Interest on federal tax deficiencies and overpayments.

Interest on Federal Tax Deficiencies and Overpayments

Introduction

Like many areas of our federal income tax laws, the computation of interest on tax deficiencies (1) and overpayments has become increasingly complex over the years. Fortunately, some of this increasing complexity has been offset by the availability of computers to help in the computations. Thus, the mechanics of making the computation -- which once involved an arcane "month-day" method peculiar to the computation of interest on taxes and still is complicated by frequently changing rates -- can be computerized to do in seconds what would otherwise take hours. (2) It remains necessary, however, for the person making the interest computation to know the rules that determine the period during which interest runs and whether, on the one hand, a single period applies to all of the amount of the deficiency or overpayment or, on the other hand, the aggregate underpayment or overpayment for a given year must be fragmented into separate elements with a different interest period for each element.

In years past, it was not uncommon to find mathematical errors in the interest computations made by the Internal Revenue Service. Consequently, prudent tax practitioners would verify the correctness of such computations. Such mathematical errors are much less likely to occur today, because the IRS itself uses computers to do the mathematical part of the computations. Verification is still important, however, because the IRS may have used the wrong starting date, the wrong ending date, or otherwise not have followed the rules prescribed by the law. (3)

The purpose of this article is two-fold: to provide taxpayers and practitioners with sufficient guidance to make interest computations that will conform to the IRS's interest computations if it is desired to pay additional taxes and interest before a bill for such interest is received from the IRS, and to enable taxpayers and practitioners to verify interest computations made by the IRS. Moreover, because interest has become an increasingly large factor in the cost of any resolution of tax disputes, (4) the correct computation of interest is important in evaluating potential dispositions of such disputes.

Background

In general, interest is due to the government if there is an underpayment of taxes and, with certain exceptions, interest is due to the taxpayer if there is an overpayment of taxes. Before passage of the Tax Reform Act of 1986, interest on underpayments and interest on overpayments were computed at the same rates. This is no longer the case: the Code now provides that interest charged on underpayments is to be one percent more than interest allowed on overpayments.

Changes in the rate and method of computing interest on tax underpayments and overpayments have grown almost geometrically. For years, such interest was simple interest at the rate of six percent per year. It was computed on the basis of a peculiar "month-day" method that was seldom, if ever, used for other purposes. The method was easy to use in the days before computers, however, and most tax practitioners learned to live with it. (5)

In 1975, the first change in rate or method of computation in approximately 40 years occurred when the interest rate was increased from six percent to nine percent. Between that first change and the end of 1989, there have been 19 other changes in either the interest rate or the method of making the computation (e.g., simple interest on a daily method, compound interest, etc.) in even the most straightforward situations. In addition, numerous other special rules have been introduced, such as special rules for the computation of interest on substantial underpayments attributable to tax-motivated transactions. Is there any wonder that errors are made in such interest computations?

Where a computer program is used to assist in the interest computation, presumably these variations in rates and methods will be automatically taken into account. The principal concerns, therefore, become determining the amount on which interest is to be computed and the beginning date and ending date of the interest period. Those areas will be discussed first.

There are basically two types of interest that may be involved:

* interest that is charged to the taxpayer in the case of an asserted underpayment, which is frequently termed "assessed interest" because it is assessed and collected as a part of the tax; (6) and

* interest that is payable to the taxpayer in the case of an overpayment of tax or an overpayment of assessed interest, which is frequently termed "statutory interest."

The terms "assessed interest" and "statutory interest" will be used in this article to distinguish between the two types of interest. (7)

Assessed interest can be a part of the amount on which statutory interest is computed (i.e., whee there is an overpayment of assessed interest). When there has been an overpayment that is refunded, typically the government will send the taxpayer a single check that may contain three elements: (i) a refund of the overpayment of tax, (ii) a refund of the overpayment of assessed interest, and (iii) statutory interest on the overpayment of both tax and assessed interest. Unfortunately, there is often no indication of what portion of the single check is attributable to each of these elements, notwithstanding that each element has different tax consequences. (8)

Throughout this article, the amount on which interest is to be computed will be termed the "base amount." In simple situations, the base amount may be the entire amount of the tax underpayment or overpayment. In other situations, however, the base amount may be only a portion of the entire tax underpayment or overpayment, because interest runs on a part of the entire underpayment or overpayment for a period that is different from the period applicable to another part of the underpayment or overpayment; that is to say, the applicable interest period or periods may dictate or affect the determination of the base amount.

Base Amount

Where a single interest period applies to a tax underpayment on which interest is due, the tax base is the excess of the correct tax over the amount paid. Similarly, where a single interest period applies to a tax overpayment on which interest is due, the tax base is the excess of the aggregate tax paid over the correct tax.

Where different interest periods apply to different parts of the aggregate underpayment or overpayment on which interest is due, the practice is to make a separate interest computation for each part of the underpayment or overpayment that has a different interest period. This approach is graphically presented in Diagram 1, in which the interest period is represented by the horizontal axis and the amount of the underpayment or overpayment is represented by the vertical axis. Where different interest periods apply, the interest computation is made by fragmenting the amount of underpayment or overpayment "horizontally" and making separate interest computations for each element of the underpayment or overpayment.

Thus, the interest computation would properly not be made by fragmenting the interest periods "vertically" and making a separate interest computation for each element of the interest period having a different amount of underpayment or overpayment. See Diagram 2. A limited exception to this may arise in the case of certain interest computations that span December 31, 1982 -- the end of the period when simple interest computations applied.

After determining the amount of an tax underpayment or overpayment on which interest is due but before making any interest computation, there should be a determination whether a single interest period applies to the underpayment or overpayment. If it does, the entire amount of the underpayment or overpayment is the base amount. If it does not (because one interest period applies to one part of the underpayment or overpayment and another interest period applies to another part), the aggregate amount of the underpayment or overpayment must be fragmented into each element that has an interest period that is different from the other, with each such element becoming a base amount for a separate interest computation. The total of the amounts of interest computed in such separate interest computations is the total amount of interest on the underpayment or overpayment.

Statutory interest is payable on an overpayment of assessed interest. It may be necessary to make a computation of the correct amount of assessed interest to determine the amount of the overpayment of assessed interest. Thus, the excess of the assessed interest that was paid over the correct amount of the assessed interest is the overpayment of assessed interest. Such an overpayment is a base amount for a computation of owing statutory interest. Interest may also be due on additions to the tax and tax penalties after such amounts have been assessed, in which case the amount of the addition to the tax or the penalty is the base amount.

Interest Period

The interest period is the period between the time when interest starts to run and the time when interest ceases to run. Each of those times depends on the character of the base amount. If the base amount is an underpayment of tax, generally the interest starts to run on the payment due date; if it is an overpayment, generally the interest starts to run on the date the overpayment is made. The time when the interest ceases to run depends on a number of factors discussed below.

1. Underpayments

Section 6601(a) of the Code provides that if any amount of tax is not paid by the last date prescribed for payment, interest runs from such last date to the date paid. Thus, for a calendar-year corporation, interest on an underpayment of such tax generally starts to run on March 15 of the year following the year for which such tax is due. (9) In the case of an individual using the calendar year for income tax purposes, interest on an underpayment of income tax generally starts on April 15 of the year following the year for which the tax is due. (10) Estate tax returns and the tax thereunder are currently due nine months after the decedent's death, (11) and gift tax returns and the tax thereunder are currently due April 15 following the close of the calendar year in which the gift is made, (12) and those respective dates are the start of the underpayment interest period.

Notwithstanding that section 6601(a) provides that the interest period runs until the date the tax is paid, the interest on underpayments often ends before the date of payment. In the case of a deficiency as defined in section 6211 (relating to income, estate, gift, and certain excise taxes), section 6601(c) provides that, if a waiver of restrictions under section 6213(d) on the assessment of such deficiency (13) has been filed and if notice and demand for payment of such tax is not made within 30 days after the filing of such waiver, interest is not imposed for the period beginning immediately after such 30th day and ending with the date of notice and demand. (14)

In addition, section 6601(e)(3) provides that if notice and demand is made for payment of any amount and such amount is paid within 10 days after the date of such notice and demand, then interest on the amount so paid is not imposed after the date of notice and demand. The effect of section 6601(c) and section 6601(e)(3), taken together, is that if a Form 870 waiver is filed and the tax is thereafter paid within 10 days of the date of the notice and demand, the interest period will end 30 days after the waiver is filed (unless the tax is theretofore paid). (15)

For taxable years beginning before 1983, corporations could elect to make installment payments of income tax. (16) That election could affect the start of the interest period for underpayments. (17)

When an overpayment claimed on a return is either refunded or applied against the next year's estimated tax and subsequently it is determined that the tax shown on the return is understated, interest on the deficiency may start later than the due date of the return, depending on how the claimed overpayment was handled. Rev. Rul. 88-98, 1988-2 C.B. 356, discusses several situations where the claimed overpayment was either refunded without interest or credited to an installment of estimated tax for the next year.

If any portion of a tax underpayment is satisfied by a credit of an overpayment for another period, then no interest is imposed on the portion of the tax so satisfied for any period during which, if the credit had not been made, interest would have been allowable with respect to such overpayment. (18) The interest computation with respect to such an overpayment will be discussed below. The effect of this provision generally is that if the tax that was underpaid was due before the date of the overpayment, interest on the underpayment satisfied by the crediting of the overpayment stops on the date of the overpayment so credited (19); if the tax that was underpaid was due after the date of the overpayment, no interest is due on the underpayment.

In the case of any assessable penalty, additional amount, or addition to the tax, generally interest is due only if such assessable penalty, aditional amount, or addition to the tax is not paid within 10 days from the date of notice and demand therefor, and in such case interest is imposed only for the period from the date of notice and demand to the date of payment. (20) Exceptions to this rule are provided in the case of certain additions to the tax relating to the filing or contents of the tax return, where the interest period begins on the due date of the return (taking account of any extension of time to file the return) and ends on the date of payment of such addition to tax. (21)

2. Overpayments

Section 6611(b) of the Code provides the general rules for the period for interest on overpayments. In the case of an overpayment that is applied as a credit to satisfy another liability, the interest period runs from the date of the overpayment to the due date of the amount against which the credit is taken. (22) In the case of an overpayment that is refunded, the interest period runs from the date of overpayment to a date (to be determined by the IRS) preceding the date of the refund check by not more than 30 days. (23)

Pursuant to section 6611(d), which incorporates section 6513, payment of any portion of the tax before the last day prescribed for payment of the tax is considered as made on such last day. As previously noted, (24) generally the tax is due on the date prescribed for filing the return, and section 6513(a) states that the last day prescribed for filing the return or paying the tax is to be determined without regard to any extension of time granted to the taxpayer and without regard to any election to pay the tax installments. Thus, any overpayment shown on the return attributable, say, to estimated tax payments in excess of the tax due, is deemed an overpayment on the due date for the return, even though such estimated tax payments will have been made before such due date.

Furthermore, section 6611(b)(3) provides that, in the case of a late return (i.e., a return filed after the last day prescribed for filing such return, determined with regard to extensions), no interest is allowed for any period before the date on which such return is filed. Section 6611(e) further provides that no interest is allowed on an overpayment of income tax if such overpayment is refunded within 45 days after the date prescribed for filing the return of such tax (determined without regard to any extension of time for filing the return) or is refunded within 45 days after the return is filed where the return is filed after such last date. (25) In addition, section 6513(d) provides that if any overpayment of income tax is claimed as a credit against estimated tax for the succeeding taxable year, such amount is considered a payment in respect of the succeeding taxable year and not as an overpayment for the taxable year in which the overpayment arose.

In many cases, taxpayer's claim that there has been an overpayment arises because there has been an audit by the IRS as a result of which a deficiency has been asserted and the taxpayer has paid the asserted deficiency and assessed interest thereon. The overpayment does not arise until the taxpayer has paid an amount in excess of the amount due. For example, if the taxpayer makes an interim payment of the amount due in respect of adjustments not disputed and subsequently makes an additional payment of tax in respect of other adjustments (some of which are no longer in dispute and others of which are disputed and are subsequently resolved in the taxpayer's favor), the overpayment of tax arises (and thus the interest period begins) only when the subsequent payment is made.

In such a situation, the base amount is the amount by which the aggregate amount of tax paid exceeds the tax due. Assuming that assessed interest was paid with the payments of taxes, there would also be an overpayment of assessed interest in the amount by which the assessed interest paid exceeded the amount of assessed interest actually due (i.e., calculated on the correct amount of underpayment of tax). The interest period for the overpayment of such assessed interest would begin on the date the overpayment of assessed interest was made. (26)

In contrast, if the taxpayer establishes that there was another favorable adjustment that causes the tax actually due to be less than that shown on the return, there would be three interest periods for three different tax base amounts:

* the intermediate payment of the asserted deficiency computed in respect of adjustments not disputed would be one base amount with an interest period beginning when such interim payment was made;

* the subsequent payment of the asserted deficiency would be another base amount with an interest period beginning when such subsequent payment was made; and

* the amount by which the tax shown on the return exceeded the tax actually due would be a third base amount with an interest period beginning on the due date of the return (determined without regard to any extension of time to file such return).

In addition, the entire amount of assessed interest paid would be an overpayment representing a base amount with an interest period beginning on the date such assessed interest was paid. The aggregate statutory interest due would be the total of these separately calculated amounts.

If an overpayment of income tax results from a carryback of a net operating loss or a net capital loss in a later year, interest on the overpayment resulting from such carryback starts at a date later than for an overpayment that existed when the return for the overpayment year was filed. Section 6611(f)(1) currently provides that interest on an overpayment resulting from such a carryback does not start to run until the "filing date" for the tax year in which the net operating loss or net capital loss arose. For this purpose, the term "filing date" means the last day prescribed for filing the return for the loss year (determined without regard to any extension). (27) For interest accruing prior to October 4, 1982, a slightly different rule applies: interest on the overpayment attributable to such a carryback starts to run at the end of the loss year, rather than on the "filing date" for such year. (28)

A similar rule applies for interest on an overpayment attributable to a carryback of business credits under section 39 (including the investment tax credit, the targeted jobs tax credit, the alcohol fuels tax credit, and the employee stock ownership tax credit), the research credit carryback under section 30(g)(2), (29) and the foreign tax credit. (30) That is to say, interest for any such overpayment does not begin to run until the "filing date" for the tax year that gives rise to the carried-back credit (or until the end of such tax year in the case of interest accruing before October 4, 1982).

Furthermore, in the case of a net operating loss carryback, a capital loss carryback, or one of the credit carrybacks discussed in the preceding paragraph, a variation of the 45-day rule under section 6611(e) applies, so that no interest is payable if the overpayment attributable to such a carryback is refunded within 45 days of the date when the claim for such overpayment is filed. (31) Also, if a taxpayer first files a claim for refund of such an overpayment and subsequently files an application for a tentative refund under section 6411(a) (i.e., a "quickie refund") with respect to such overpayment, the 45-day period starts to run when the application under section 6411(a) was filed. (32)

Rates and Methods for Computing Interest

If a computer program to compute interest on federal taxes is available, presumably it will automatically make interest calculations using the rates and method prescribed for the interest period involved. If such computations must be made without the benefit of such a program, however, separate interest computations must be made for each portion of the interest period that has a different interest rate or different computation method; the interest for the aggregate interest period is the sum of such separate interest computations. If the interest period extends over a long period, this can involve many separate interest computations.

Rev. Proc. 83-7, 1983-1 C.B. 583, provides a fairly comprehensive description of the interest rates and computation methods in effect prior to 1983 and for the first six months of 1983, when compound interest first went into effect. Thereafter interest rates changed, and the frequency with which they changed increased, but the computation method has stayed the same. Rev. Proc. 83-7 also provides tables and factors for computing interest both under the simple interest rates and procedures in effect prior to 1983 and under the daily compounding rules effective for interest accruing after 1982. Therefore, for anyone desiring to understand the intricacies of the computation of interest on federal taxes, Rev. Proc. 83-7 is required reading. It is also the source of the interest factors that must be used if a computer program to make the interest computations is not to be used.

1. Interest Rates and Methods in Effect Before 1983

For interest prior to July 1, 1975, simple interest at six percent a year was prescribed by the Code. (33) The "month-day" method (which is described below) was employed to compute such interest. The "month-day" method continued to be the prescribed method for interest through Janury 31, 1980, although varying interest rates were in effect. From February 1, 1980, through December 31, 1982, the IRS used a daily rate to compute simple interest at the prescribed rate. the Tax Equity and Fiscal Responsibility Act of 1982 (TEFRA) added section 6622 to the Code, which requires the daily compounding of interest on all amounts accruing after December 31, 1982.

The "month-day" method of computing interest was well suited to the computation of interest when the interest rate was six-percent simple interest and when computers were not available to assist in the computation. The interest period was stated in terms of the number of years, months, and days, and an interest factor was assigned to each number: six percent for each year, one-half of one percent for each month (regardless of the number of days in the month), and a factor from a simple 30-factor table for the number of days. (34) The three interest factors (for years, months, and days) were added up to obtain a total interest factor for the interest period, and the base amount was multiplied by such total interest factor.

To obtain the number of years, months, and days, the date of the end of the interest period was set up in terms of the year, the month of the year, and the day of the month. The date of the beginning of the interest period was similarly set up and subtracted from the end of the interest period, as follows:

End of interest period: #year/#month/#day Beginning of period: #year/#month/#day Period: #years/#months/#days

If the number for the day of the month at the end of the interest period were smaller than the number for the day of the month at the beginning of the interest period, the number of days in the month preceding the month in which the interest period ends would be "borrowed" and added to the day number, and the number for the month at the end of the interest period would be reduced by one.

Thus, the number of days to be "borrowed" depended on the month in which the interest period ends, and leap years would be taken into account if the interest period ended in March (because the "borrowing" would be from February, which may be 28 or 29 days.) Similarly, if the number for the month of the year at the end of the interest period (reduced for any "borrowing" required for days) were smaller than the number for the month of the year at the beginning of the interest period, 12 months would be "borrowed" from the year figure, and the number for the year at the end of the interest period would be reduced by one.

For example, if the end of the interest period were July 10, 1974, and the beginning of the interest period were December 17, 1970, the beginning and ending dates would be set up, as follows:

End of interest period: 74/7/10 Beginning of period: 70/12/17

After "borrowing" 30 days from June (the month before July) to add to the day number at the end of the interest period, and "borrowing" 12 months to add to the month number (reduced by one for the "borrowing" to increase the day number) at the end of the interest period, the interest period would be calculated, as follows:

End of interest period: 73/18/40 Beginning of period: 70/12/17 Period: 3/6/23

Thus, the interest period would be 3 years, 6 months, and 23 days, and the interest factor would be:

For years: 3 x .06 = .18 For months: 6 x .005 = .030 For days: (from table): .003780820 Total: .213780820

The base amount would then be multiplied by this factor to compute the interest for the period.

Until its subsequent revision, section 6621(a) of the Code, as added by Pub. L. No. 93-625, (35) provided that the interest rate would be nine percent unless a different rate was established under section 6621(b). (36) Accordingly, the interest rate was nine percent for the period from July 1, 1975, through January 31, 1976, when the interest rate was set at seven percent. (37) The seven-percent rate was in effect through January 31, 1978, when a new rate of six percent went into effect through January 31, 1980. (38) Throughout this period, the "month-day" method of computation was used. (39) Rev. Proc. 83-7 includes the year, month, and day interest factors to be used for such computations. (40)

Starting with February 1, 1980, the IRS shifted to the computation of interest using a daily rate. At that point in time, the interest rate was established as 12 percent, (41) and the interest was to be computed by simply multiplying the number of days in the interest period by a daily interest factor of .000328767 (which is .12 divided by 365). (42) The 12-percent rate continued in effect through January 31, 1982, after which the interest rate was established as 20 percent (43) and stayed at that level through December 31, 1982. During the 20-percent period, the daily interest factor was .000547945 (which is .20 divided by 365).

2. Compound Interest Starting in 1983

Under section 6622(a) of the Code, as added by TEFRA, (44) interest computed using daily compounding rules was required for interest accruing after December 31, 1982. Rev. Proc. 83-7 was designed to provide comprehensive instructions on converting simple interest to compound interest. Interest under the old methods and rates was to be computed through December 31, 1982, and then all tax, assessed penalty or addition to the tax, and all interest (whether or not assessed) was to be added together to determine the amount to be carried over on which daily interest would be charged under the compounding rules. Tables of daily compound interest factors were provided for interest rates from 1 percent through 24 percent for both non-leap years and for leap years. (45) When the compound interest requirement went into effect on January 1, 1983, the interest rate was set at 16 percent. Interest rates were to be established semi-annually based on the adjusted prime rate charged by banks.

Prior to the further revision of the interest rules enacted by the Tax Reform Act of 1986, (46) interest rates went from 16 percent in the first half of 1983, to 11 percent for the last half of 1983 and all of 1984 (although 1984 required the use of different tables because it was a leap year), to 13 percent for the first half of 1985, back to 11 percent for the second half of 1985, to 10 percent for the first half of 1986, and to 9 percent for the second half of 1986.

3. Interest in 1987 and Thereafter

For interest after December 31, 1986, the Tax Reform Act of 1986 shifted to quarterly revisions of the interest rate and provided for a one-percent differential between the rate charged for underpayments and the rate credited for overpayments. Initially, for the first three quarters of 1987, the rate was nine percent for underpayments and eight percent for overpayments. The rates increased to 10 percent for underpayments and 9 percent for overpayments for the last quarter of 1987, and they increased again to 11 percent for underpayments and 10 percent for overpayments for the first quarter of 1988 (a leap year, requiring use of the leap year tables in Rev. Proc. 83-7). For the second and third quarters of 1988, the rates decreased to 10 percent for underpayments and 9 percent for overpayments, but they went bck up again to 11 percent and 10 percent, respectively, for the last quarter of 1988. For the first quarter of 1989, the rates continued at 11 percent and 10 percent (although, since 1989 was not a leap year, different tables in Rev. Proc. 83-7 are applicable). The rates increased to 12 percent and 11 percent in the second and third quarters of 1989 and the went back down to 11 percent and 10 percent for the fourth quarter of 1989 and the first quarter of 1990.

4. Resume of Interest Rates and Methods

The interest rates and methods described above may be reflected in tabular form, as follows:

Period and Method Rate

Interest thru 6/30/75: Simple interest - "month-day" method 6%

Interest from 7/1/75 thru 1/31/76: Simple interest - "month-day" method 9%

Interest from 2/1/76 thru 1/31/78: Simple interest - "month-day" method 7%

Interest from 2/1/78 thru 1/31/80: Simple interest - "month-day" method 6%

Interest from 2/1/80 thru 1/31/82: Simple interest - daily method 12%

Interest from 2/1/82 thru 12/31/82: Simple interest - daily method 20%

Interest from 1/1/83 thru 6/30/83: Compound interest 16%

Interest from 7/1/83 thru 12/31/83: Compound interest 11%

Interest from 1/1/84 thru 12/31/84: Compound interest (leap year) 11%

Interest from 1/1/85 thru 6/30/85: Compound interest 13%

Interest from 7/1/85 thru 12/31/85: Compound interest 11% Interest from 1/1/86 thru 6/30/86: Compound interest 10%

Interest from 7/1/86 thru 12/31/86: Compound interest 9%

Restricted Interest

When an underpayment of income tax that otherwise would be due is reduced or eliminated because of a carryback of a loss or a credit, special interest computation rules come into play. The underpayment that is eliminated by the carryback is sometimes referred to as an "extinguished deficiency" or a "potential deficiency." Notwithstanding that the tax underpayment extinguished by the carryback does not have to be paid, interest is payable on the extinguished deficiency. Such interest is sometimes referred to as "restricted interest." (47)

The concept of interest on a "potential deficiency" originated before the Code expressly provided for such interest. It evolved because the Code did provide that interest on an overpayment resulting from a carryback did not begin to run until the taxpayer became entitled to the carryback at the end of the carryback year. Because a taxpayer who had not underpaid his tax could not get interest on a refund attributable to a carryback prior to the end of the carryback year, it seemed equitable to charge another taxpayer who had underpaid his tax with interest on the underpayment extinguished by the carryback. The Supreme Court upheld this treatment in Manning v. Seeley Tube & Box Co. (48)

The principal that interest should be paid on an "extinguished deficiency" was essentially codified by the enactment of section 6601(e) as part of the original Internal Revenue Code of 1954; the provision was subsequently redesignated section 6601(d).

Until the enactment of TEFRA, interest on an "extinguished deficiency" ran to the end of the taxable year in which the carryback arose. Currently, and for interest accruing after October 3, 1982, the interest runs to the filing date (determined without regard to extensions) for the return for the taxable year in which the carryback arose. (49) For example, a calendar-year corporation that filed its 1984 income tax return showing less tax than was actually owed, and which subsequently had a loss in 1987 that was carried back to 1984 (thereby extinguishing the previously-existing 1984 deficiency), would owe restricted interest on the extinguished deficiency from March 15, 1985, to March 15, 1988.

A unique situation arises with respect to restricted interest for a period before December 31, 1982, for a taxable year for which there is also an overpayment before that date. (50) Prior to 1983, the Code provided that interest was not to be charged on interest. (51) Consequently, there was no interest on restricted interest prior to 1983. After compound interest was required for periods after 1982, Rev. Proc. 83-7 prescribed that all tax, assessed penalty or addition to tax, and interest (whether or not assessed) was to be added together to determine the amount to be carried over on which daily interest would be charged under the compounding rules. (52) Thus, any pre-1983 payment of assessed interest would be an overpayment of assessed interest only to the extent such payment exceeded the assessed interest owed, including the restricted interest. It follows logically that, if there were not an overpayment of assessed interest, any restricted interest due in excess of the assessed interest paid should be offset against the overpayment of tax, and compound interest on the net overpayment (i.e., the overpayment reduced by the restricted interest due) would be computed for the period after 1982. If there were such a net overpayment, there would be no interest on the restricted interest for the period after 1982. (53)

Other Special Circumstances 

1. Interest at a Four-Percent Rate

Section 6601(j) provides for a four-percent interest rate on certain estate tax payable in installments pursuant to section 6166, in lieu of the rate set under section 6621. In addition, prior to amendments by section 7(b) of Pub. L. No. 93-625, the four-percent interest rate applied to extensions of time for payment as provided in then-section 6601(b) (relating to extensions of time in the case of certain estates) and then-section 6601(j) (relating to extensions of time in the case of certain expropriation losses), and on certain overpayments as provided in section 514(b)(3)(D) (relating to interest with respect to certain debt-financed income).

2. Estimated Tax Penalties

Section 6622(b) provides that the requirement for the daily compounding of interest after December 31, 1982, does not apply for purposes of computing the penalty under section 6654 or section 6655 for underpayment of estimated tax. Simple interest computations are required for these purposes. The "period of underpayment" under section 6654 or section 6655 (i.e., the penalty period) runs from the due date for the installment of estimated tax to the earlier of (1) the date of payment or (2) the 15th day of the fourth month (for individuals) or the 15th day of the third month (for corporations) following the close of the taxable year. Thus, the penalty period can never exceed one year.

Section 6621(b)(2)(B) provides that, for purposes of computing the penalty under section 6654 for individuals (but not the penalty under section 6655 for corporations), the rate in effect for the third month after the end of the taxable year will be applied for the first 15 days of the fourth month (i.e., the final 15 days of the period for which the penalty can apply). For most individuals -- those using a calendar taxable year -- this means that the rate in effect for March will be applicable for the first 15 days of April.

3. Interest on Substantial Underpayments Attributable to Tax Motivated Transaction

Section 6621(c) of the Code, as applicable to returns the due date for which (determined without regard to extensions) is before January 1, 1990, (54) provides for interest at 120 percent of the normally applicable rate in the case of interest accruing after December 31, 1984, on a "substantial underpayment" attributable to a "tax motivated transaction" as defined by section 6621(c)(3)(A). A "substantial underpayment" for this purpose is an underpayment that exceeds $1,000. A "tax motivated transaction" means --

(a) any valuation overstatement (within the meaning of section 6659(c)),

(b) any loss disallowed by reason of section 456(a) (limiting certain losses to the amount "at risk") and any credit disallowed under section 46(c)(8) (limiting the investment credit in the case of "nonqualified nonrecourse financing"),

(c) any "straddle" (as defined in section 1092(c) without regard to subsections (d) and (e) of section 1092),

(d) any use of an accounting method specified in Treasury regulations that may result in a substantial distortion of income,

(e) any sham or fraudulent transaction, and

(f) other types of transactions that may be specified in the Treasury regulations as "tax motivated" for purposes of this provision, with a later specified effective date.

Rev. Proc. 83-7 does not provide tables of compound interest factors for interest at 120 percent of the normally applicable rates, so some sort of computer program to compute such interest is essential. (55)

4. Special Interest Provisions Outside the Code

Special provisions relating to the computation of interest may be outside the Internal Revenue Code. For example, Rev. Proc. 60-17, 1960-2 C.B. 942, identifies a number of provisions where a public law enacting a provision specifies a limitation on interest related tosuch provision and where such limitation does not become a part of the Code. (56) Taxpayers should be aware of these non-Code interest provisions.

Illustrative Examples

The following examples may be helpful in illustrating the rules and concepts discussed above:

1. Simple Underpayment

A calendar year corporation reported and paid tax of $1,546,378 for 1978. On audit, the correct tax liability was determined to be $1,637,321. A Form 870 was filed on April 19, 1983. Notice and demand was issued August 5, 1983, showing a tax due of $90,943 and assessed interest due of $51,717.58; the tax and assessed interest was paid on August 12, 1983. The assessed interest was correctly computed, as follows:

Base amount (tax deficiency): $90,943.00 Interest period: 3/15/79 - 5/19/83 Assessed interest due: $51,717.58 (57)

2. Relatively Simple Overpayment

A calendar-year corporation paid an estimated tax of $2 million for taxable year 1982; the tax return filed on March 10, 1983, reported a tax liability of $1,937,678, and a refund of the overpayment was requested. A refund of $62,322 was paid on April 28, 1983, without interest. A claim for refund was filed on May 23, 1985; the correct tax liability was determined to be $1,875,798. A check dated September 23, 1985, in the amount of $88,125.63 is delivered to taxpayer.

Verification determines that the check is in the appropriate range, representing a tax refund of $61,880 and statutory interest of $21,245.63. Statutory interest was computed to August 30, 1985, which is within 30 days of the date of the refund check, as follows:

Base amount (tax overpayment): $61,880.00 Interest period: 3/15/83 - 8/30/85 Statutory interest $21,245.63 Total payment $83,125.63

3. Payment of Disputed Deficiency and Subsequent Refund

A calendar-year corporation reported and paid tax of $3,678,945 for 1978. On audit, a deficiency of $2,037,678 was asserted and a Form 870 for that amount was filed on August 24, 1983. The amount shown on the notice and demand dated October 6, 1983, as the asserted deficiency and assessed interest erroneously computed as $1,368,397.58 (it should have been computed as $1,302,639.12) was paid on October 12, 1983. A claim for refund was filed on January 15, 1984. The correct tax liability was determined to be $4,327,739. A check dated March 22, 1986, in the amount of $3,073,287.40 is delivered to the taxpayer.

Verification determines that the amount of the check was correctly computed, as follows:

Tax overpayment on 10/12/83: Tax paid with return $3,678,945.00 Deficiency 2,037,678.00 Total tax paid $5,716,623.00 Correct tax liability 4,327,739.00 Overpayment of tax $1,388,884.00

Assessed interest overpayment on 10/12/83: Correct tax liability $4,327,739.00 Tax paid with return 3,678,945.00 Correct deficiency $ 648,794.00 (Base amount for computation of assessed interest) Interest period: 3/15/79 - 9/23/83 Correct assessed interest $ 414,758.59 Assessed interest paid 1,368,397.59 Overpayment of assessed interest $ 953,638.99

Statutory interest on overpayment: Tax overpayment $1,388,884.00 Assessed int. overpayment 953,638.99 Total (Base amount) $2,342,522.99 Interest period: 10/12/83 - 3/5/86 Statutory interest $ 730,764.41

Refund check: Refund of tax $1,388,884.00 Refund of assessed int. 953,638.99 Statutory interest 730,764.41 Total $3,073,287.40

The statutory interest was computed to a date within 30 days of the date of the refund check.

4. Deficiency with Restricted Interest

A calendar-year corporation reported and paid a tax of $2,573,728 for 1983. In 1986, it had a net operating loss shown on a timely-filed return that is carried back to 1983. On audit of the 1983 tax return, it was determined that there was a tax deficiency for 1983 of $543,276 taking account of the 1986 loss carryback to 1983, and that the deficiency would have been $728,716 if it were not for the 1986 loss carryback. A Form 870 for the $543,276 deficiency was filed on July 24, 1987, and the notice and demand was thereafter issued on September 30, 1987. The notice and demand should be for the tax deficiency of $543,276 and assessed interest of $388,897.80, computed, as follows:

Base amount for restricted interest: Deficiency without carryback $728,716.00 Deficiency after carryback 543,276.00 Extinguished deficiency $185,440.00 (Base amount)

Interest period: 3/15/84 - 3/15/87 Restricted interest $ 70,071.16

Base amount for regular interest (tax deficiency) $543,276.00 Interest period: 3/15/84 - 8/23/87 Regular assessed interest $318,826.64

Total assessed interest: Restricted interest $ 70,071.16 Regular interest 318,826.64 Total $388,897.80

5. More Complex Situation -- Combination of Restricted Interest on Extinguished Deficiency and Successive Overpayments Prior to 1983

A calendar-year corporation reported and paid a tax of $2,508,630 for 1973. In 1976, it had a net operating loss shown on a timely-filed return that is carried back to 1973. On audit of the 1973 return, a deficiency was asserted for 1973 in the amount of $273,528 (without regard to the loss carryback from 1976, which had not yet been audited). That deficiency and assessed interest in the amount of $59,423.65 was paid on April 28, 1987, simultaneous with the filing of a Form 870 with respect to such payment. A claim for refund for 1973 was filed, and it was subsequently determined that the correct 1973 tax liability, before the 1976 loss carryback, was $2,683,720 and that the correct tax after giving effect to the loss carryback was $2,467,926. The statutory interest on the refund was computed to August 24, 1988, with a view to issuance of the check within 30 days thereafter.

Although it is not certain how the interest on such a combination of circumstances would be computed, it would seem that the aggregate amount of the payment could be $992,434.74, computed, as follows:

Base amount for restricted interest: Correct liability before carryback $2,683,720.00 Tax paid with return 2,508,630.00 Initial deficiency $ 175,090.00 (Base amount)

Interest period: 3/15/74 - 12/31/76 (to end of carryback year, rather than to filing date, because before 10/4/82) Restricted interest $ 34,033.82

Base amount for first overpayment: (attributable to entitlement to the loss carryback on 1/1/77) Tax paid with return $2,508,630.00 Correct tax after carryback 2,467,926.00 Overpayment (Base amount) $ 40,704.00 Interest period: 1/1/77 - 12/31/82 (to end of simple interest period) Statutory interest $ 25,199.68

Base amount for subsequent overpayment: Deficiency paid $ 273,528.00 Assessed interest paid $59,423.65 Less restricted interest 34,033.82 Overpayment of assessed interest 25,389.83 Total (Base amount) $ 298,917.83 Interest period: 4/28/77 - 12/31/82 (to end of simple interest period) Statutory interest $ 178,279.92

Base amount for net overpayment on 1/1/83: First overpayment - tax $ 40,704.00 Statutory int. to 12/31/82 25,199.68 Second overpayment - tax 273,528.00 Overpayment of assessed int. 25,389.83 Statutory int. to 12/31/82 178.279.92 Net overpayment on 12/31/82 $ 543,101.43 (Base amount)

Interest period: 12/31/82 - 8/24/88 Statutory interest $ 449,333.31

Aggregate payment: Refund of tax $ 314,232.00 Refund of assessed interest 25,389.83 Statutory interest 652.812.91 Total $ 992,434.74

Conclusion

The history of the various methods for computing interest on tax deficiencies and overpayments provides a striking illustration of how the advent of computers has been both a blessing and a curse. It is a blessing in that it enables us to make computations quickly, easily, and accurately that would otherwise be very difficult. On the other hand, it is a curse because the ability to make such computations with computers has encouraged the introduction of complexities into the procedures. Society would simply not tolerate such complexities if computers were not available to do the "grunt work." Sometimes it seems that the curse outweighs the blessing.

James V. Heffeman is a partner in the Washington, D.C., office of Sutherland, Asbill & Brennan. His involvement with interest on federal taxes dates back as far as 1955, when he was of counsel for the taxpayer in the consideration by the Supreme Court of the United States of Premier Oil Co. v. United States, decided together with Koppers Co. v. United States, 348 U.S. 254 (1955). Those cases involved the issue of interest on a "potential deficiency" in World War II excess profits taxes that was eliminated by a determination of entitlement to use a constructive average base period net income under section 722 of the Internal Revenue Code of 1939.

Footnotes -- Interest on Federal Tax Deficiencies and Overpayments

(1) The terms "deficiencyc and "underpayment" will be used interchangeably in this article. As a technical matter, however, the term "deficiency" is defined by section 6211 of the Internal Revenue Code of 1986 to apply only to taxes over which the Tax Court has jurisdiction (income, estate, gift, and certain excise taxes). Even as to such taxes, a deficiency can technically be different from an underpayment. Thus, there is no deficiency if the correct tax is shown on the taxpayer's return, even though there may be an underpayment because the full tax shown on the return has not been paid. An unpaid tax shown on a return or assessed but not paid when due is not a deficiency, but is more properly termed a delinquency.

(2) The author has written a computer program, designated TAXINT-87, for use on an IBM or compatible personal computer together with the Lotus 1-2-3 spreadsheet program which, in seconds, will compute the interest at the various rates and in the various methods used by the IRS by simply entering the amount on which interest is to be computed and the beginning and ending dated of the interest period. Other interest computation programs are available commercially.

(3) Errors may arise not because IRS personnel want to do the computations wrong or do not care, but rather because the law can be so complex in some situations. The author has had a relatively recent (and, regrettably, not uncommon) experience where the taxpayer was entitled to refunds of overpayments and where a series of checks were sent to the taxpayer without any explanation of how much of each check was for a refund of taxes, for a refund of an overpayment of assessed interest, or for statutory interest on the overpayment of taxes and assessed interest. The situation was complex due in part to a number of credit and loss carrybacks that affected the computations. Upon checking the computations, it was discovered that the payments to the taxpayer were short by hundreds of thousands of dollars.

(4) By August 5, 1989, the interest due on a corporation's income tax deficiency for calendar year 1982 would already have exceeded the amount of the tax deficiency; interest on a 1981 deficiency would have exceeded 100 percent even more quickly -- by December 6, 1987.

(5) The "month-day" method is of more than historical interest. It still must be used today if the interest period starts before February 1, 1980.

(6) I.R.C. [section] 6601(e)(1). Such interest is sometimes termed "deficiency interest."

(7) The term "restricted interest" is frequently used to refer to a sub-type of assessed interest that is computed on the portion of a deficiency extinguished by a loss carryback, a credit carryback, or similar retroactive adjustment. Such interest is sometimes referred to as interest on an "extinguished deficiency" or a "potential deficiency." An early use of the term "restricted interest" may be found in Rev. Proc. 60-17, 1960-2 C.B. 942, where interest on a deficiency extinguished by a carryback was discussed along with interest in other situations; the term "restricted interest" was applied to refer to interest that was limited or restricted by some statutory prohibition of interest. In a sense, interest on a deficiency extinguished by a carryback is "restricted" in that interest on the initial deficiency ceases to run at some point (discussed in the text that follows) because of the entitlement to the carryback deduction.

(8) Normally, a tax refund does not constitute taxable income. In addition, the refund of the overpayment of assessed interest is taxable income only to the extent that the payment of the assessed interest was deducted in a prior taxable period with a tax benefit from such deduction. I.R.C. [section] 111; see Eboli v. Commissioner, 93 T.C. 123 (1989). This could also be the case with the tax refund if the tax were a type of tax that could be claimed as a deduction. The amount of the statutory interest, however, is always includible in taxable income. Furthermore, the crediting of an overpayment to satisfy an assessed interest liability for another period can result in an interest expense deduction under section 163(a) of the Code. Eboli v. Commissioner, supra.

(9) Corporations reporting on a calendar-year basis are generally required by section 6072(b) of the Code to file income tax returns by March 15 following the close of the calendar year. If a fiscal year is used, the return is required by the 15th day of the third month following the close of the fiscal year. As prescribed by section 6151 of the Code, generally the tax is due on the date prescribed for filing the return (determined without regard to any extension of time to file the return). For taxable years beginning before 1983, corporations could elect to make installment payments of income tax, which could a ffect the start of the interest period.

(10) Except as otherwise prescribed, the income tax return of an individual, trust, or estate using the calendar year is required by section 6072(a) of the Code to be filed by the 15th day of April following the close of the calendar year. If a fiscal year is used by an individual, the return must be filed by the 15th day of the fourth month following the close of the fiscal year. Section 6151 of the Code requires that the tax be paid by such filing date (determined without regard to any extension of time for filing).

(11) I.R.C. [subsection] 6075(a) and 6151. For decedents dying before 1971, the estate tax return was due 15 months after the decedent's death.

(12) I.R.C. [subsection] 6075(b) and 6151. Quarterly gift tax returns have sometimes been required by section 6075.

(13) The waiver of restrictions to which section 6601(c) refers is the Form 870 or the Form 870-AD, each of which waives the restriction on the assessment and collection of the tax, thereby giving up the right of the taxpayer to file a petition to the Tax Court for a redetermination of the deficiency. A Form 870 is deemed filed when it is delivered to the IRS; a Form 870-AD, however, is not deemed filed until it has been accepted by the IRS, which may be a substantial time after receipt.

(14) Form 3552, captioned "Statement of Tax Due on Federal Tax Return," is typically used as the notice and demand. It shows both the amount of the tax and the amount of the interest that has been assessed.

(15) Similarly, if a Form 870-AD is used, the interest period will end 30 days after the Form 870-AD is accepted on behalf of the IRS (unless the tax is theretofore paide.

(16) I.R.C. [subsection] 6152(a) and (b) before enactment of Pub. L. No. 97-248 (Tax Equity and Fiscal Responsibility Act of 1982).

(17) See Rev. Rul. 68-258, 1968-1 C.B. 541, as amplified by Rev. Rul, 75-465, 1975-2 C.B. 486.

(18) I.R.C. [section] 6601(f).

(19) Where the overpayment is reflected in the tax return for a subsequent year, interest on the underpayment satisfied by the crediting of such subsequent overpayment runs to the due date of the return for the subsequent year (determined without regard to any extension), if that return is filed timely or filed during an extension period, and to the actual date of filing, if that return is delinquent. Rev. Rul. 88-97, 1988-2 C.B. 355.

(20) I.R.C. [section] 6601(e)(2)(A). The excise tax under section 4975 of the Code for prohibited transactions has been held to be a tax, not a penalty, so interest thereon starts with the tax return due date, not on the date of notice and demand following assessment. Latterman v. United States, 872 F.2d 564 (3d Cir. 1989). This decision is in conflict with several prior decisions, including the Court of Appeals for the Eighth Circuit in Rockefeller v. United States, 718 F.2d 290 (8th Cir. 1983), aff'g 572 F. Supp. 9 (E.D. Ark. 1982).

(21) I.R.C. [section] 6601(e)(2)(B). This applies in the case of additions to the tax under section 6651(a)(1) (late filing of the return), section 6653 (negligence or fraud), sections 6659 and 6660 (certain valuation overstatements or understatements), and section 6661 (substantial understatement of tax liability). (Editor's Note: The foregoing statutory references are to the Internal Revenue Code prior to the enactment of the Omnibus Budget Reconciliation Act of 1989, Pub. L. No. 101-239, which made substantial changes to and renumbered the Code's penalty provisions.)

(22) I.R.C. [section] 6611(b)(1). Terminating interest on the due date of the amount against which the credit is taken coordinates with section 6601(f), which deals with interest on underpayments satisfied by a credit. If the tax that was underpaid was due before the date of the overpayment, interest on the underpayment satisfied by the crediting of such overpayment stops on the date of the overpayment so credited, and no interest is payable on the overpayment that is credited to satisfy such underpayment. In contrast, if the tax that was underpaid was due after the date of the overpayment, interest on the overpayment credited to satisfy such underpayment stops on the due date of the underpayment, and no interest is due on the underpayment so satisfied. For years before 1987 (when a one-percent differential between interest on underpayments and interest on overpayments came into effect), the reduction under section 6601(f) in the amount of interest on the underpayment that would otherwise be payable by the taxpayer (in the absence of the crediting of the overpayment) is equal to the reduction under section 6611(b)(1) in the amount of interest on the overpayment that would otherwise be payable to the taxpayer.

(23) I.RC. [section] 6611(b)(2). The purpose of the 30-day leeway is to provide administrative convenience, so that the IRS can first compute the interest and then process and deliver the refund check without incurring additional interest for the period after the date used in making the interest computation.

A taxpayer who receives a refund check that he believes does not include enough statutory interest should nevertheless accept and deposit check, because, even if the interest is wrong, no additional interest will be payable on the amount of the refund covered by the check. Furthermore, section 6611(b)(2) expressly states that the acceptance of the check does not deprive the taxpayer of the right to claim any additional payment and interest thereon.

(24) See notes 9 and 10 supra.

(25) For example, if a corporate income tax return for a calendar year is filed on March 15 of the following year and any overpayment shown on such return is refunded by April 29, no interest is allowed on such overpayment. In contrast, if the time to file such return is extended to September 15 and the return is actually filed on September 1, no interest is allowed on such overpayment so long as the overpayment is refunded by October 15.

(26) Where an asserted underpayment of tax is satisfied by the crediting of an overpayment of tax for another period, the reduction under section 6601(f) in the amount of interest that would otherwise be payable by the taxpayer (in the absence of the crediting of the overpayment) is not treated as a payment of assessed interest which would constitute an overpayment of interest if it were subsequently held that there was not an underpayment of tax. Consequently, there would not be statutory interest on the amount by which the interest on the asserted underpayment was reduced. Texas Eastern Corp. v. United States, 18 Ct. Cl. 387 (Cl. Ct. 1989). Instead there would be more statutory interest due on the overpayment of tax erroneously credited to the asserted underpayment, but there would be no interest on interest until 1983, when compound interest came into effect.

(27) I.R.C. [section] 6611(f)(3)(A).

(28) I.R.C. [section] 6611(f)(1), before its amendment by [section] 346(c)(1)(A), Pub. L. No. 97-248 (TEFRA).

(29) I.R.C. [section] 6611(f)(2).

(30) I.R.C. [section] 6611(g).

(31) I.R.C. [section] 6611(f)(3)(B).

(32) I.R.C. [section] 6611(f)(3)(C).

(33) I.R.C. [subsection] 6601(a) and 6611(a) prior to the enactment of Pub. L. No. 93-625.

(34) The factors in the table were derived simply by dividing .06 by 365 (the number of days in a year) and multiplying the result by the number of days the factor represents. The same daily factors were used for leap years and for non-leap years. As described in the text that follows, however, leap years were taken into account for other purposes.

(35) [section] 7(a)(1), Pub. L. No. 93-625.

(36) As enacted, section 6621(b) provided that an adjustment thereunder could not be made prior the expiration of 23 months following the date of any preceding adjustment. The interest rate was to be set at a rate equal to 90 percent ofthe prime rate charged by commercial lenders. I.R.C. [section] 6621(c).

(37) Rev. Rul. 75-487, 1975-2 C.B. 488.

(38) See IR-1897, dated October 14, 1977.

(39) One somewhat peculiar result of the "month-day" method is that the seven-month period from June 30, 1975, through January 31, 1976 (the period over which the interest rate was nine percent) is counted as seven months and one day (because June has 30 days, whereas January has 31 days). As a consequence, the interest factor used by the IRS for nine-percent simple interest for that period is .0527465753, not simply .0525, which would be the interest factor for seven months at nine percent.

(40) When the nine-percent rate was in effect, the yearly interest factor was .09, the monthly interest factor was .0075, and the daily interest factor, which was provided in a table, was computed as .09 divided by 365 and multiplied by the day number. Similarly, when the seven-percent rate was in effect, the yearly interest factor was .07, the monthly interest factor was .00583333 (which is .07 divided by 12), and the daily interest factor provided in a table was computed as .07 divided by 365 and multiplied by the day number.

(41) Rev. Rul. 79-366, 1979-2 C.B. 402.

(42) Under the IRS's practice, the extra day in a leap year is not taken into account to determine the simple interest daily interest factors. One peculiar result of this is that the interest factor the IRS uses for 12-percent simple interest for the two-year period from January 31, 1980, through January 31, 1982, inclusive, is .2403287671, not simply .24. This is because the daily interest factor is derived by dividing .12 by 365 regardless of whether the interest period includes a leap year, but the period from January 31, 1980, through January 31, 1982, inclusive, is 731 days, not 730 days, because it includes February 29, 1980.

(43) Rev. Rul. 81-260, 1981-2 C.B. 244. The Economic Recovery Tax Act of 1981, Pub. L. No. 97-34, amended section 6621 of the Code, applicable to adjustments made after August 13, 1981, to provide for annual adjustments to the interest rate and to set the rate at 100 percent of the prime rate, rounded to the nearest whole percent.

(44) [section] 344(a), Pub. L. No. 97-248.

(45) The formula for the computation of the daily compound interest factors for a non-leap year is:

[(1 + r/365).sup.d] - 1

where r is the annual rate and d is the number of days in the compound interest period. For a leap year the number 366 would be substituted for the number 365.

(46) [subsection] 1511 and 1512, Pub. L. No. 99-514.

(47) As previously explained, restricted interest is a sub-type of assessed interest. The term "restricted interest" has also been applied to any interest, both interest on underpayments and interest on overpayments, with respect to which there are special provisions in law which limit or prohibit such interest. See Rev. Rul. 60-17, 1960-2 C.B. 942, 943. In this article, however, the term "restricted interest" is limited to interest payable on a deficiency extinguished by a carryback.

(48) 338 U.S. 561 (1950). The same concept was applied in Koppers Co. v. United States, 348 U.S. 254 (1955), involving a "potential deficiency" in World War II excess profits taxes that was eliminated by a determination that the taxpayer was entitled to use a constructive average base period net income under section 722 of the 1939 Code to determine what was the amount of "excess profits" subject to the tax. Unlike a carryback that arises only as a result of events in a subsequent period, the section 722 determination related to the tax period in which the deficiency arose. But the Supreme Court concluded that interest should be paid on the "potential deficiency" because a refund of an overpayment resulting from section 722 relief would not have carried interest until the determination of entitlement to such relief.

(49) I.R.C. [section] 6601(d).

(50) Such an overpayment could arise in various ways, such as (1) the carryback was sufficiently large that it not only extinguished the initial deficiency, but also created an overpayment or (2) the carryback was not large enough to extinguish the initial deficiency, but thereafter (and before 1983) tax and assessed interest was paid in an amount ultimately determined to be more than was due.

(51) I.R.C. [section] 6601(e)(2) prior to the enactment of TEFRA (which is applicable to interest accruing after December 31, 1982). The prohibition of interest on interest came with the enactment of the 1954 Code; under the 1939 Code, if assessed interest were not paid within 10 days of notice and demand, interest was charged on such assessed interest from the date of notice and demand. I.R.C. of 1939, [section] 294(b).

(52) [section] 3.02-2, Rev. Proc. 83-7, supra.

(53) Of course, if the restricted interest due on December 31, 1982, exceeded the overpayment of tax plus statutory interest thereon to that date, such excess would be a net underpayment subject to compound interest after 1982, and there would be no statutory interest on the overpayment after 1982.

(54) Section 6621(c) of the Code was repealed by section 7721(b) of the Omnibus Budget Reconciliation Act of 1989, Pub. L. No. 101-239. Because section 7721(d) provides that the repeal applies only with respect to returns the due date for which is after December 31, 1989, however, the provisions discussed below continue to apply after 1989 with respect to returns due before 1990.

(55) The formula referred to in note 45, supra, can be used to compute the appropriate interest factor, using 120 percent of the normal underpayment rate for the "r" factor and the number of days in the interest period for the "d" factor (the exponent in the formula). The task of manually (i.e., without a computer) making a computation using an exponent consisting of the number of days in an extended interest period, however, is daunting.

(56) An illustration of this is section 3(i) of Pub. L. No. 86-69, the Life Insurance Company Income Tax Act of 1959, which provided that all payments made prior to September 15, 1959, with respect to 1958 income tax liabilities shall be deemed to be payments on that date, as a result of which no interest was payable on any underpayment or overpayment of 1958 income tax liabilities prior to that date.

(57) The interest period is from the due date of the return to the date 30 days after the Form 870 was filed. Appendix A is a replication of a computer-generated backup showing the computation of the assessed interest. The period for this illustration was picked so the backup would show computation of simple interest on the month-day method, daily simple interest, and daily compound interest after 1982. Similar computations would have to be made for each of the interest periods in the illustrations that follow.