under the rules of section 6655(e)(3) and paragraph (a) of this section, the following computation is necessary:

(vii) To determine the amount of the fourth installment under the rules of section 6655(e)(3) and paragraph (a) of this section, the following computation is necessary:

(viii) Because the total amount of each required estimated tax payment determined under section 6655(e)(3) and paragraph (a) of this section exceeds the amount of each required estimated tax payment determined under section 6655(d) and §1.6655-1(d) and (e), the exception described in section 6655(e) and this section does not apply and the addition to the tax with respect to the underpayment for the June 15, 2006, and September 15, 2006, installments will be imposed unless another exception (for example, see section 6655(e)(2)) applies with respect to these installments.

(f) Effective date. This section applies to taxable years beginning after the date that is 30 days after the date the final regulations are published in the Federal Register.

Par. 8. Section 1.6655-4 is added to read as follows:

(a) Large corporation defined. The term large corporation means any corporation (or a predecessor corporation) that had taxable income of at least $1,000,000 for any taxable year during the testing period. For purposes of this section, a predecessor corporation is the distributor or transferor corporation in a transaction to which section 381 (relating to carryovers in certain corporate acquisitions) applies.

(b) Testing period. For purposes of paragraph (a) of this section, the term testing period means the 3 taxable years immediately preceding the taxable year for which estimated tax is being determined (the current taxable year) or, if less, the number of taxable years the taxpayer has been in existence.

(c) Computation of taxable income during testing period—(1) Short taxable year. In the case of a corporation (or predecessor corporation) that had a short taxable year during the testing period, for purposes of determining whether the $1,000,000 amount referred to in paragraph (a) of this section is equaled or exceeded, the taxable income for the short taxable year is computed by—

(i) Multiplying the taxable income for the short taxable year by 12; and

(ii) Dividing the resulting amount by the number of months in the short taxable year.

(2) Computation of taxable income in taxable year when there occurs a transaction to which section 381 applies. (i) For purposes of determining whether an acquiring corporation had taxable income of $1,000,000 or more for a taxable year in which there occurs a transaction to which section 381 applies, the acquiring corporation’s taxable income will be the sum of—

(A) The taxable income of the acquiring corporation for its taxable year; plus

(B) The taxable income of the distributor or transferor corporation for that portion of the acquiring corporation’s taxable year up to and including the date of distribution or transfer (as defined in §1.381(b)-1(b)).

(ii) For purposes of determining whether a transferor or distributor corporation had taxable income of $1,000,000 or more for a taxable year in which there occurs a transaction to which section 381 applies, the distributor or transferor corporation’s taxable income shall be reduced by the amount of its taxable income for that portion of its taxable year corresponding to the acquiring corporation’s taxable year up to and including the date of distribution or transfer (as defined in §1.381(b)-1(b)).

(d) Members of controlled group—(1) In general. For purposes of applying paragraph (a) of this section, the taxable income of members of a controlled group of corporations (as defined in section 1563(a)) must be aggregated for each year of the testing period. The provisions of this section shall not apply to a controlled group for any taxable year in which the aggregate taxable income of the members of the controlled group is less than $1,000,000.

(2) Aggregation. For purposes of paragraph (d)(1) of this section, a taxable loss of any member of the controlled group for a taxable year during the testing period is not taken into account.

(3) Allocation rule. If the aggregate taxable income of members of a controlled group computed pursuant to paragraph (d)(1) of this section exceeds $1,000,000 during the testing period, the $1,000,000 amount that is relevant for purposes of determining, under paragraph (a)(1) of this section, whether a corporation is a large corporation shall be divided equally among the component members of such group (including component members excluded pursuant to paragraph (d)(2) of this section) unless all of such component members consent to an apportionment plan providing for an alternative allocation of such amount. The procedure for making and filing this plan will be the same as the procedure used for making and filing an apportionment plan under section 1561. See section 1561 and the regulations.

(4) Controlled group members. (i) In the case of any corporation that was a member of a controlled group of corporations at any time during the testing period but is not a member of such group during the taxable year involved, the taxable income of the former member for the testing period is determined as if such corporation were not a member of a group at any time during that period. With respect to the controlled group, the taxable income of its former member will not be taken into account in determining such group’s taxable income for any taxable year during the testing period for purposes of applying paragraph (a)(1) of this section.

(ii) For purposes of paragraph (d)(4)(i) of this section, the determination of whether a corporation is a member of a controlled group during the testing period is based on whether the corporation was a member of the controlled group on the last day of the month preceding the due date of the required installment.

(e) Effect on a corporation’s taxable income of items that may be carried back or carried over from any other taxable year. In determining whether a corporation (or predecessor corporation) is a large corporation for its current taxable year, items that could offset taxable income during a taxable year included in the testing period (for example, those described in sections 172 and 1212) are not to be taken into account and the taxable income of a corporation for any taxable year during the testing period shall be determined without regard to items carried back or carried over from any other taxable year.

(f) Consolidated returns. [Reserved].

(g) Example. The provisions of this section may be illustrated by the following example:

Example. Y Corporation and Z Corporation are calendar year taxpayers. In 2006, Z acquires all of the assets of Y in a transaction to which section 381 applies. Z’s taxable income for both 2004 and 2005 was less than $1,000,000. Y’s taxable income for 2006 is determined under paragraph (c)(2) of this section to be $300,000 for that portion of the acquiring corporation’s taxable year up to and including the date of transfer. Z’s taxable income for 2006 is $800,000. Under the provisions of paragraph (c)(2) of this section, Z’s 2006 taxable income for purposes of determining whether it is a large corporation for taxable year 2007 is $1,100,000 ($800,000 + $300,000). Thus, Z is a large corporation for the 2007 taxable year. In addition, if Z’s 2006 taxable income, as determined under paragraph (c)(2) of this section, had been less than $1,000,000 but Y’s taxable income in 2004 or 2005 had been $1,000,000 or more, Z would be a large corporation for taxable year 2007 because Y is a predecessor corporation.

(h) Effective date. This section applies to taxable years beginning after the date that is 30 days after the date the final regulations are published in the Federal Register.

(a) In general. Except as otherwise provided in this section, the provisions of section 6655 and the regulations are applicable in the case of a short taxable year (including an initial taxable year) for which a payment of estimated tax is required to be made.

(b) Exception to payment of estimated tax. In the case of a short taxable year, no payment of estimated tax is required if—

(1) The short taxable year is a period of less than 4 full calendar months; or

(2) The tax shown on the return for such taxable year (or, if no return is filed, the tax) is less than $500.

(c) Installment due dates—(1) In general—(i) Taxable year of four months but less than twelve months. Except as otherwise provided, in the case of a short taxable year, if such year results in a taxable year of four or more full calendar months but less than twelve full calendar months, the due dates prescribed in §1.6655-1(f)(2) shall apply.

(ii) Exception. If the date determined under paragraph (c)(1)(i) of this section for the first required installment due during the taxpayer’s short taxable year is earlier than the 15th day of the fourth month of the taxpayer’s short taxable year, the taxpayer’s first required installment shall be due on the first due date otherwise determined under paragraph (c)(1)(i) of this section that is on or after the 15^th day of the fourth month of the short taxable year.

(2) Early termination of taxable year—(i) In general. Except as provided in paragraph (c)(2)(ii) of this section, if a taxable year ends early (for example, as a result of an acquisition or a change in taxable year), the due date for the final required installment shall be the date that would have been the due date of the next required installment if the event that gave rise to the short taxable year had not occurred.

(ii) Exception. If the date determined under paragraph (c)(2)(i) of this section is within thirty days of the last day of the short taxable year, the due date for the final required installment shall be the fifteenth day of the second month following the month that includes the last day of the short taxable year.

(d) Amount due for required installment—(1) In general. The amount due for any required installment determined under section 6655(d)(1)(B)(i) for a short taxable year shall be 100% of the required annual payment for the short taxable year divided by the number of required installments due (as determined under this section) for the short taxable year.

(2) Tax shown on the return for the preceding taxable year. If the current taxable year is a short taxable year, the amount due for any required installment determined under section 6655(d)(1)(B)(ii) shall be determined in the following manner—

(i) Take 100% of the tax shown on the return of the corporation for the preceding taxable year;

(ii) Multiply such amount by the number of full calendar months in the current short taxable year and divide by 12; and

(iii) Divide the amount determined under paragraph (d)(2)(ii) of this section by the number of required installments due (as determined under this section) for the current short taxable year.

(3) Applicable percentage. In the case of any required installment determined under section 6655(e), the applicable percentage under section 6655(e)(2)(B)(ii) shall be—

(i) 25%, 50%, 75%, and 100% for the first, second, third, and fourth (last) required installments, respectively, if the taxpayer will have four required installments due for the short taxable year;

(ii) 33.33%, 66.67%, and 100% for the first, second, and third (last) required installments, respectively, if the taxpayer will have three required installments due for the short taxable year;

(iii) 50% and 100% for the first and second (last) required installments, respectively, if the taxpayer will have two required installments due for the short taxable year; or

(iv) 100% for the first (and last) required installment if the taxpayer will have one required installment for the short taxable year.

(e) Examples. The following examples illustrate the rules of this section:

Example 1. A corporation is a calendar year taxpayer that was acquired by B corporation on April 16, 2007, resulting in A having a short taxable year from January 1 through April 16, 2007. Because A has a taxable year of less than four full calendar months, no estimated tax payments are required by A for the short taxable year.

Example 2. B corporation began business on January 10, 2007, and adopted a calendar year as its taxable year. B computes its required installments based on 100 percent of the tax shown on the return for the taxable year in accordance with section 6655(d)(1)(B)(i). Pursuant to §1.6655-1(f)(2)(i), the due dates of B’s required installments for B’s initial taxable year from January 10, 2007, through December 31, 2007, are April 15, 2007, June 15, 2007, September 15, 2007, and December 15, 2007. However, because the due dates for the first, third, and fourth required installments fall on a weekend, B’s required installment payments will be timely if paid on or before the first business day following the actual due date of the required installments, that is, April 16, 2007, September 17, 2007, and December 17, 2007, respectively, for the first, third, and fourth required installments. Pursuant to paragraph (d)(1) of this section, the amount due with each required installment is 25% of the required annual payment for B’s first required installment, 50% of the required annual payment for B’s second required installment, 75% of the required annual payment for B’s third required installment, and 100% of the required annual payment for B’s fourth required installment.

Example 3. Corporation C began business on February 12, 2007, and adopted a calendar year as its taxable year. C computes its required installments based on 100 percent of the tax shown on the return for the taxable year in accordance with section 6655(d)(1)(B)(i). Pursuant to §1.6655-1(f)(2)(i), the due dates of C’s required installments for C’s initial taxable year from February 12, 2007, through December 31, 2007, are April 15, 2007, June 15, 2007, September 15, 2007, and December 15, 2007. However, in accordance with paragraph (c)(1)(ii) of this section, C’s first required installment is due June 15, 2007, because April 15, 2007, is earlier than the fifteenth day of the fourth month of C’s taxable year. As a result, C’s second required installment is due September 15, 2007, and C’s third (and last) installment is due December 15, 2007. However, because the due dates for the second and third (and last) required installments fall on a weekend, C’s required installment payments will be timely if paid on or before the first business day following the actual due date of the required installments, that is, September 17, 2007, and December 17, 2007, respectively, for the second and third (and last) required installments. Pursuant to paragraph (d)(1) of this section, the amount due with each required installment is 33.33% of the required annual payment for C’s first required installment, 66.67% of the required annual payment for C’s second required installment, and 100% of the required annual payment for C’s third (and last) required installment.

Example 4. Same facts as Example 3 except C began business on April 10, 2007. In accordance with paragraph (c)(1)(ii) of this section, C’s first required installment is due September 15, 2007, because April 15, 2007, and June 15, 2007, are earlier than the fifteenth day of the fourth month of C’s taxable year. As a result, C’s second (and last) required installment is due December 15, 2007. However, because the due dates for the first and second (and last) required installments fall on a weekend, C’s required installment payments will be timely if paid on or before the first business day following the actual due date of the required installments, that is, September 17, 2007, and December 17, 2007, respectively, for the first and second (and last) required installments. Pursuant to paragraph (d)(1) of this section, the amount due with each required installment is 50% of the required annual payment for C’s first required installment, and 100% of the required annual payment for C’s second (and last) required installment.

Example 5. D corporation began business on February 12, 2007, and adopted a fiscal year ending October 31 as its taxable year. D computes its required installments based on 100 percent of the tax shown on the return for the taxable year in accordance with section 6655(d)(1)(B)(i). Pursuant to §1.6655-1(f)(2)(ii), the due dates of D’s required installments for D’s initial taxable year from February 12, 2007, through October 31, 2007, are February 15, 2007, April 15, 2007, July 15, 2007, and October 15, 2007. However, in accordance with paragraph (c)(1)(ii) of this section, D’s first required installment is due July 15, 2007, because February 15, 2007, and April 15, 2007, are earlier than the fifteenth day of the fourth month of D’s taxable year. As a result, D’s second (and last) installment is due October 15, 2007. However, because the due date for the first required installment falls on a weekend, D’s first required installment payment will be timely if paid on or before the first business day following the actual due date of the required installment, that is, July 16, 2007. Pursuant to paragraph (d)(1) of this section, the amount due with each required installment is 50% of the required annual payment for D’s first required installment, and 100% of the required annual payment for D’s second (and last) required installment.

Example 6. Same facts as Example 5 except D corporation began business on May 10, 2007. In accordance with paragraph (c)(1)(ii) of this section, D’s first (and last) installment is due October 15, 2007, because July 15, 2007, is earlier than the fifteenth day of the fourth month of D’s taxable year. Pursuant to paragraph (d)(1) of this section, the amount due with D’s required installment is 100% of the required annual payment, computed as 100% divided by the number of required installments due for the short taxable year.

Example 7. E corporation is a calendar year taxpayer that computes its required installments based on 100 percent of the tax shown on the return for the taxable year in accordance with section 6655(d)(1)(B)(i). E computes its 2007 required installments based on a projected 2007 total tax liability of $600,000. On July 31, 2007, E is acquired by F corporation resulting in E having a short taxable year from January 1, 2007, through July 31, 2007. E determines that its total tax liability for the short period is $350,000. The due dates for E’s first and second required installments are April 15, 2007, and June 15, 2007, respectively. However, because the due date for the first required installment falls on a weekend, E’s first required installment payment will be timely if paid on or before the first business day following the actual due date of the required installment, that is, April 16, 2007. Pursuant to section 6655(d)(1)(A), E paid $150,000 with each required installment. Pursuant to paragraph (c)(2) of this section, E’s third (and last) required installment of estimated tax is due on September 15, 2007, and the percentage of the required annual payment due with such installment is 100% pursuant to paragraph (d)(1) of this section. However, because the due date for the third (and last) required installment falls on a weekend, E’s third (and last) required installment payment will be timely if paid on or before the first business day following the actual due date of the required installment, that is, September 17, 2007. Accordingly, E is required to pay $50,000 with its final required installment on September 17, 2007 ($350,000 total tax liability for the short taxable year less prior installment payments of $300,000).

Example 8. Same facts as Example 7 except that E is acquired by F corporation on August 31, 2007. Pursuant to paragraph (c)(2)(ii) of this section, E’s third (and last) required installment of estimated tax is due on October 15, 2007, because September 15, 2007, the date that would have been the due date of E’s next required installment if F’s acquisition of E had not occurred, is within thirty days of the last day of E’s short taxable year, and 100% of the required annual payment is due with such installment.

Example 9. F corporation is a calendar year taxpayer that computes its required installments based on 100 percent of the tax shown on the return for the taxable year in accordance with section 6655(d)(1)(B)(i). F computes its 2007 estimated tax payments based on a projected 2007 total tax liability of $900,000. On December 3, 2007, F is acquired by G corporation resulting in F having a short taxable year from January 1, 2007, through December 3, 2007. F determined its total tax liability for the short period to be $800,000. The due dates for F’s first, second, and third required installments are April 15, 2007, June 15, 2007, and September 15, 2007, respectively. However, because the due dates for the first and third required installments fall on a weekend, F’s required installment payments will be timely if paid on or before the first business day following the actual due date of the required installments, that is, April 16, 2007, and September 17, 2007, respectively, for the first and third required installments. Pursuant to section 6655(d)(1)(A), F paid $225,000 with each required installment. Pursuant to paragraph (c)(2)(ii) of this section, F’s fourth (and last) required installment of estimated tax is due on February 15, 2008, and the percentage of the required annual payment due with such installment is 100% pursuant to paragraph (d)(1) of this section. Accordingly, F is required to pay $125,000 with its final required installment due February 15, 2008 ($800,000 total tax liability for the short taxable year less prior installment payments of $675,000).

Example 10. G corporation, a calendar year taxpayer, reported a tax liability of $75,000 on its return for the taxable year ending December 31, 2006, and is not a large corporation as defined in section 6655(g). On July 31, 2007, G makes a final distribution of its assets, in connection with a plan of complete liquidation, resulting in a short taxable year from January 1, 2007, through July 31, 2007. To satisfy the requirements of the exception described in section 6655(d)(1)(B)(ii) for payments determined by reference to the tax shown on the return of the corporation for the preceding taxable year, pursuant to paragraph (d)(2) of this section, G must pay in a proportionate amount of its 2006 tax liability based on the number of months in the current taxable year. Accordingly, G must pay $43,750 ($75,000 X 7/12) through payments of estimated tax payments in 2007, with $14,583 due on April 15, 2007, June 15, 2007, and September 15, 2007. However, because the due dates for the first and third required installments fall on a weekend, G’s required installment payments will be timely if paid on or before the first business day following the actual due date of the required installments, that is, April 16, 2007, and September 17, 2007, respectively, for the first and third required installments.

Example 11. Same facts as Example 10 except that G makes a final distribution of its assets, in connection with a plan of complete liquidation, on October 1, 2007, resulting in a short taxable year from January 1, 2007, through October 1, 2007. To satisfy the requirements of the exception described in section 6655(d)(1)(B)(ii), G must pay $56,250 ($75,000 x 9/12) through payments of estimated tax in 2007, with $14,063 due on April 15, 2007, June 15, 2007, September 15, 2007, and December 15, 2007, respectively. However, because the due dates for the first, third, and fourth required installments fall on a weekend, G’s required installment payments will be timely if paid on or before the first business day following the actual due date of the required installments, that is, April 16, 2007, September 17, 2007, and December 17, 2007, respectively, for the first, third, and fourth required installments.

Example 12. H corporation began business on February 15, 2007, and adopted a calendar year. H computes its required installments based on 100 percent of the tax shown on the return for the taxable year in accordance with section 6655(d)(1)(B)(i). H estimated at the beginning of its short taxable year that its estimated tax liability for short taxable year February 15, 2007, through December 31, 2007, would be $180,000. H paid its first required installment of estimated tax of $60,000 on June 15, 2007, its second required installment of estimated tax of $60,000 on September 17, 2007, and its third (and last) required installment of estimated tax of $60,000 on December 17, 2007 ($180,000 total estimated tax liability for the short taxable year less prior installment payments of $120,000). H reported a tax liability of $240,000 on its return for the short period February 15, 2007, through December 31, 2007, with no credits against tax. There was an underpayment in the amount of $20,000 on the first installment date through September 15, 2007, $40,000 on the second installment date through December 15, 2007, and $60,000 on the third (and last) installment date through March 15, 2008, determined as follows:

(f) 52 or 53 week taxable year. For purposes of this section, a taxable year of 52 or 53 weeks shall be deemed a period of 12 months in the case of a corporation that computes its taxable income in accordance with the election permitted by section 441(f).

(g) Use of annualized income or seasonal installment method—(1) In general. Regardless of the annual accounting period used by a corporation (for example, calendar year, fiscal year) the taxpayer may use the method described in §1.6655-2 (annualized income installment method) or §1.6655-3 (adjusted seasonal installment method) to compute its required installments of estimated tax when the current taxable year is a short taxable year.

(2) Computation of annualized income installment. To the extent a short taxable year includes an annualization period elected by the taxpayer, the taxpayer shall compute its annualized income installment by determining the tax on the basis of such annualized income for the annualization period multiplied by the number of months in the short taxable year divided by 12.

(3) Annualization period for final required installment. For purposes of determining the final required installment (as described in paragraph (c)(2) of this section) for a short taxable year, annualized taxable income shall be determined by placing on an annualized basis the taxable income for the last complete annualization period that occurs within the short taxable year.

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

Example 1. X corporation began business on February 12, 2007, and adopted a calendar year as its taxable year. X adopts an accrual method of accounting and uses the annualized income installment method under section 6655(e)(2)(A)(i) to calculate all of its required installment payments for its 2007 taxable year. Pursuant to §1.6655-1(f)(2)(i), the due dates of X’s required installments for X’s initial taxable year from February 12, 2007, through December 31, 2007, are April 15, 2007, June 15, 2007, September 15, 2007, and December 15, 2007. However, in accordance with paragraph (c)(1)(ii) of this section, X’s first required installment is due June 15, 2007. As a result, X’s second required installment is due September 15, 2007, and X’s third (and last) required installment is due December 15, 2007. However, because the due dates for the third and fourth required installments fall on a weekend, X’s required installment payments will be timely if paid on or before the first business day following the actual due date of the required installments, that is, September 17, 2007, and December 17, 2007, respectively, for the third and fourth required installments. The amount of X’s first and second required installments are each based on annualizing X’s taxable income from February 12, 2007, through April 30, 2007, (the first three months of X’s taxable year) and X’s third (and last) required installment is based on annualizing X’s taxable income from February 12, 2007, through July 31, 2007 (the first six months of X’s taxable year). Because X will have three required installments due for its short taxable year, pursuant to paragraph (d)(3)(ii) of this section, the applicable percentage is 33.33% for X’s first required installment, 66.67% for X’s second required installment, and 100% for X’s third (and last) required installment.

Example 2. Y, a calendar year corporation, made a final distribution of its assets, in connection with a plan of complete liquidation, on August 1, 2007. Y filed a timely election to use the alternative annualization periods described under section 6655(e)(2)(C)(i) and determined that its taxable income for the first 2, 4 and 7 months of the taxable year was $25,000, $50,000 and $140,000. The due dates for Y’s required installments for its short taxable year January 1, 2007, through August 1, 2007, are April 15, 2007, June 15, 2007, and September 15, 2007. However, because the due dates for the first and third required installments fall on a weekend, Y’s required installment payments will be timely if paid on or before the first business day following the actual due date of the required installments, that is, April 16, 2007, and September 17, 2007, respectively, for the first and third required installments. Y made installment payments of $10,000, $10,000, and $20,000, respectively, on April 16, 2007, June 15, 2007, and September 17, 2007. The taxable income for each period is annualized as follows:

(i)(A) To determine whether the first required installment equals or exceeds the amount that would have been required to have been paid if the estimated tax were equal to one hundred percent of the tax computed on the annualized income for the 2-month period taking into account the number of months in the short taxable year, the following computation is necessary:

(B) Because the total amount of estimated tax that is timely paid on or before the first installment date ($10,000) exceeds the amount required to be paid on or before this date if the estimated tax were one hundred percent of the tax determined by placing on an annualized basis the taxable income for the first 2-month period taking into account the number of months in the short taxable year, the exception described in §1.6655-2(a) applies and no addition to tax will be imposed for the installment due on April 15, 2007.

(ii)(A) To determine whether the required installments made on or before June 15, 2007, equal or exceed the amount that would have been required to have been paid if the estimated tax were equal to one hundred percent of the tax computed on the annualized income for the 4-month period taking into account the number of months in the short taxable year, the following computation is necessary:

(B) Because the total amount of estimated tax available to apply towards the amount due for the second installment ($12,369 ($10,000 paid on the second installment date plus $2,369 overpayment of the first installment)) exceeds the amount required to be paid on or before this date if the estimated tax were one hundred percent of the tax determined by placing on an annualized basis the taxable income for the first 4-month period for the taxable year taking into account the number of months in the short taxable year, the exception described in §1.6655-2(a) applies and no addition to tax will be imposed for the installment due on June 15, 2007.

(iii)(A) Pursuant to paragraph (c) and (d) of this section, the final required installment is due by September 15, 2007, and the applicable percentage due for the final required installment is 100%. However, because the due date for the final required installment falls on a weekend, Y’s final required installment payment will be timely if paid on or before the first business day following the actual due date of the required installment, that is, September 17, 2007. To determine whether the installment payments made on or before September 17, 2007, equal or exceed the amount that would have been required to have been paid if the estimated tax were equal to one hundred percent of the tax computed on the annualized income for the 7-month period taking into account the number of months in the short taxable year, the following computation is necessary:

(B) Because the total amount of estimated tax available to apply towards the amount due for the final installment ($24,738 ($20,000 that is timely paid on the third installment date plus $4,738 overpayment of the second installment)) exceeds the amount required to be paid on or before this date if the estimated tax were one hundred percent of the tax determined by placing on an annualized basis the taxable income for the first 7-month period for the taxable year taking into account the number of months in the short taxable year, the exception described in §1.6655-2(a) applies and no addition to tax will be imposed for the final installment due on September 15, 2007.

(h) Preceding taxable year a short taxable year. If the preceding taxable year referred to in section 6655(d)(1) was a short taxable year, the tax computed on the basis of the facts shown on the return for such preceding year, for purposes of determining the applicability of the exception described in section 6655(d)(2), shall be the tax computed on the annual basis in the manner described in section 443(b)(1) (prior to the reduction of the tax liability in the manner described in the last sentence).

(i) Effective date. This section applies to taxable years beginning after the date that is 30 days after the date the final regulations are published in the Federal Register.

(a) In general. In computing any required installment, a corporation must use the methods of accounting used in computing taxable income for the taxable year for which estimated tax is being determined (the current taxable year).

(b) Exceptions—(1) Automatic accounting method changes. If a taxpayer is making a change in method of accounting for the current taxable year that is permitted to be made with the automatic consent of the Commissioner, the new method of accounting shall be used in determining any required installment if, and only if, the copy of the Form 3115, “Application for Change in Accounting Method,” has been mailed to the IRS National Office on or before the last day of the annualization period.

(2) Non-automatic accounting method changes. If a taxpayer is making a change in method of accounting for the current taxable year that requires the prior consent of the Commissioner, the new method of accounting shall be used in determining any required installment if, and only if, the consent agreement reflecting the Commissioner’s consent to the change in method of accounting and the prescribed terms and conditions for effecting such change has been signed by the taxpayer and mailed to the IRS National Office on or before the last day of the annualization period.

(c) Examples. The following examples illustrate the rules of this section:

Example 1. X corporation, a calendar year taxpayer, uses an accrual method of accounting and the annualization method under section 6655(e)(2)(A)(i) to calculate its 2006 required installments. X receives advance payments each taxable year with respect to agreements for the sale of goods properly includible in X’s inventory. The advance payments received by X qualify for deferral under §1.451-5(c). Although X is eligible to defer the advance payments in accordance with §1.451-5(c), X’s method of accounting with respect to the advance payments is to include the advance payments in income when received. If, as of the last day of the annualization period, X’s method of accounting for advance payments is to include the advance payments in income when received, and the requirements of paragraph (b)(1) or (b)(2) of this section, as applicable, are not met, then X must use that method of accounting for purposes of computing such required installment.

Example 2. Y corporation, a calendar year taxpayer, uses an accrual method of accounting and the annualization method under section 6655(e)(2)(A)(i) to calculate its 2006 required installments. Y computes its annual taxable income by deducting its liability for state income taxes in the taxable year the taxes are paid, without regard to the recurring item exception of section 461(h) and the regulations. If, as of the last day of the annualization period, Y’s method of accounting for state income taxes is to deduct such taxes in the taxable year the taxes are paid without regard to the recurring item exception, and the requirements of paragraph (b)(1) or (b)(2) of this section, as applicable, are not met, then Y must use that method of accounting for purposes of computing such required installment.

(d) Effective date. This section applies to taxable years beginning after the date that is 30 days after the date the final regulations are published in the Federal Register.

Par. 12. Newly designated §1.6655-7 is revised to read as follows:

(a) Section 6655(h) imposes an addition to the tax under chapter 1 of the Internal Revenue Code in the case of any excessive amount (as defined in paragraph (c) of this section) of an adjustment under section 6425 that is made before the 15th day of the third month following the close of a taxable year beginning after December 31, 1967. This addition to tax is imposed whether or not there was reasonable cause for an excessive adjustment.

(b) If the amount of an adjustment under section 6425 is excessive, there shall be added to the tax under chapter 1 of the Internal Revenue Code for the taxable year an amount determined at the annual rate referred to in the regulations under section 6621 upon the excessive amount from the date on which the credit is allowed or refund paid to the 15^th day of the third month following the close of the taxable year. A refund is paid on the date it is allowed under section 6407.

(c) The excessive amount is equal to the lesser of the amount of the adjustment or the amount by which—

(1) The income tax liability (as defined in section 6425(c)) for the taxable year, as shown on the return for the taxable year; exceeds

(2) The estimated income tax paid during the taxable year, reduced by the amount of the adjustment.

(d) The computation of the addition to the tax imposed by section 6425 is made independent of, and does not affect the computation of, any addition to the tax that a corporation may otherwise owe for an underpayment of an installment of estimated tax.

(e) The following example illustrates the rules of this section:

Example. (i) Corporation X, a calendar year taxpayer, had an underpayment as defined in section 6655(b), for its fourth installment of estimated tax that was due on December 15, 2006, in the amount of $10,000. On January 2, 2007, X filed an application for adjustment of overpayment of estimated income tax for 2006 in the amount of $20,000.

(ii) On February 16, 2007, the IRS, in response to the application, refunded $20,000 to X. On March 15, 2007, X filed its 2006 tax return and made a payment in settlement of its total tax liability. Assuming that the addition to tax is computed under section 6621(a)(2) at a rate of 8% per annum for the applicable periods of underpayment, under section 6655(a), X is subject to an addition to tax in the amount of $197 (90/365 X $10,000 X 8%) on account of X’s December 15, 2006, underpayment. Under section 6655(h), X is subject to an addition to tax in the amount of $118 (27/365 X $20,000 X 8%) on account of X’s excessive adjustment under section 6425. In determining the amount of the addition to tax under section 6655(a) for failure to pay estimated income tax, the excessive adjustment under section 6425 is not taken into account.

(f) An adjustment is generally to be treated as a reduction of estimated income tax paid as of the date of the adjustment. However, for purposes of §1.6655-1 through §1.6655-6, the adjustment is to be treated as if not made in determining whether there has been any underpayment of estimated income tax and, if there is an underpayment, the period during which the underpayment existed.

(g) This section applies to taxable years beginning after the date that is 30 days after the date the final regulations are published in the Federal Register.

(a) For regulations under section 6655, see §§1.6655-1 through 1.6655-7 of this chapter.

(b) This section applies to taxable years beginning after the date that is 30 days after the date the final regulations are published in the Federal Register.

Mark E. Matthews,
Deputy Commissioner for
Services and Enforcement.