General Instructions

Future Developments

For the latest information about developments related to Form 8697 and its instructions, such as legislation enacted after they were published, go to www.irs.gov/form8697.

What's New

  • Form 8697 is not being revised at this time. Continue to use the December 2011 revision of Form 8697 with these updated instructions.

  • The tax rate used for the interest computation for individuals and certain pass-through entities has changed. See the instructions for Part II, line 2, later.

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 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 Regulations section 1.460-4. 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, subsequent to the year of completion, in which the contract price or contract costs are adjusted for one or more of these long-term contracts from a prior year.

Pass-Through Entities

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. For a mid-contract change in taxpayer resulting in the conversion of a C corporation into an S corporation, the look-back method is applied at the entity level with respect to contracts entered into prior to the conversion regardless of whether the S corporation is considered closely held. See the section discussing Mid-Contract Change in Taxpayer.

If you are an owner of an interest in a pass-through entity 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 in a post-completion tax year. The pass-through entity will provide on Schedule K-1 the information you need to complete this form.

Mid-Contract Change in Taxpayer

If prior to the completion of a long-term contract accounted for using the percentage of completion method or the percentage of completion capitalized cost method, there is a transaction that makes another taxpayer responsible for accounting for income from the same contract, the taxpayer responsible for computing look-back interest depends on whether the ownership change is due to a constructive completion transaction or a step-in-the shoes transaction. For guidance regarding these transactions, see Regulations 1.460-4(g). In the case of constructive completion transactions, the old taxpayer treats the contract as completed in the transaction year and applies the look-back method to the pre-transaction years. The new taxpayer is treated as entering into a new contract and applies the look-back method to the post-transaction years upon the contract's completion. In the case of step-in-the-shoes transactions, the new taxpayer applies the look-back method to both the pre and post transaction years. See Regulations section 1.460-6(g) for additional guidance.

Exception for Certain Construction Contracts

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

  • Any home construction contract (as defined in section 460(e)(6)(A)) or

  • 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 is not a home construction contract and, therefore, 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 million or

  • 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 completed contracts. 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 Regulations section 1.460-6(j) for more details. If you timely filed your return without making the election, you may make the election on an amended return filed no later than 6 months after the due date of your tax return (excluding extensions). Write “Filed pursuant to section 301.9100” at the top of the amended return.

Filing Instructions

If You Owe Interest (or No Interest Is To Be Refunded to You)

Attach Form 8697 to your income tax return. The signature section of Form 8697 does not have to be completed by you or the paid preparer.

For individuals, include any interest due in the amount to be entered for total tax (after credits and other taxes) on your return (for example, 2012 Form 1040, line 61). Write on the dotted line to the left of the entry space “From Form 8697” and the amount of interest due.

For partnerships (that are not closely held), write “From Form 8697” and include any interest due in the bottom margin of the tax return. Attach a check or money order for the full amount made payable to “United States Treasury.” Write the partnership's employer identification number (EIN), daytime phone number, and “Form 8697 Interest” on the check or money order.

For S corporations that are not closely held, include any interest due in the amount to be entered for additional taxes (for example, 2012 Form 1120S, line 22c). Write on the dotted line to the left of the entry space “From Form 8697” and the amount of interest due. A closely held S corporation would also follow these procedures following a conversion from a C corporation for the contracts entered into prior to the conversion. See the rules related to Mid-Contract Change in Taxpayer, earlier.

For closely held pass-through entities, look-back interest is applied at the owner level and not the entity level.

For corporations, include the amount of interest due on the appropriate line of Form 1120, Schedule J, Part I (for example, 2012 Form 1120, Schedule J, line 9c).

Look-back interest owed is not subject to the estimated tax penalty. See Regulations section 1.460-6(f)(2).

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 IRS at the applicable address listed below.

  • Individuals:

    Department of Treasury 
    Internal Revenue Service 
    Philadelphia, PA 19255-0001

  • All others:

    Department of Treasury 
    Internal Revenue Service 
    Cincinnati, OH 45999-0001

Complete the signature section of Form 8697 following the instructions for the signature section of your income tax return. If you file a joint return, the signature of both spouses is required on Form 8697. If additional Forms 8697 are needed to show more than 2 redetermination years, sign only the first Form 8697.

File Form 8697 by the date you are required to file your income tax return (including extensions). Keep a copy of Form 8697 and any attached schedules for your records.

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 1.460-1(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. The election not to discount is made on a contract-by-contract basis and is binding with respect to all post-completion adjustments that arise with respect to that 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.

Delayed Reapplication Method

For purposes of reapplying the look-back method after the year of contract completion, you may elect the delayed reapplication method to minimize the number of required reapplications of the look-back 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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