Corporate Estimated Tax, 44338-44366 [E7-14946]

Agencies

• Internal Revenue Service
• DEPARTMENT OF THE TREASURY

[Federal Register Volume 72, Number 151 (Tuesday, August 7, 2007)]
[Rules and Regulations]
[Pages 44338-44366]
From the Federal Register Online via the Government Printing Office [www.gpo.gov]
[FR Doc No: E7-14946]



[[Page 44337]]

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Part IV





Department of the Treasury





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Internal Revenue Service



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26 CFR Parts 1, 301 and 602



Corporate Estimated Tax; Final Rule

Federal Register / Vol. 72, No. 151 / Tuesday, August 7, 2007 / Rules 
and Regulations

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DEPARTMENT OF THE TREASURY

Internal Revenue Service

26 CFR Parts 1, 301, and 602

[TD 9347]
RIN 1545-AY22


Corporate Estimated Tax

AGENCY: Internal Revenue Service (IRS), Treasury.

ACTION: Final regulations.

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SUMMARY: This document contains final regulations that provide guidance 
to corporations with respect to estimated tax requirements. These final 
regulations generally affect corporate taxpayers who are required to 
make estimated tax payments. These final regulations reflect changes to 
the law since 1984. This document also removes the section 6154 
regulations.

DATES: Effective date: These regulations are effective on August 7, 
2007.
    Applicability date: These regulations apply to tax years beginning 
after September 6, 2007.

FOR FURTHER INFORMATION CONTACT: Timothy Sheppard, at (202) 622-4910 
(not a toll-free number).

SUPPLEMENTARY INFORMATION:

Background

    This document contains amendments to the Income Tax Regulations (26 
CFR part 1), the Procedure and Administration Regulations (26 CFR part 
301), and the OMB Control Numbers under the Paperwork Reduction Act 
Regulations (26 CFR part 602) relating to corporate estimated taxes 
under section 6425 and section 6655 of the Internal Revenue Code 
(Code). This document also removes Sec. Sec.  1.6154-1, 1.6154-2, 
1.6154-3, 1.6154-4, 1.6154-5, and 301.6154-1. The IRS is removing the 
section 6154 regulations because Congress repealed section 6154 in 
1987.
    These regulations reflect changes to the law made by the Deficit 
Reduction Act of 1984, Public Law 98-369 (98 Stat. 494); the Superfund 
Amendments and Reauthorization Act of 1986, Public Law 99-499 (100 
Stat. 1613); the Tax Reform Act of 1986, Public Law 99-514 (100 Stat. 
2085); the Omnibus Budget Reconciliation Act of 1987, Public Law 100-
203 (101 Stat. 1330); the Revenue Act of 1987, Public Law 100-203 (101 
Stat. 1330-382); the Omnibus Trade and Competitiveness Act of 1988, 
Public Law 100-418 (102 Stat. 1107); the Technical and Miscellaneous 
Revenue Act of 1988, Public Law 100-647 (102 Stat. 3342); the Omnibus 
Budget Reconciliation Act of 1989, Public Law 101-239 (103 Stat. 2106); 
the Omnibus Budget Reconciliation Act of 1990, Public Law 101-508 (104 
Stat. 1388); the Tax Extension Act of 1991, Public Law 102-227 (105 
Stat. 1686); the Act of Feb. 7, 1992, Public Law 102-244 (106 Stat. 3); 
the Unemployment Compensation Amendments of 1992, Public Law 102-318 
(106 Stat. 290); the Omnibus Budget Reconciliation Act of 1993, Public 
Law 103-66 (107 Stat. 312); the Uruguay Round Agreements Act of 1994, 
Public Law 103-465 (108 Stat. 4809); the Small Business Job Protection 
Act of 1996, Public Law 104-188 (110 Stat. 1755); the Taxpayer Relief 
Act of 1997, Public Law 105-34 (111 Stat. 788); the Ticket to Work and 
Work Incentives Improvement Act of 1999, Public Law 106-170 (113 Stat. 
1860); the Community Renewal Tax Relief Act of 2000, Public Law 106-554 
(114 Stat. 2763); the Economic Growth and Tax Relief Reconciliation Act 
of 2001, Public Law 107-16 (115 Stat. 38); the Jobs and Growth Tax 
Relief Reconciliation Act of 2003, Public Law 108-27 (117 Stat. 752); 
and the American Jobs Creation Act of 2004, Public Law 108-357 (118 
Stat. 1418).
    These regulations do not reflect changes made by the Tax Increase 
Prevention and Reconciliation Act of 2005, Public Law 109-222 (120 
Stat. 345) (TIPRA), as amended by the U.S. Troop Readiness, Veterans' 
Care, Katrina Recovery, and Iraq Accountability Act of 2007, Public Law 
110-28 (121 Stat. 112), because TIPRA made temporary, targeted changes 
to the time and amount of any required installment otherwise due in 
September 2010 and September 2011. TIPRA also changed the amount of 
required installments in 2006, 2012, and 2013 for corporations with 
assets of not less than $1 billion. Although these changes are not 
reflected in these regulations, these and any further changes made in 
the Code supersede the rules in these regulations.
    A notice of proposed rulemaking under section 6655 (REG-107722-00) 
was published in the Federal Register (70 FR 73393) on December 12, 
2005. The proposed regulations provide guidance on how to determine the 
amount of a corporation's estimated tax due with each quarterly 
installment. No requests for a public hearing were received, so the 
public hearing on the proposed regulations, scheduled for March 15, 
2006, was cancelled. The IRS received written and electronic comments 
responding to the notice of proposed rulemaking. After consideration of 
all comments, the proposed regulations are adopted as revised by this 
Treasury decision.

Explanation of Provisions and Summary of Comments

    Section 6655 generally requires corporations to make quarterly 
estimated tax payments or be assessed an addition to tax for any 
underpayment. As a general rule, payments are due on the fifteenth day 
of the fourth, sixth, ninth, and twelfth months. Each quarterly payment 
must be at least twenty-five percent of the required annual payment in 
order to avoid an underpayment penalty. Generally, the required annual 
payment equals one hundred percent of the tax shown on the return for 
the current year tax, or for certain small taxpayers, the lesser of one 
hundred percent of the tax shown on the return for the current year tax 
or one hundred percent of the tax shown on the return for the preceding 
taxable year. Alternatively, corporations may elect to use an 
annualized income installment or an adjusted seasonal installment if 
less than the amount computed under the general rules.

1. Comments Concerning Sec.  1.6655-1 (Addition to Tax in the Case of a 
Corporation) of the Proposed Regulations

A. Recapture of a Tax Credit Not Included in the Definition of ``Tax''
    One commentator requested that the final regulations clarify that 
the recapture of a tax credit under Chapter 1 is not a section 11 tax 
and not included within the definition of tax for purposes of section 
6655 unless there is authority that provides that the recaptured credit 
is treated as a tax imposed by section 11.
    Revenue Ruling 78-257 (1978-1 CB 440) provides that the term tax, 
as defined in section 6655, includes the amount of tax resulting from 
the recomputation of a prior year's investment credit at the applicable 
rate for the current year. However, Berkshire Hathaway, Inc. v. United 
States, 802 F.2d 429 (Fed. Cir. 1986), held that, for purposes of the 
definition of tax under section 6655, the recapture tax under former 
section 47 was not a tax imposed by section 11. The Court concluded 
that because the taxpayer paid no tax imposed by section 11 in the 
preceding taxable year, that taxpayer was not subject to an addition to 
tax for failing to pay estimated tax in the current year under the 
former provision in section 6655(d)(2) that allowed a taxpayer to pay 
estimated tax in the current year based on the law applicable to (other 
than the rates), and the known facts of,

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the prior year's return. Based on the holding in Berkshire Hathaway, 
Sec.  1.6655-1(g)(1)(iii) of the final regulations provides that, 
unless otherwise provided in the Internal Revenue Code, for purposes of 
the definition of tax as used in section 6655, a recapture of tax, such 
as a recapture provided by section 50(a)(1)(A) and any other similar 
provision, is not considered to be a tax imposed by section 11. 
Therefore, Rev. Rul. 78-257 is removed. See Sec.  601.601(d)(2)(ii)(b).
B. Tax Rate Changes for Preceding Year Safe Harbor
    Section 6655(d)(1)(B)(ii) allows taxpayers to determine their 
required annual payment based on 100 percent of the tax shown on the 
preceding year's return. Commentators suggested that the rule provided 
in Sec.  1.6655-1(g)(3) of the proposed regulations, which requires 
taxpayers to recompute the tax determined for the preceding taxable 
year based on the current year tax rates if the tax rates for the 
current year and the preceding year differ, is not authorized by 
section 6655. The commentators suggested that, prior to the effective 
date of its amendment in 1987, section 6655 allowed estimated tax 
payments to be based on the facts shown on the return for the preceding 
taxable year and the law applicable to that year but using the tax 
rates for the current taxable year. The commentators requested that the 
final regulations not adopt the rule provided in Sec.  1.6655-1(g)(3) 
of the proposed regulations.
    Section 6655 no longer provides specific statutory authority to 
recompute tax determined for the preceding taxable year using the rates 
applicable to the current taxable year. Therefore, the final 
regulations do not adopt the rule provided in Sec.  1.6655-1(g)(3) of 
the proposed regulations.
C. Return for the Preceding Taxable Year
    One commentator requested that the final regulations clarify that 
the regulations adopt the holding in Mendes v. Commissioner, 121 T.C. 
308 (2003). In Mendes, the Tax Court held that a tax return that is 
filed after the IRS issues a notice of deficiency is not a return for 
purposes of section 6654(d)(1)(B)(i). Id. at 324-325. Mendes cited 
Evans Cooperage Co., Inc. v. United States, 712 F.2d 199 (5th Cir. 
1983), for the proposition that the purpose of the preceding year safe 
harbor is ``to provide a predictable escape from any possible penalty 
liability [and this purpose] would be defeated if penalties for 
underpayment of estimated taxes during the year were based, not on the 
easily determinable amount reflected on the preceding year's return, 
but instead upon the ultimate tax liability, possibly determined by 
adverse tax audit, a year or so after the tax year for * * * which the 
estimated tax installments were paid.'' Mendes, 121 T.C. at 326 
(quoting Evans Cooperage, 712 F.2d at 204). Evans Cooperage held that 
the statutory reference to ``tax shown on the return of the corporation 
for the preceding taxable year'' refers to the timely filed return for 
the preceding year, not to any later-filed amended return. Evans 
Cooperage, 712 F.2d at 204.
    Section 1.6655-1(g)(2) of the proposed regulations provides that 
the reference in section 6655(d)(1)(B)(ii) to ``return of the 
corporation of the preceding taxable year'' includes the Federal income 
tax return as amended, only if an amended Federal income tax return has 
been filed before the due date for an installment. As long as a 
taxpayer has remaining estimated tax installment payments to make 
during the tax year and is basing the payments on the preceding year 
return, the remaining payments should be made based on the most recent 
information the IRS has on the preceding year return. This includes the 
information on an amended return for the preceding year filed before an 
installment due date. Section 1.6655-1(g)(2) of the final regulations 
retains this rule but clarifies that the term ``return for the 
preceding taxable year'' includes the Federal income tax return as 
amended only if filed before the applicable installment due date if an 
amended Federal income tax return is filed for the preceding taxable 
year. If an amended Federal income tax return is filed on or after an 
installment due date, then the term ``return for the preceding taxable 
year'' does not include that amended Federal income tax return with 
respect to the installments due prior to the time the amended Federal 
income tax return is filed. This rule applies regardless of whether the 
IRS issues a notice of deficiency prior to the filing of the amended 
Federal income tax return.

2. Comments Concerning Sec.  1.6655-2 (Annualized Income Installment 
Method) of the Proposed Regulations

    As a general comment to the proposed regulations, one commentator 
noted that the estimated tax payment rules should strive to provide the 
most accurate picture of annualized taxable income based on facts known 
as of the end of an annualization period. The IRS and Treasury 
Department agree with this comment and recognize that treating an 
annualization period as a short taxable year does not necessarily 
result in an accurate estimate of annualized taxable income. The final 
regulations make it clear that taxpayers may not determine taxable 
income for an annualization period or an adjusted seasonal installment 
period as though the period is a short taxable year.
    Consistent with the general rejection of a short taxable year 
approach, the final regulations recognize that certain types of items 
that are generally incurred once (or otherwise infrequently) during the 
taxable year or that are subject to special exceptions, should not be 
annualized because doing so would create a distortion in the estimate 
of annualized taxable income. This approach also recognizes that 
although distortions may occur in the annualization process due to 
general fluctuations in the timing of items of income and deductions 
incurred throughout the year, taxpayers should generally be permitted 
to rely on such annualized estimates to the extent the estimate is 
based upon information available to the taxpayer as of the end of the 
annualization period.
    A commentator expressed concern that the rules provided in the 
proposed regulations were too mechanical and created traps for the 
unwary. In response to this comment, the final regulations provide 
rules which are intended to produce a reasonably accurate estimate of 
annualized taxable income for estimated tax purposes without imposing 
an undue compliance burden on taxpayers. Specifically, the final 
regulations address this general concern by allowing taxpayers to make 
a reasonably accurate allocation of certain items of income or expense. 
However, a taxpayer's annualized taxable income for estimated tax 
purposes is primarily based on items of income and expense recognized 
during the annualization period. Therefore, the annualization method is 
as inherently complex as computing taxable income.
A. Reasonably Accurate Allocation
    Commentators noted that many of the rules provided in the proposed 
regulations with respect to economic performance and recurring expenses 
would create significant administrative burdens, result in similarly 
situated taxpayers being treated differently, and did not further the 
underlying goal of providing an accurate picture of annualized taxable 
income.
    The final regulations do not retain the recurring expense rules 
provided in the proposed regulations. The final regulations provide 
special rules for specific items of deduction that are routinely 
incurred on an annual basis or for which a special exception to the

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general accounting rules exists. Given the nature of these items, 
applying the general annualization rules to these items could result in 
a significant distortion in the estimate of annualized taxable income. 
These items include real property tax deductions; employee and 
independent contractor bonus compensation deductions (including the 
employer's share of employment taxes related to such compensation); 
deductions under sections 404 (deferred compensation) and 419 (welfare 
benefit funds); items allowed as a deduction for the taxable year by 
reason of section 170(a)(2) and Sec.  1.170A-11(b) (certain charitable 
contributions by accrual method corporations), Sec.  1.461-5 (recurring 
item exception) or Sec.  1.263(a)-4(f) (12-month rule); and items of 
deduction designated by the Secretary by publication in the Internal 
Revenue Bulletin (IRB) (see Sec.  601.601(d)(2)(ii)(b)).
    The final regulations require that these specified items of 
deduction be allocated in a reasonably accurate manner. The item of 
deduction that must be allocated in a reasonably accurate manner 
includes the total amount of the item of deduction recognized by the 
taxpayer during the taxable year regardless of whether the item is 
deemed to be paid or incurred during the taxable year as a result of 
events that occurred during the taxable year, after the taxable year, 
or both. While a reasonably accurate allocation may permit certain 
items to be recognized in an annualization period prior to being paid 
or incurred, an amount may only be taken into account to the extent the 
item of deduction is properly recognized by the taxpayer during the 
taxable year. Therefore, taxpayers will be subject to a section 6655 
addition to tax for an underpayment of estimated tax if an underpayment 
results from a deduction the taxpayer expected to be incurred but was 
not ultimately recognized as a deduction by the taxpayer in the 
computation of taxable income for that year.
    The final regulations provide that an allocation will be considered 
to be made in a reasonably accurate manner if the item is allocated 
ratably throughout the tax year. In addition, an allocation will be 
considered to be made in a reasonably accurate manner to the extent it 
provides a reasonable estimate of taxable income for the taxable year 
based upon the facts known as of the end of the annualization period. 
The final regulations provide a list of some relevant factors to be 
taken into consideration in determining whether an allocation provides 
a reasonable estimate of taxable income based upon facts known as of 
the end of the annualization period. The IRS and Treasury Department 
recognize that various allocations may be considered to be done in a 
reasonably accurate manner and intend for taxpayers to have flexibility 
in determining which allocation to use, particularly when use of a 
specific allocation reduces administrative burdens on the taxpayer. In 
general, allocations that are made with the intent to distort will not 
be considered to have been made in a reasonably accurate manner.
    Many of the items of deduction which are required to be allocated 
in a reasonably accurate manner include items that may not have 
otherwise been allowed to be taken into account by taxpayers (for 
example, year-end bonus liabilities, items paid after year end) under 
the general annualization rules to the extent they were deemed to be 
incurred in the last quarter of the year. In this regard, the final 
regulations provide a measure of relief to taxpayers with respect to 
such items. The final regulations provide that the Secretary may 
designate in future IRB guidance additional items of deduction that are 
required to be allocated in a reasonably accurate manner. Taxpayers are 
encouraged to bring items to the attention of the IRS and Treasury 
Department that they believe should be allocated in a reasonably 
accurate manner rather than applying the general annualization rules.
    Commentators requested that taxpayers be permitted to take the 
exceptions provided in section 170(a)(2) and Sec.  1.170A-11(b) 
(certain charitable contributions by accrual method corporations), 
Sec.  1.461-5 (recurring item exception) or Sec.  1.263(a)-4(f) (12-
month rule) into account for purposes of determining items of expense 
incurred during an annualization period. As noted above, these 
exceptions frequently apply either to expenses paid annually or to 
expenses paid after the end of the taxable year. The specific rules and 
underlying intent of these exceptions do not easily translate to the 
concept of an annualization period. The final regulations provide that 
items of expense that utilize these exceptions will be considered to be 
properly taken into account if they are allocated among annualization 
periods in a reasonably accurate manner. Therefore, the final 
regulations permit taxpayers for estimated tax payment purposes to 
allocate throughout the tax year items of deduction recognized in the 
taxable year as a result of these exceptions to the extent the 
allocation is made in a reasonably accurate manner. The final 
regulations adopt this approach in order to reduce the complexity and 
burden associated with the computation of estimate taxes by allowing 
taxpayers to allocate these specific items of expense in a reasonably 
accurate manner while also preventing unintended distortions under the 
annualization method.
B. Net Operating Loss Deductions
    Several commentators addressed provisions in the proposed 
regulations requiring a net operating loss (NOL) deduction to be taken 
into account in computing an annualized installment after annualizing 
the taxable income for the annualization period. One commentator argued 
that economic performance with respect to an NOL carryover has already 
occurred and therefore, the NOL deduction should be taken into account 
in computing an annualized installment before annualizing the taxable 
income for the annualization period. Another commentator suggested that 
special rules be provided for extraordinary items such as NOL 
deductions noting the unique nature of such items. Comments were also 
received suggesting that NOL deductions should be treated the same as 
any other deduction.
    NOL deductions are different from other items of deduction 
occurring throughout the year in that there is no anticipation that 
similar deductions will recur throughout the year or in future years. 
In this regard, NOL deductions are more like extraordinary items. 
Treating NOL deductions in the same manner as other recurring 
deductions would be inconsistent with attempting to provide a 
reasonably accurate picture of annualized taxable income and could 
result in a distorted estimate of annualized taxable income similar to 
the distortions created by the various techniques the regulations are 
intended to prevent. The final regulations treat a NOL deduction as an 
extraordinary item that is treated as occurring on the first day of the 
taxable year and is taken into account after annualization. As a result 
of the final regulations, Rev. Rul. 67-93 (1967-1 CB 366) is removed. 
See Sec.  601.601(d)(2)(ii)(b).
C. Credit Carryovers
    One commentator suggested that a credit carryover should be taken 
into account in computing an annualized installment before annualizing 
the taxable income for the annualization period because economic 
performance has occurred for the credit carryover. In general, 
taxpayers annualize components of a credit for the current taxable year 
to determine the amount of a credit because the credit is based on

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components for the current year. However, credit carryovers are 
generally based on the components for the entire year in which the 
credit arose. Therefore, the credit carryover already is computed based 
on annualized components for the year in which the credit arose. 
Because a credit carryover is based on annualized components, the final 
regulations provide that a credit carryover must be taken into account 
after determining the annualized tax and before taking into account the 
applicable percentage for the annualization period.
D. Credits Incurred in an Annualization Period and Recaptured Credits
    One commentator suggested that the final regulations provide that 
credits incurred in an annualization period are not annualized. The 
commentator suggested that annualization should be based on the 
underlying basis for the credit. The commentator also suggested that if 
a credit is based on an item that is annualized in computing the 
required installment for the annualization period, the amounts should 
be annualized in determining the amount of the credit. Finally, the 
commentator suggested that similar rules should apply to the recapture 
of credits that are included within the definition of tax.
    Section 1.6655-2(f)(3)(iii) of the final regulations provides that 
the items upon which the credit is computed are annualized pursuant to 
the provisions of Sec.  1.6655-2(f)(1) and the amount of the credit is 
computed based on the annualized items. The amount of the credit is 
then deducted from the annualized tax. For example, for an 
annualization period consisting of three months in a full 12-month 
taxable year, the items upon which the credit is based that are taken 
into account for the three-month period are multiplied by four, the 
credit is determined, and the credit reduces the annualized tax. 
Reducing the annualized tax by a credit before taking into account the 
applicable percentage is consistent with the statutory definition of 
tax provided in section 6655(g)(1) and the annualized income 
installment method provided in section 6655(e). In order to clarify 
this rule, Sec.  1.6655-2(b)(1) of the final regulations provides that 
tax means tax after taking into account credits and before applying the 
applicable percentage. These rules generally do not apply to a credit 
recapture because, as discussed in heading 1A of the preamble, a credit 
recapture, such as a recapture provided by section 50(a)(1)(A), is not 
taken into account when determining the tax for an annualized income 
installment for purposes of section 6655.
E. Depreciation and Amortization Expense
    One commentator requested clarification on the alternative method 
in Sec.  1.6655-2(f)(2)(v)(A) of the proposed regulations. The proposed 
regulations provide that a taxpayer may claim for an annualization 
period at least a proportionate amount of 50 percent of the taxpayer's 
estimated depreciation and amortization (depreciation) expense for the 
current taxable year attributable to assets that a taxpayer had in 
service on the last day of the preceding taxable year, that remain in 
service on the first day of the current taxable year, and that are 
subject to the half-year convention. Several commentators suggested 
that the regulations were not clear on how a taxpayer determines how 
much more than 50 percent may be used and requested that the final 
regulations provide criteria for making this determination.
    Another commentator suggested that the general rule in Sec.  
1.6655-2(f)(2)(v)(A) of the proposed regulations for taking into 
account depreciation was impractical for many taxpayers because of the 
administrative burdens associated with the computation of actual and 
expected depreciation expense. The commentator also suggested that the 
rule does not provide an alternative calculation methodology for assets 
subject to a convention other than the half-year convention or for 
intangible assets. The commentator requested that the final regulations 
provide alternative computation methodologies for all depreciable and 
amortizable assets and allow taxpayers to take into account section 179 
deductions. The commentator also requested that the final regulations 
eliminate the alternative rule in Sec.  1.6655-2(f)(2)(v)(A) of the 
proposed regulations that allows taxpayers to take into account a 
proportionate amount of 50 percent of taxpayers' current year estimated 
depreciation expense. The commentator requested that instead the final 
regulations provide a safe harbor that allows taxpayers to claim a 
proportionate amount of 90 percent of the prior year depreciation 
expense for all assets placed in service in an earlier year.
    By including the alternative rule in Sec.  1.6655-2(f)(2)(v)(A) of 
the proposed regulations, the IRS and Treasury Department intended to 
illustrate the minimum amount of depreciation a taxpayer is entitled to 
take for a taxable year. In response to the comments referenced above, 
the final regulations do not include the alternative method in Sec.  
1.6655-2(f)(2)(v)(A) of the proposed regulations. The final regulations 
provide a general rule that permits taxpayers to estimate their annual 
depreciation expense and include a proportionate amount of such expense 
for annualization purposes. The final regulations also provide that, in 
determining the estimated annual depreciation expense, a taxpayer may 
take into account purchases, sales or other dispositions, changes in 
use, additional first-year depreciation deductions, and other similar 
events and provisions that, based on all the relevant information 
available as of the last day of the annualization period (such as 
capital spending budgets, financial statement data and projections, or 
similar reports that provide evidence of the taxpayer's capital 
spending plans for the current taxable year), are reasonably expected 
to occur or apply during the taxable year. The IRS and Treasury 
Department believe that prescribing special rules for depreciation is 
appropriate because unlike many other deductions, depreciation 
generally accrues ratably throughout the taxable year. Therefore, in 
contrast to the general annualization rules, the final regulations 
require depreciation expense to be taken into account ratably 
throughout the taxable year.
    As an alternative to the general rule for depreciation expense, the 
final regulations provide two safe harbors. The first safe harbor 
requires taxpayers to take into account for an annualization period a 
proportionate amount of depreciation expense allowed for the taxable 
year from: (1) Assets that were in service on the last day of the prior 
taxable year, are in service on the first day of the current taxable 
year, and have not been disposed of during the annualization period; 
(2) assets that were placed in service during the annualization period 
and have not been disposed of during that period; and (3) assets that 
were in service on the last day of the prior taxable year and that are 
disposed of during the annualization period. For purposes of additional 
first-year depreciation deductions, the final regulations provide that 
only a proportionate amount of the current year's additional first-year 
depreciation deduction to be taken into account in determining a 
taxpayer's taxable income for the taxable year is taken into account in 
computing taxable income for an annualization period. In addition, the 
final regulations provide that amounts that the taxpayer deducts under 
section 179 or any similar provision, are treated

[[Page 44342]]

the same as additional first-year depreciation.
    The second safe harbor included in the final regulations provides 
that a taxpayer may take into account a proportionate amount of 90 
percent of its preceding year's depreciation that is taken on its 
Federal income tax return for the preceding taxable year. However, if 
the taxpayer's preceding taxable year is less than 12 months (a short 
taxable year), the amount of depreciation expense taken into account 
for the preceding taxable year must be put on an annualized basis. In 
addition, a taxpayer must use whatever depreciation safe harbor method 
it selects under Sec.  1.6655-2(f)(3)(iv)(B) of the final regulations 
for all depreciation deductions within the annualization period for the 
annualized income installment but may use a different depreciation 
method provided in Sec.  1.6655-2(f)(3)(iv) for each annualized income 
installment during the taxable year.
F. Events Arising After the Installment Due Date
    One commentator requested that the final regulations include 
examples of events that would arise after the installment due date that 
would be considered reasonably unforeseeable to illustrate the rule 
provided in Sec.  1.6655-2(h) of the proposed regulations. In 
considering the request for more specific guidance as to what 
constitutes an unforeseeable event, the IRS and Treasury Department 
determined that providing relief for certain unforeseeable events would 
more appropriately be addressed through contemporaneous guidance. 
Furthermore, the unforeseeable event exception provided in the proposed 
regulations was inherently subjective and retaining such a rule would 
be difficult to administer. In addition, certain provisions in the 
final regulations allow events that occur after the end of an 
annualization period to be taken into account but only to the extent 
the anticipated events actually occur. Therefore, the final regulations 
do not retain the unforeseeable event exception as provided in Sec.  
1.6655-2(h) of the proposed regulations.
    The final regulations do permit taxpayers in specific circumstances 
to take into account transactions that are properly reflected in the 
taxpayer's return for a particular year to be taken into account for 
annualization purposes regardless of when the underlying event giving 
rise to the item occurs. For example, the final regulations permit 
taxpayers to defer income related to a transaction to which sections 
1031 or 1033 may apply even if the replacement of property required 
under sections 1031 or 1033 has not occurred as of the end of an 
annualization period to the extent the taxpayer has a reasonable belief 
that qualifying replacement property will be acquired.
G. Items That Substantially Affect Taxable Income But Cannot Be 
Determined Accurately by the Installment Due Date
    Section 1.6655-2(g) of the proposed regulations provides that in 
determining the applicability of the annualized income installment 
method or the adjusted seasonal installment method, reasonable 
estimates may be made from existing data for items that substantially 
affect income if the amount of such items cannot be determined with 
reasonable accuracy by the installment due date. Examples of these 
items are the inflation index for taxpayers using the dollar-value LIFO 
(last-in, first-out) inventory method, intercompany adjustments for 
taxpayers that file consolidated returns, and the liquidation of a LIFO 
layer at the installment date that the taxpayer reasonably believes 
will be replaced at the end of the year.
    The IRS and Treasury Department believe that the language in Sec.  
1.6655-2(g) of the proposed regulations could be misinterpreted and 
broadly applied to items to which the rule was not intended. The final 
regulations provide that Sec.  1.6655-2(g) applies only to the items 
specifically listed. These items include the inflation index for 
taxpayers using the dollar-value LIFO inventory method, adjustments 
required under section 263A, intercompany adjustments for taxpayers 
that file consolidated returns, the liquidation of a LIFO layer at the 
installment date that the taxpayer reasonably believes will be replaced 
at the end of the year, section 199 computations, deferred gain under 
sections 1031 and 1033 that the taxpayer reasonably believes will be 
replaced with qualifying property, and to any other item specifically 
designated in guidance published in the Internal Revenue Bulletin.
H. Taking Into Account a Section 199 Deduction
    Commentators requested clarification on how taxpayers using the 
annualized income installment method (or the adjusted seasonal 
installment method) should take into account a section 199 deduction. 
One commentator suggested that because the section 199 deduction is 
calculated based on income and expense items incurred during the 
taxable year and has some characteristics of a credit, the final 
regulations should treat a section 199 deduction as a credit. 
Commentators also suggested that the final regulations require 
taxpayers to annualize income and compute the section 199 deduction 
based on the annualized amount. Another commentator requested that the 
final regulations treat a section 199 deduction as an item that 
substantially affects taxable income but cannot be accurately 
determined by the installment due date. The commentator requested that 
the final regulations allow taxpayers to make a reasonable estimate of 
the section 199 deduction for purposes of determining the proportionate 
amount that should be taken into account in determining annualized 
taxable income.
    Although the section 199 deduction is calculated based on income 
and expense items incurred during the taxable year, the section 199 
deduction is a deduction and not a credit. Therefore, a section 199 
deduction must be taken into account to reduce taxable income, not to 
reduce tax. Under the final regulations, a section 199 deduction is 
computed prior to annualizing the taxable income for the annualization 
period. However, in recognition that qualification for the section 199 
deduction is restricted by various annual limitations that may not be 
known as of the end any specific annualization period, the final 
regulations provide that a section 199 deduction should be treated as 
an item that substantially affects taxable income but cannot be 
accurately determined by the installment due date. Therefore, the final 
regulations permit taxpayers to make a reasonable estimate of the 
section 199 deduction for purposes of determining the amount to be 
taken into account in determining annualized taxable income.
I. Section 263A Expenses
    One commentator suggested that the proposed regulations do not 
provide rules on how taxpayers should account for section 263A 
adjustments to compute annualized taxable income. The commentator 
requested that the final regulations not require taxpayers to compute 
an actual section 263A adjustment for an installment period because 
this computation would create a significant administrative burden for 
taxpayers. The commentator also requested that the final regulations 
provide simplifying rules that allow taxpayers to compute the section 
263A adjustment for an installment period by multiplying the prior 
year's absorption ratio by the inventory on hand at the end of the 
annualization period or by

[[Page 44343]]

estimating the annual adjustment and prorating it to each annualization 
period.
    Section 263A expenses are added to the items covered by the rules 
provided in Sec.  1.6655-2(g) of the final regulations for items that 
substantially affect taxable income but cannot be accurately determined 
by the installment due date. Therefore, taxpayers may use reasonable 
estimates from existing data with respect to the amount of adjustments 
required under section 263A if that amount cannot be determined with 
reasonable accuracy by the installment due date.
J. LIFO
    One commentator noted that although the proposed regulations 
provide simplifying rules to determine the internal inflation index for 
taxpayers using internal dollar-value LIFO inventory methods, the 
proposed regulations do not provide rules for taxpayers to determine an 
external inflation index under the inventory price index computation 
(IPIC) LIFO method. The commentator requested that the final 
regulations include a rule that allows taxpayers to determine an 
estimated external inflation index by multiplying the prior year 
inventory mix by the applicable inflation index for the annualization 
period. The commentator also requested that the final regulations 
include a rule that allows a taxpayer that elected to use final indices 
to use preliminary indices if the final indices for the appropriate 
month have not been published. The dollar-value LIFO inventory method 
includes the use of external indexes, such as the IPIC LIFO method, as 
well as internal indexes. Therefore, the IRS and Treasury Department do 
not believe that a separate rule is necessary for the use of external 
inflation indexes.
K. Advance Payment
    One commentator noted that the proposed regulations do not address 
how a taxpayer who defers revenue either under Sec.  1.451-5(c) or Rev. 
Proc. 2004-34 (2004-1 CB 991) should account for an advance payment to 
determine annualized taxable income. Section 1.451-5(c) and Rev. Proc. 
2004-34 generally allow a taxpayer to defer recognition of a qualifying 
advance payment for a limited time but only to the extent that 
financial statements also defer recognition of the income. The 
commentator requested that the final regulations include a rule that 
allows a taxpayer using the deferral method under Sec.  1.451-5(c) or 
Rev. Proc. 2004-34 to not recognize an advance payment as income in the 
annualization period until the advance payment is recognized in the 
taxpayer's applicable financial statements for the annualization 
period. The commentator also requested that the final regulations allow 
a taxpayer using a deferral method to recognize any portion of an 
advance payment on the last day of the taxable year in which the 
advance payment is required to be recognized under Sec.  1.451-5(c) or 
Rev. Proc. 2004-34, if that portion of the advance payment is not 
recognized in the taxpayer's financial statements for any of the 
annualization periods arising within the limited time provided in Sec.  
1.451-5(c) or Rev. Proc. 2004-34. See Sec.  601.601(d)(2)(ii)(b).
    The IRS and Treasury Department agree with the commentator that the 
final regulations should specifically address advance payments and that 
the rule should be consistent with Sec.  1.451-5 and Rev. Proc. 2004-
34. Pursuant to Sec.  1.6655-2(f)(3)(i)(A) of the final regulations, if 
the taxpayer uses the method of accounting provided in Sec.  1.451-
5(b)(1)(ii) for an advance payment, the advance payment is includible 
in computing taxable income under that method of accounting except 
that, if Sec.  1.451-5(c) applies, any amount not included in computing 
taxable income by the end of the second taxable year following the year 
in which a substantial advance payment is received, and not previously 
included in accordance with the taxpayer's accrual method of 
accounting, is includible in computing taxable income on the last day 
of such second taxable year. In addition, Sec.  1.6655-2(f)(3)(i)(B) of 
the final regulations provides that if the taxpayer uses the deferral 
method provided in section 5.02 of Rev. Proc. 2004-34 for an advance 
payment, the advance payment is includible in computing taxable income 
under that method of accounting for annualization purposes. But any 
amount not included in computing taxable income by the end of the 
taxable year succeeding the taxable year of receipt is includible in 
computing taxable income on the last day of such succeeding taxable 
year. The final regulations provide an example involving an advance 
payment.
L. Extraordinary Items
    One commentator suggested that the final regulations provide 
special treatment for extraordinary items for purposes of computing 
annualized taxable income and suggested that the regulations consider 
the extraordinary items listed in Sec.  1.1502-76(b)(2)(ii)(C). The 
commentator requested that the final regulations not require taxpayers 
to take into account extraordinary items under the general rules of 
Sec.  1.6655-2(f) of the proposed regulations because doing so would 
result in a distortion of annualized taxable income. The commentator 
requested that extraordinary items be taken into account after 
annualizing taxable income. The commentator requested that the final 
regulations provide that taxpayers begin to account for extraordinary 
items in the annualization period in which the extraordinary event 
occurs or, alternatively, in the annualization period in which it 
becomes reasonably foreseeable that the extraordinary event will occur. 
The commentator also requested that the final regulations provide an 
exclusive list of extraordinary items by referring to the list of 
extraordinary items in Sec.  1.1502-76(b)(2)(ii)(C) with certain 
modifications.
    The IRS and Treasury Department agree with the commentator that the 
annualization of extraordinary items could result in a distortion of 
annualized taxable income. The final regulations include a list of 
extraordinary items similar to the items in Sec.  1.1502-
76(b)(2)(ii)(C). Included in the list of extraordinary items in the 
final regulations are NOL deductions and section 481(a) adjustments. In 
addition, the final regulations also provide a de minimis rule wherein 
only extraordinary items in excess of $1,000,0000 will be required to 
be accounted for after annualizing taxable income. However, this de 
minimis rule does not apply to NOL deductions and section 481(a) 
adjustments.
M. Section 481(a) Adjustments
    The rule in Sec.  1.6655-2(f)(2)(iv) of the proposed regulations 
provides that a taxpayer takes into account a section 481(a) adjustment 
related to an automatic accounting method change during an 
annualization period only if a copy of the Form 3115, ``Application for 
Change in Accounting Method'', has been mailed to the IRS National 
Office on or before the last day of the annualization period. One 
commentator suggested that the rule provided by Sec.  1.6655-
2(f)(2)(iv) of the proposed regulations creates administrative burdens 
for taxpayers, is inconsistent with the depreciation and amortization 
rules provided in Sec.  1.6655-2(f)(2)(v) of the proposed regulations, 
and could result in the filing of incomplete Forms 3115. The 
commentator suggested that the rule in Sec.  1.6655-2(f)(2)(iv)(B)(1) 
of the proposed regulations causes an administrative burden by 
requiring taxpayers to recompute taxable income using a different 
method of accounting than would be used to calculate taxpayers' tax 
provision for financial

[[Page 44344]]

accounting purposes, which generally allows taxpayers to take into 
account section 481(a) adjustments for an automatic accounting method 
change if they anticipate that the change will be timely filed. The 
commentator also suggested that if the final regulations adopt the rule 
in Sec.  1.6655-2(f)(2)(v) of the proposed regulations that allows 
taxpayers to anticipate capital expenditures to estimate depreciation 
expense for an annualization period, the final regulations should 
provide a similar rule for automatic accounting method changes by 
allowing taxpayers to take into account section 481(a) adjustments 
resulting from anticipated filings for automatic accounting method 
changes.
    The final regulations provide that, in general, any section 481(a) 
adjustment that results from a change in accounting method that is 
approved by the Commissioner and properly reflected in the taxpayer's 
return for the tax year is taken into account as an extraordinary item 
deemed to occur on the first day of the tax year for annualization 
purposes. The final regulations provide that a section 481(a) 
adjustment may be taken into account in this manner notwithstanding (i) 
the annualization period in which the Form 3115 is filed (including 
requests filed after year-end), (ii) whether the requested change in 
accounting method is considered an automatic or non-automatic 
accounting method change request, (iii) whether the section 481(a) 
adjustment is positive or negative, and (iv) the date on which the 
taxpayer receives the approval of the Commissioner. In allowing for a 
section 481(a) adjustment to be taken into account in this manner, 
taxpayers should be aware that they will be subject to a section 6655 
addition to tax for an underpayment of estimated tax in an installment 
period caused from taking into account a section 481(a) adjustment the 
taxpayer expected to be incurred but for which the taxpayer does not 
receive the consent of the Commissioner to change its method of 
accounting for that particular tax year. The final regulations also 
provide an exception to the general rule. Under the exception a 
taxpayer may choose to treat the filing of a Form 3115 as the date on 
which the extraordinary item is deemed to occur rather than the first 
day of the tax year but only with respect to the section 481(a) 
adjustment (or a portion thereof) that is recognized in the year of 
change. Use of this exception will impact the period in which the 
taxpayer will be required to take into account the new method of 
accounting as provided in Sec.  1.6655-6.
N. Simplify the 52/53 Week Taxable Year Rules
    One commentator suggested that the 52/53 week taxable year rules 
provided by Sec.  1.6655-2(e) of the proposed regulations are too 
complex and administratively burdensome. The commentator suggested that 
the final regulations not include the 52/53 week taxable year rules in 
Sec.  1.6655-2(e) of the proposed regulations and rely on the general 
concept of annualization. The commentator suggested that taxpayers with 
52/53 week taxable years under section 441(f) know how to annualize 
their applicable annualization period without the rules provided by 
Sec.  1.6655-2(e) of the proposed regulations.
    The purpose of the annualized income installment method is to give 
taxpayers a method of determining annualized income based on the actual 
facts that occur in the annualization period. Therefore, with limited 
exceptions, the IRS and Treasury Department drafted the proposed 
regulations and these final regulations to provide rules that only 
allow taxpayers to take into account items of income and expense that 
arise in the applicable annualization period. The IRS and Treasury 
Department recognize that the 52/53 week taxable year rules provided by 
Sec.  1.6655-2(e) of the proposed regulations are complex. Although the 
final regulations retain the 52/53 week taxable year rules provided by 
Sec.  1.6655-2(e) of the proposed regulations, the final regulations 
also provide a safe harbor that allows a taxpayer with a 52/53 week 
taxable year to determine its annualization period on the month that 
ends closest to the end of its applicable thirteen-week period or four-
week period that ends within the applicable annualization period. 
However, an eligible taxpayer may only use this safe harbor if it is 
used for determining annualization periods for all required 
installments for the taxable year.
O. Controlled Foreign Corporations, Partnerships, and Other Pass-
Through Entities
    One commentator suggested that the final regulations provide rules 
on how taxpayers should take into account distributions from a section 
936 corporation or a controlled foreign corporation to determine 
annualized taxable income for an installment period. The commentator 
also suggested that the final regulations provide rules on how 
taxpayers should take into account a distributive share of income from 
passthrough entities other than partnerships, such as trusts, S 
corporations, and real estate investment trusts (REITs), to determine 
annualized taxable income for an installment period. The commentator 
requested that the final regulations expand the scope of Sec.  1.6655-
2(f)(2)(vi) of the proposed regulations to incorporate the statutory 
provisions for section 936(h), section 951(a), and closely held REITs, 
and also provide rules to take into account the distributive share of 
income received from other types of passthrough entities.
    Section 1.6655-2(f)(3)(v) of the final regulations expands the rule 
in Sec.  1.6655-2(f)(2)(vi) of the proposed regulations to provide for 
the statutory rules in section 6655(e)(4) and section 6655(e)(5) for 
taking into account subpart F income, income under section 936(h), and 
dividends received by closely held REITs when computing any annualized 
income installment. In addition, Sec.  1.6655-2(f)(3)(v)(D) adds a rule 
that requires items from passthrough entities other than partnerships 
and closely held REITs to be taken into account in computing any 
annualized income installment in a manner similar to the manner under 
which partnership items are taken into account under Sec.  1.6655-
2(f)(3)(v)(A) of the final regulations.

3. Comments Concerning Sec.  1.6655-3 (Adjusted Seasonal Installment 
Method) of the Proposed Regulations

A. Adjusted Seasonal Installment Method and Alternative Minimum Tax
    One commentator suggested that the determination of whether a 
corporation qualifies for the adjusted seasonal installment method 
under section 6655(e)(3), and the amount of the required installment 
under this method, is based only on the corporation's taxable income 
and tax on that taxable income. The commentator requested that the 
final regulations clarify that a corporation using the adjusted 
seasonal installment method is only required to make estimated tax 
payments with respect to taxable income and tax on that taxable income, 
and not on the alternative minimum tax (AMT) or any other tax. Any 
required installment must include AMT because AMT is included in the 
definition of tax in section 6655(g)(1) and Sec.  1.6655-1(g)(1) of the 
final regulations. Including AMT in the determination of tax is 
consistent with the general annualization method and adjusted seasonal 
installment method and recognizes the overall separate and parallel 
nature of the AMT. Therefore, Sec.  1.6655-3(d)(4) of the final 
regulations provides that the amount of an installment determined using 
the adjusted seasonal installment method

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must properly take into account the amount of any AMT under section 55 
that would apply for the period of the computation. For this purpose, 
the amount of any AMT that would apply is determined by applying to 
alternative minimum taxable income, tentative minimum tax, and AMT, the 
rules provided in Sec.  1.6655-3(c) of the final regulations for 
determining the amount of an installment using the adjusted seasonal 
installment method.
B. Adjusted Seasonal Installment Method Base Period Percentage
    Section 6655(e)(3)(D)(i) provides that the base period percentage 
for any period of months is the average percent that the taxable income 
for the corresponding months in each of the 3 preceding taxable years 
bears to the taxable income for the 3 preceding taxable years. One 
commentator requested that the final regulations clarify whether the 
base period percentage provided in Sec.  1.6655-3(d)(1) of the proposed 
regulations can be negative.
    The rule provided in section 6655(e)(3)(D)(i) requires that the 
base period percentage be computed based on taxable income. The rule 
does not provide that taxpayers take into account a loss. Therefore, a 
taxpayer can never have a negative base period percentage. The lowest 
number the base period percentage can equal is zero. Section 1.6655-
3(d)(1) of the final regulations provides that the base period 
percentage is computed based on taxable income, which the IRS and 
Treasury Department believe provides a clear rule that an overall loss 
for the applicable period of months used to calculate the base period 
percentage cannot be used to compute the base period percentage. If a 
taxpayer has an overall loss for an applicable period of months used in 
the computation of the base period percentage, the taxpayer must use 
zero in place of the loss.

4. Comments Concerning Sec.  1.6655-4 (Large Corporations) of the 
Proposed Regulations

A. Section 381 Transactions to Determine Large Corporation Status
    One commentator requested that the final regulations modify the 
rules in Sec.  1.6655-4(c)(2) of the proposed regulations to clarify 
that, when computing taxable income for a year in which there is a 
section 381 transaction to determine if a corporation is a large 
corporation, the adjustment for the section 381 transaction relates 
only to the portion of taxable income applicable to the transferred 
assets.
    Generally, for a transaction to qualify under section 381, an 
acquiring corporation must acquire a majority of the assets of the 
acquired corporation. Section 1.6655-4(c)(2) of the proposed 
regulations provides that when determining if a corporation is a large 
corporation for a taxable year in which a section 381 transaction 
occurs, an acquiring corporation must include in its income the 
distributor or transferor corporation's income for the taxable year up 
to and including the date of distribution or transfer. This rule 
requires the acquiring corporation to include 100 percent of the 
distributor or transferor corporation's taxable income (or loss) in the 
acquiring corporation's income even if the acquiring corporation 
acquires less than 100 percent of the assets of the distributor or 
transferor corporation as long as section 381 applies to the 
transaction. The final regulations do not include a rule providing that 
the adjustment for a section 381 transaction relates only to the 
portion of taxable income applicable to the transferred assets when 
computing taxable income for a year in which there is a section 381 
transaction to determine if a corporation is a large corporation. The 
IRS and Treasury Department believe that such a rule would be 
unnecessarily complex considering that the rule in the proposed 
regulations is both taxpayer favorable (if there are losses of the 
distributor or transferor corporation) and taxpayer unfavorable (if 
there is taxable income of the distributor or transferor corporation) 
and considering that in these transactions, the acquiring corporation 
generally acquires a majority of the distributor or transferor 
corporation's assets. However, Sec.  1.6655-4(c)(2)(i)(B) of the final 
regulations amends Sec.  1.6655-4(c)(2)(i)(B) of the proposed 
regulations to clarify that an acquiring corporation takes into account 
the distributor or transferor corporation's taxable income or loss for 
purposes of determining whether a corporation is a large corporation 
for a taxable year in which a section 381 transaction occurs.
B. Aggregation
    One commentator suggested that the rule provided by Sec.  1.6655-
4(d)(2) of the proposed regulations, which does not allow taxpayers to 
take into account a taxable loss of a member of a controlled group of 
corporations for a taxable year during the testing period, results in a 
distorted view of the taxable income of the controlled group of 
corporations. The commentator requested that the final regulations 
modify the rule in Sec.  1.6655-4(d)(2) of the proposed regulations to 
allow taxpayers to take into account losses of a member of a controlled 
group of corporations when determining whether a corporation is 
considered a large taxpayer because this is consistent with the 
principles for the computation of consolidated taxable income.
    Section 6655(g)(2)(B)(ii) requires that the $1,000,000 exemption be 
divided among members of a controlled group under rules similar to the 
rules of section 1561. The purpose of the statute is to limit members 
of a controlled group, as an aggregate, to $1,000,000 of exemption from 
large corporation treatment. The aggregation rule in Sec.  1.6655-
4(d)(2) is intended to allow a controlled group to quickly determine 
whether the controlled group must allocate the $1,000,000 limitation 
among the members of the group. It is not intended to treat the 
controlled group as a single taxpayer, in which all members of the 
group will be treated as a large corporation, if the taxable income of 
the controlled group, as an aggregate, is over $1,000,000. Thus, for 
example, if member A of a controlled group had taxable income of 
$900,000 and member B of the group had taxable income greater than 
$1,000,000, the controlled group could choose to allocate $900,000 to 
member A so that member A will not be treated as a large corporation, 
but member B would be treated as a large corporation no matter how much 
of the $1,000,000 limitation is allocated to member B. This is 
consistent with the rules under section 1561.

5. Comments Concerning Sec.  1.6655-5 (Short Taxable Years) of the 
Proposed Regulations

A. Taxpayer's Initial Taxable Year
    One commentator noted that a taxpayer is not required to choose its 
taxable year until it files a tax return on its chosen basis in 
accordance with Sec.  1.441-1(c)(1). The commentator requested that the 
final regulations modify the rule in Sec.  1.6655-5(c)(1)(ii) of the 
proposed regulations to provide that a taxpayer will not be penalized 
if, in its initial taxable year, it makes estimated tax payments based 
on a presumption that the taxpayer will have a taxable year that is a 
calendar year even if the taxpayer subsequently chooses a fiscal year.
    Because a taxpayer has until the date it files its initial tax 
return to choose its taxable year, the final regulations modify the 
rule in Sec.  1.6655-5(c)(1)(ii) of the proposed regulations to allow a 
taxpayer with an initial short taxable year to make estimated tax 
payments as

[[Page 44346]]

though it chose to be a calendar year taxpayer until the taxpayer files 
its return for its initial short taxable year. Pursuant to this 
modified rule, a taxpayer with an initial short taxable year may make 
estimated tax payments as though it were a calendar year taxpayer until 
it files its tax return for its initial taxable year.
B. Taxpayer's Final Taxable Year
    One commentator suggested that Sec. Sec.  1.6655-5(d)(1), 1.6655-
5(d)(2), and 1.6655-5(d)(3) of the proposed regulations provide rules 
that may require taxpayers with short taxable years to make installment 
payments based on an applicable percentage that is more than the 
standard 25 percent per installment period. The commentator suggested 
that these rules may result in a section 6655 addition to tax being 
imposed on a taxpayer who makes annualization payments based on 25 
percent of its annualized tax and later in the year discovers that, due 
to an unforeseen termination of its tax year, it should have made its 
annualization payments based on a higher applicable percentage because 
it will have fewer than four installment payments. The commentator also 
suggested that the rule in Sec.  1.6655-2(h) of the proposed 
regulations, which addresses events arising after an installment due 
date that were not reasonably foreseeable, does not appear to protect a 
taxpayer that makes an installment payment based on 25 percent of its 
annualized tax and later discovers that it should have based its 
installment payment on a higher applicable percentage because it had an 
unforeseen termination of its tax year resulting in a short taxable 
year. The commentator requested that the final regulations revise the 
rules in Sec. Sec.  1.6655-5(d)(1), 1.6655-5(d)(2), and 1.6655-5(d)(3) 
of the proposed regulations so that payments made for an installment 
period in a short taxable year do not exceed 25 percent. As an 
alternative, the commentator requested that the final regulations 
revise the rules in Sec.  1.6655-2(h) of the proposed regulations to 
allow a taxpayer with an unexpected termination of its tax year to make 
a payment with its final required installment equal to the remaining 
portion of 100 percent of its required annual payment to avoid a 
penalty on its earlier required installments.
    A taxpayer should not be penalized for making payments based on the 
applicable percentage of 25 percent for each installment period when it 
does not know that it will have an early termination year that will 
result in it making less than four installment payments. Therefore, 
Sec.  1.6655-5(d)(4) of the final regulations provides a rule 
addressing the applicable percentage for an installment period in which 
the taxpayer does not reasonably expect that the taxable year will be 
an early termination year. In the case of any required installment 
determined under section 6655(e) in which the taxpayer does not know 
that the taxable year will be an early termination year, the applicable 
percentage under section 6655(e)(2)(B)(ii) and Sec.  1.6655-5(d)(3)(i) 
of the final regulations is the applicable percentage for each 
installment period with the remaining balance of the estimated tax 
payment for the year due with the final installment.
C. Internal Revenue Manual Provisions and Annualizing Taxable Income in 
an Initial or Final Taxable Year
    One commentator noted that Internal Revenue Manual Part 
20.1.3.6.3(2) provides that a corporation filing a short period return 
that is either an initial or final return is not required to annualize 
its taxable income to compute the penalty. The commentator requested 
that the final regulations clarify this rule.
    The rule in IRM 20.1.3.6.3(2) provides that if a taxpayer has a 
short taxable year that is either an initial or final year, the 
taxpayer should not annualize its taxable income based on a full 12 
month period. Instead, the taxpayer should annualize its taxable income 
based on the number of months in the short taxable year. This rule was 
intended to be provided in Sec.  1.6655-5(g)(2) of the proposed 
regulations. However, the computational rule in Sec.  1.6655-5(g)(2) of 
the proposed regulations is incorrect and does not result in the 
computation of the correct amount for every installment payment during 
a short taxable year. The final regulations revise the rule in Sec.  
1.6655-5(g