IRS Tax Forms  
Instructions for Form 8697, (Revised 0398) 2001 Tax Year

Interest Computation Under the Look-Back Method for Completed Long-Term Contracts

Privacy Act and Paperwork Reduction Act Notice.

The Privacy Act of 1974 and Paperwork Reduction Act of 1980 say that when we ask you for information we must tell you our legal right to ask for it, why we are asking for it, and how it will be used. We must also tell you what could happen if we do not receive it and whether your response is voluntary or mandatory under the law.

Section 460 provides special rules for computing interest under the look-back method for completed long-term contracts. Section 6001 and its regulations say that you must file a return or statement with us for any tax you are liable for. Your response is mandatory under this section and its regulations. Section 6109 and its regulations say that you must show your identifying number (social security number or employer identification number) on what you file. This is so we know who you are and can process your return and other papers.

You are not required to provide the information requested on a form that is subject to the Paperwork Reduction Act unless the form displays a valid OMB control number. Books or records relating to a form or its instructions must be retained as long as their contents may become material in the administration of any Internal Revenue law. Generally, tax returns and return information are confidential, as required by section 6103.

We ask for the information on this form to carry out the Internal Revenue laws of the United States. We need this information to ensure that you are complying with these laws and to figure and collect or refund the correct amount of interest.

We may give the information to the Department of Justice and to other Federal agencies, as provided by law. We may also give it to cities, states, the District of Columbia, and U.S. commonwealths or possessions to carry out their tax laws. We may also give it to foreign governments because of tax treaties they have with the United States.

If you do not file Form 8697, do not provide the information we ask for, or provide fraudulent information, you may forfeit any refund of interest otherwise owed to you, be charged penalties, or be subject to criminal prosecution.

The time needed to complete and file this form will vary depending on individual circumstances. The estimated average time is:

Recordkeeping  
Part I 8 hr., 22 min.
Part II 9 hr., 5 min.
Learning about the law or the form  
Part I 2 hr., 11 min.
Part II 1 hr., 35 min.
Preparing, copying, assembling, and sending the form to the IRS  
Part I 2 hr., 25 min.
Part II 1 hr., 49 min.

If you have comments concerning the accuracy of these time estimates or suggestions for making this form simpler, we would be happy to hear from you. You can write to the Tax Forms Committee, Western Area Distribution Center, Rancho Cordova, CA 95743-0001. DO NOT send the tax form to this address. Instead, see Filing Instructions on page 2.

General Instructions

Changes To Note

Election Not To Apply Look-Back Method in De Minimis Cases

You may elect to have the look-back method not apply in certain de minimis cases. See De Minimis Exception on this page for details.

Interest Rate Periods

For contracts completed in tax years ending after August 5, 1997, new rules apply to determine the applicable interest rate and the period for which the rate applies. See the instructions for lines 7 and 8 on page 3 for details.

Purpose of Form

Use Form 8697 to figure the interest due or to be refunded under the look-back method of section 460(b)(2) on certain long-term contracts entered into after February 28, 1986, that are accounted for under either the percentage of completion method or the percentage of completion-capitalized cost method. For guidance concerning these methods, see Notice 89-15, 1989-1 C.B. 634. For details and computational examples illustrating the use of the look-back method, see Regulations section 1.460-6.

Who Must File

General Rule

You must file Form 8697 for each tax year in which you completed a long-term contract entered into after February 28, 1986, that you accounted for using either the percentage of completion method or the percentage of completion-capitalized cost method for Federal income tax purposes. You also must file Form 8697 for any tax year in which the contract price or contract costs are adjusted for one or more of these long-term contracts from a prior year.

A pass-through entity (partnership, S corporation, or trust) that is not closely held must apply the look-back method at the entity level to any contract for which at least 95% of the gross income is from U.S. sources. A pass-through entity is considered closely held if, at any time during any tax year for which there is income under the contract, 50% or more (by value) of the beneficial interests in the entity is held (directly or indirectly) by or for five or fewer persons. For this purpose, rules similar to the constructive ownership rules of section 1563(e) apply.

If you are an owner of an interest in a pass-through entity for every year in which a long-term contract was being accounted for under the percentage of completion method or the percentage of completion-capitalized cost method and the pass-through entity is not subject to the look-back method at the entity level, you must file this form for your tax year that ends with or includes the end of the entity's tax year in which the contract was completed or adjusted.

If the taxpayer reporting income from a long-term contract changes prior to the year of completion of the contract, the taxpayer as of the date of completion will be responsible for the payment of interest (if any) due from any year in which the contract was being accounted for under either the percentage of completion method or the percentage of completion- capitalized cost method. Generally, only the taxpayer that had accounted for a long-term contract in a year that an overpayment occurred may request a refund of interest on the overpayment.

Exception for Certain Construction Contracts

The look-back method does not apply to the regular taxable income from:

  1. Any home construction contract (as defined in section 460(e)(6)(A)), or
  2. Any other construction contract entered into by a taxpayer: (a) who estimates the contract will be completed within 2 years from the date the contract begins, and (b) whose average annual gross receipts for the 3 tax years preceding the tax year in which the contract is entered into do not exceed
    $10 million. See section 460(e).

However, the look-back method does apply to the alternative minimum taxable income from any such contract that must be accounted for using the percentage of completion method for alternative minimum tax purposes. See section 56(a)(3) for details.

Small Contract Exception

The look-back method does not apply to any contract completed within 2 years of the contract start date if the gross price of the contract (as of contract completion) does not exceed the smaller of:

  1. $1 million, or
  2. 1% of the taxpayer's average annual gross receipts for the 3 tax years before the tax year of contract completion.

See section 460(b)(3)(B) for details.

De Minimis Exception

You may elect not to apply the look-back method in certain de minimis cases for contracts completed in tax years ending after August 5, 1997. The look-back method does not apply in the following cases if the election is made:

  1. In the completion year if, for each prior contract year, the cumulative taxable income (or loss) actually reported under the contract is within 10% of the cumulative look-back income (or loss). Cumulative look-back income (or loss) is the amount of taxable income (or loss) that you would have reported if you had used actual contract price and costs instead of estimated contract price and costs.
  2. In a post-completion year if, as of the close of the post-completion year, the cumulative taxable income (or loss) under the contract is within 10% of the cumulative look-back income (or loss) under the contract as of the close of the most recent year in which the look-back method was applied to the contract (or would have been applied if the election had not been made).

For purposes of item 2, discounting under section 460(b)(2) does not apply.

To make the election, attach a statement to your timely filed income tax return (determined with extensions) for the first tax year of the election. Write at the top of the statement NOTIFICATION OF ELECTION UNDER SECTION 460(b)(6). Include on the statement your name, identifying number, and the effective date of the election. Also identify the trades or businesses that involve long-term contracts. Once made, the election applies to all contracts completed during the election year and all later tax years and may not be revoked without IRS consent. See Temporary Regulations section 1.460-6T(j) for more details.

Filing Instructions

If You Owe Interest or No Interest Is To Be Refunded To You

Attach Form 8697 to your income tax return.

For taxpayers other than partnerships, include any interest due in the amount to be entered for total tax (after credits and other taxes) on your return (e.g., 1997 Form 1040, line 53; 1997 Form 1120, Schedule J, line 10, etc.). Write on the dotted line to the left of the entry space From Form 8697 and the amount of interest due.

For partnerships, write From Form 8697 and any interest due in the bottom margin of the tax return, and attach a check or money order for the full amount payable to Internal Revenue Service (not IRS). Write the partnership's employer identification number (EIN), daytime phone number, and Form 8697 Interest on the check or money order.

If Interest Is To Be Refunded To You

Do not attach Form 8697 to your income tax return. Instead, file Form 8697 separately with the Internal Revenue Service Center where your income tax return is required to be filed. File the form in a separate envelope from that of your income tax return. Keep a copy of Form 8697 and any attached schedules for your records.

Sign Form 8697 following the instructions for the Signature section of your income tax return. If additional Forms 8697 are needed (to show more than 3 prior tax years), sign only the first Form 8697.

File Form 8697 by the date you are required to file your income tax return (including extensions).

Filing a Corrected Form 8697

You must file a corrected Form 8697 only if the amount shown on Part I, line 6, or Part II, line 7, for any prior year changes as a result of an error you made, an income tax examination, or the filing of an amended tax return.

When completing Part I, line 1, of the corrected Form 8697, follow the instructions on the form but do not enter the adjusted taxable income from Part I, line 3, of the original Form 8697. When completing Part I, line 5 (or Part II, line 6), of the corrected Form 8697, do not include the interest due, if any, from Part I, line 10 (or Part II, line 11), of the original Form 8697 that was included in your total tax when Form 8697 was filed with your tax return.

  • If both the original and corrected Forms 8697 show an amount on the line for interest you owe, file an amended income tax return.
  • If both the original and corrected Forms 8697 show an amount on the line for interest to be refunded to you, write Amended in the top margin of the corrected Form 8697, and file it separately.
  • If your original Form 8697 shows an amount on the line for interest you owe, and the corrected Form 8697 shows an amount on the line for interest to be refunded to you, you must:
    1. File an amended income tax return showing $0 interest from Form 8697, and
    2. File the corrected Form 8697 separately (but do not write Amended at the top of the form because this is the first Form 8697 that you will file separately).
  • If the original Form 8697 shows an amount on the line for interest to be refunded to you, and the corrected Form 8697 shows an amount on the line for interest you owe, you must:
    1. File the corrected Form 8697 separately (with Amended written at the top) showing $0 interest to be refunded, and
    2. File an amended income tax return and attach a copy of the corrected Form 8697.

Attachments

If you need more space, attach separate sheets to the back of Form 8697. Put your name and identifying number on each sheet.

Applying the Look-Back Method Under Special Situations

10% Method

For purposes of the percentage of completion method, a taxpayer may elect to postpone recognition of income and expense under a long-term contract entered into after July 10, 1989, until the first tax year as of the end of which at least 10% of the estimated total contract costs have been incurred. For purposes of the look-back method, the recognition of income and expense must be postponed for such contracts until the first tax year as of the end of which at least 10% of the actual total contract costs have been incurred. Therefore, income and expense will be allocated to a different tax year if the first tax year that the 10% threshold is exceeded based on actual costs differs from the first tax year that the 10% threshold is exceeded based on estimated costs. The election to use the 10% method applies to all long-term contracts entered into during the tax year for which the election is made and all later years. See section 460(b)(5) for more details.

Change Orders

A change order for a contract is not treated as a separate contract for purposes of applying the look-back method unless the change order would be treated as a separate contract under the rules for severing and aggregating contracts provided in Regulations section 1.451-3(e). Therefore, if a change order is not treated as a separate contract, that portion of the actual contract price and contract costs attributable to the change order must be taken into account in allocating contract income to all tax years of the contract, including tax years before the change order was agreed to.

Post-Completion Adjustments

General Rule

If the contract price or costs are revised to reflect amounts properly taken into account after the contract completion date for any reason, you must apply the look-back method in the year such amounts are properly taken into account, even if no other contract is completed in that year. Generally, the amount of each such post-completion adjustment to total contract price or contract costs is discounted, solely for look-back purposes, from its value at the time the amount is taken into account in computing taxable income to its value at the time the contract was completed. The discount rate for this purpose is the Federal mid-term rate under section 1274(d) in effect at the time the amount is properly taken into account.

However, you may elect not to discount post-completion adjustments for any contract. To make this election, attach a statement to your timely filed income tax return (determined with extensions) for the first tax year after completion in which you take into account any adjustment to the contract price or contract costs. Indicate on the statement that you are making an election not to discount post-completion adjustments under Regulations section 1.460-6(c)(1)(ii)(c)(2) and identify the contracts to which the election applies. Once made, the election is binding for all post-completion adjustments that apply to a contract under an election.

Delayed Reapplication Method

For purposes of reapplying the look-back method after the year of contract completion, you may elect the delayed reapplication method. Under this method, the look-back method is reapplied after the contract completion year (or after a later reapplication of the look-back method) only when one of the following conditions is met for that contract:

  1. The net undiscounted value of increases or decreases in the contract price occurring from the time of the last application of the look-back method exceeds the smaller of $1 million or 10% of the total contract price at that time,
  2. The net undiscounted value of increases or decreases in contract costs occurring from the time of the last application of the look-back method exceeds the smaller of $1 million or 10% of the total actual contract costs at that time,
  3. The taxpayer goes out of existence,
  4. The taxpayer reasonably believes the contract is finally settled and closed, or
  5. None of the above conditions (1-4) are met by the end of the 5th tax year that begins after the last previous application of the look-back method.

To elect the delayed reapplication method, attach a statement to your timely filed income tax return (determined with extensions) for the first tax year of the election. Indicate on the statement that you are making an election under Regulations section 1.460-6(e) to use the delayed reapplication method. Once made, the election is binding for all long-term contracts for which you would reapply the look-back method in the absence of the election in the year of the election and all later years, unless the IRS consents to a revocation of the election. See Regulations section 1.460-6(e) for more details.

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